Abstract: If taking into account the current level of interest rates, policy direction, and economic outlook, as well as the exaggerated concerns about the uncertainty of credit expansion and policy adjustment, and the fact that these uncertainties can be gradually eliminated or reduced in the long run, then it would seem clearer that the market is at a low position. We need to make the trade-off between risk and return, and it will undoubtedly require more in-depth and sober thinking.
Since mid-December 2021, monetary conditions have been significantly eased; yet with growth-stabilizing policies in place, China's stock market has fallen to levels that have astonished many market insiders.
Higher-than-expected US inflation, the Fed's accelerating withdrawal from monetary easing, US stock market adjustments, and a stronger dollar are widely regarded as external causes of the Chinese market correction, or maybe not the main cause, based on a strong RMB exchange rate, the fall of interest rates in the domestic bond market, the capital flow in Shanghai-HK and Shenzhen-HK Stock Connect, and the accumulation of US dollar debt.
In any event, the steady rebound in the US S&P over the past two weeks suggests that the drag of external factors, if ever had an impact, has now been removed, at least temporarily.
Since 1H 21, the real estate industry has been subjected to liquidity pressures as deleveraging policy revealed the fragility of its business models.
While the broader market has fallen since mid-December, the shares of the real estate sector have slightly risen and the banking sector mildly adjusted, implying that, despite the clear divergence within the real estate sector, the equity market, in general, is not overly concerned about the risks. The pressure is primarily concentrated in the shadow banking system including overseas Chinese dollar debt, trusts, and wealth management.
We certainly need more data to assess the impacts of stabilization policy and clarify the short-term economic direction, but structural changes in the domestic economy and policy-making, as well as their implications for businesses' long-term growth prospects, will almost certainly necessitate systematic observations.
Since the global financial crisis, governments have relied on infrastructure and property policies to stabilize economic growth, a model that is clearly coming to an end: on the one hand, these policies have resulted in high macro leverage, accumulated debt risk, and high house prices in some cities, while on the other, they have resulted in an overdraft of infrastructure and property demand, resulting in a lack of infrastructure projects that meet revenue requirements. With the government prioritizing macro leverage control, risk prevention and reduction, such traditional demand-stimulating policy has little room.
Prior to the financial crisis, China's credit expansion was largely based on funds outstanding for foreign exchange; in the last decade, it has been mainstreamed by property and infrastructure, which have supported the expansion of banks' (and their shadow systems') balance sheets. As such instruments lose their effectiveness, it will take time to experiment with and discover new tools or channels for monetary expansion and credit placement.
In 2021, China's per capita income in US dollars is already very close to the World Bank's definition of a high-income country (in fact, the results at year-end exchange rates may exceed the World Bank's 2021 criteria, though the general practice is to use average annual exchange rates for this calculation). As living standards rise and the pursuit of economic growth continues, the government shifts its policy emphasis to common prosperity, capital sprawl prevention, and carbon peaking. These changes will have a significant impact on the business environment and will necessitate the capital markets to closely monitor and assess changes in enterprises’ long-term growth prospects.
In 2021, capital markets witnessed dramatic policy shifts in the education and internet sectors, prompting them to cast a critical eye on a broader range of industries and to rethink the robustness, sustainability, and long-term growth potential of business models.
In 1H21, the "campaign-style carbon reduction" promoted by some local governments to meet their energy targets disrupted economic activity and prompted many investors to bid for decarburization-related stocks, boosting their valuation. When changes to the decarburization policy began at the end of 2021, it stands to reason that the price of these underlying stocks would fall.
These cases teach us that new policy objectives will necessitate sophisticated policy instruments to better manage the relationship between the government and the market, precisely achieve the objectives, and reduce economic costs. This policy system is possibly still in the early stages of design, mapping, and refinement, and some policy uncertainty is unavoidable for the time being.
But if you look at the long run, the uncertainties seem to disappear:
The central bank will prioritize credit expansion and interest rate cuts –that's a certainty. Despite some obstacles to short-term expansion, the central bank will always find a way to credit expansion in the medium or long term. And, as infrastructure and real estate expansion come to an end, China's average interest rate will fall.
China's technological and income level advancements continue to propel it toward high-end manufacturing and new services. China will be able to maintain rapid growth through technological and business model revolutions, as well as independent technology in areas such as EVs, renewable energy, electronics manufacturing, and elderly healthcare– that's another certainty.
From deleveraging to energy consumption control, from breaking rigid repayment to controlling invisible local debts, the government has been able to make pragmatic and flexible adjustments and corrections in previous policy practices, which fuels our optimism for the future decision-making process.
Finally, the benchmark CSI 300 index is currently valued slightly higher than the median level of the past decade, while the dynamic P/E ratio after taking into account the market's consensus expectations for 2022 earnings is in the lower 20% quartile.
Despite the economic slowdown since 2016, the general ROE of the CSI 300 has fluctuated upwards and is expected to exceed that of 2019 in 2022, thanks to the competitive market landscape improving through a continued restructuring that also supports the market's steady upward trend over the past few years.
There is a possibility for downward revisions to ROE expectations, given the short-term economic slowdown, but even so, the market can still be considered to be currently in a reasonable range, if not at a reasonable low level.
If taking into account the current interest rates, policy direction, and economic outlook, as well as the exaggerated concerns about the uncertainties of credit expansion and policy adjustment that can be eliminated or reduced in the long run, it would seem clearer that the market is at a low position. We need to make the trade-off between risks and returns, and undoubtedly it will require more in-depth and sober thinking.
This article was first published on "Gao Shanwen Economic Observations" WeChat blog on February 6, 2022. It is translated by CF40 and has not been reviewed by the author. The views expressed herein are the author's own and do not represent those of CF40 or other organizations.
