Surge in Chinese Equities

Last week, Chinese equities surged, achieving the strongest weekly performance for the Shanghai Shenzhen CSI 300 index since 2008.

The country’s central bank and regulators introduced several stimulus measures, combining monetary, fiscal, and direct market support, which nearly assures that Chinese equities will maintain their upward trajectory. However, investors are questioning the sustainability of the rally and how to best leverage it.

According to Gavekal Dragonomics, while initial market gains have been remarkable, the rally’s extent will depend on whether policymakers can uphold their recent commitments to support. Historically, China’s stock markets have fluctuated between extreme highs and lows, with five significant rallies over the past 20 years, three of which were spurred by government stimulus.

Gavekal notes, “The stimulus-driven rallies had trough-to-peak gains of 50-100%, so if Chinese equities are beginning another rally, there should still be substantial upside after the recent jump.”

However, this optimistic outlook relies on swift and decisive policy implementation. Current challenges facing China’s economy, including weak labor markets, sluggish consumer spending, and diminishing export growth, could impede the rally if left unaddressed.

The announced stimulus measures have been modest, with the People’s Bank of China (PBOC) only cutting policy rates by 20 basis points last week. Nonetheless, anticipation of a larger fiscal Package—potentially RMB2 trillion in new debt—raises hopes for robust support.

New initiatives include a RMB500 billion swap facility for institutional investors and a RMB300 billion refinancing facility to encourage stock buybacks. These actions could present a more aggressive market support mechanism, sometimes referred to as the “China put.”

Gavekal emphasizes that much of the rally is currently driven by shifting expectations rather than substantial stimulus measures.

“The early days of this rally are mostly propelled by expectations and direct central-bank market support.” The PBOC’s buyback facility could significantly enhance corporate buybacks in China, substantially improving market liquidity.

Regarding investment strategy, Gavekal advocates for a shift towards onshore stocks. Historically, during two of three previous stimulus-fueled rallies, onshore stocks outperformed their offshore counterparts by 20-40%.

“Over the last week, both onshore and offshore stocks have reacted similarly, but as the rally continues, onshore likely holds the advantage, particularly since PBOC funding targets onshore stocks directly,” the report notes.

“Among onshore stocks, Shenzhen-listed stocks have typically outperformed Shanghai-listed stocks by 5-20% during the last three stimulus rallies and are expected to do so again,” states the report.

Sector-wise, cyclical industries such as industrials, materials, and consumer discretionary have historically seen about a 10% outperformance during earlier rallies. Additionally, struggling real estate developers may significantly benefit from a potential change in housing policy, as long as the government follows through on its recent assurances.