China Stocks keep falling after disappointing stimulus – Is this a buying opportunity or falling knife?

Couple of you have been asking for my thoughts on China after the recent stimulus (that disappointed markets).

So I decided to release this FH Premium article written earlier in the week.

I definitely don’t profess to be right on this, but hopefully it will be helpful for you to understand my thought process.

Whether you agree or disagree – please feel free to share your thoughts below!

This is an FH Premium article. You can get access to more premium articles like this, together with my Stock / REIT watchlist and full Personal Portfolio on FH Premium.

What stimulus did China unveil?

Per reporting from Caixin – China Devotes $1.4 Trillion to Fixing Its Hidden Debt Problem:

The standing committee of the National People’s Congress (NPC), China’s top legislature, approved an additional quota of 6 trillion yuan for local governments to bring their hidden debt onto the books, Xu Hongcai, a deputy director of the NPC’s financial and economic affairs committee, announced at a press briefing that day.

The 6 trillion yuan will be added to special-purpose bond (SPB) quotas for local authorities to issue from 2024 to 2026, averaging 2 trillion yuan per year, according to Xu and Finance Minister Lan Foan.

In addition, the central government has allowed local authorities to use another 800 billion yuan of proceeds from new SPBs every year — starting this year — to deal with hidden debt, Lan said at the briefing. The five-year initiative will amount to 4 trillion yuan.

China’s local governments had 14.3 trillion yuan of outstanding hidden debt by the end of 2023, according to Lan. The 10 trillion yuan earmarked for hidden debt resolution, combined with another policy, should reduce local governments’ hidden debt burden to 2.3 trillion yuan by the end of 2028.

That figure is low enough for local governments to deal with on their own, Lan said, citing government estimates.

The debt swap initiatives could save local governments around 600 billion yuan in interest expenses over five years, redirecting resources originally intended for debt repayment toward economic development and public welfare, he added.

What does this mean… in plain English?

Basically, 6 trillion yuan to be issued from 2024 to 2026, for local authorities to issue special purpose bonds (SPB) to replace the hole in the balance sheet (from real estate deleveraging).

And 4 trillion in additional SPBs for local authorities to deal with their “hidden debt”, which again is the hole in the balance sheet from real estate deleveraging.

Why was the market disappointed in this?

So the 10 trillion RMB headline number that was rumored was correct.

But the reason why the market was disappointed was down to 2 key reasons:

First – The 10 trillion is spread over a number of years (up to 5 years), which significantly lessens the impact as opposed to blowing 10 trillion over 12 months.

Second – and perhaps more importantly, the stimulus was wholly targeted at solving the hole in government balance sheets.

No mention was made on consumer stimulus.

Why is consumer stimulus so important?

One of the key problems faced by China today is that consumer balance sheets have been destroyed because of a devastating combination of:

1. real estate price declines and 
2. COVID measures.

(a) is simple. Imagine if you have 50 – 80% of your net worth in real estate (not uncommon considering this is China).

And suddenly real estate prices plunge, and that part of your net worth is down by 30%, and yet the mortgage values stay the same.

Obviously you would be a lot less bullish on consumer spending.

That’s what’s happening in China now.

(b) At the same time, China did not have the same consumer stimulus during COVID.

If you recall, in Singapore when the country was locked down during COVID, the government unleashed $100 billion in stimulus  (almost 20 – 30% of GDP at the time), to do everything from paying rent, to paying salaries, to putting money in our pockets for spending.

This significantly reduced the impact of COVID, and kept consumer balance sheets intact – such that when Singapore reopened people were able to unleash their pent up spending.

In China there was no such government stimulus.

So during the 2 year lockdown, consumers/businesses drew down on their own savings to meet the shortfall.

Which meant that after the reopen, consumer balance sheets were devastated, and the consumer did not have the same spending power to unleash pent up spending (vs the West/Singapore).

Throw in the real estate deleveraging, and it was an especially toxic combination.

So this is why you see the China post-COVID recovery looking so different from Singapore or the West.

It was hoped that policymakers would finally unleash some stimulus to address consumer sentiment, but that turned out to not be the case – as the stimulus focused entirely on repairing the hole in local government balance sheets.

Until this is solved, you may not see consumer sentiment recover meaningfully.

Market Price Action for China stocks? 

On the China front – price action has been very poor.

Say what you want on the fundamentals – but the market is not buying it.

Both KWEB and Hang Seng have broken below May 2024 highs, and have also broken below 50 day moving averages.

The 3 ways I am targetting to build China exposure? How have they been performing?

I shared previously that the 3 ways I like to play a potential China recovery are tech, luxury, and copper.

Here’s the charts for all 3 sectors below.

Tech has broken below May highs and below the 50 DMA:

Copper is back at 2024 lows:

While LVMH is at 2 – 3 year lows:

For what it’s worth, this actually in some ways backs up the thesis that these 3 plays are a proxy to China, given their strong correlation to China news. 

So… is China a good buy?

For now, price action is not looking good, and the market is suggesting that this round of stimulus will not be enough to offset the deflationary spiral China is in.

The key question now is whether this will force policy makers to take further action in the months ahead.

To answer this question, we need to examine the reasoning behind why policy makers suddenly capitulated in Sep and gave in on stimulus.

There are 2 schools of thought here.

First school of thought – Policymakers are constrained by the circumstances they are in

The first school of thought, is that things got so bad in Q3 2024, that local governments were on the verge of going bankrupt, that policy makers were essentially forced into action. 

Either that or Xi started to lose his grip, and regardless of what his views were, the system itself was forced into action to prevent systemic risk.

If you subscribe to this train of thought then you’re basically saying that the circumstances have forced China’s hand.

And funnily enough, under this school of thought China is actually a buy (at the right price).

For the simple reason that if this is true – then if and when things continue to deteriorate in 2025, or whatever happens on the US-China trade war front, it means that policymakers will be forced by circumstances to inject further stimulus.

Second school of thought – Policymakers will only step in to prevent systemic risk

The second school of though is much more tricky.

Under this school of thought – the reason for the policy turnaround in Sep 2024 was a one-off (or reasons unknown to us).

This means that you cannot count on further policy action from policy makers, even if things deteriorate further.

Which is it? Will policy makers be forced into more action in 2025?

Of course if it’s the first, then the lower that China stocks go, the better a risk-reward you get, because it would mean you effectively have a “backstop” from policy makers.

If it’s the latter, then well you don’t know how much worse things are going to get.

Alternative view from a long time China follower (that I respect)

I received a great comment from one of the long time FH subscribers, who is probably much more knowledgeable on China than me.

For privacy reasons I will not reveal the name, and I loosely extract some of his replies below (lightly edited):

Hi FH, thanks for a good China piece.  Although I do not agree with some of your assumptions but I guess the conclusion of policy bottom is something I personally am beginning to align with.

However my reasons for so are different from the facts of events on a policy front.  I am looking at other facts on a political front that has changed markedly since July’s 三中全会.  It is becoming clear that Xjp is losing his influence on policies and messaging.  There are many incidents that shows this in the organisation of events both domestically and foreign, and marked shifts in tone and focus from the ccp mouthpieces such as Xinhua or Renmin etc.  As you know when listening or reading the Ccp news or articles, it is what is not said that is more important than what is openly said.  Reading in between the lines of ccp communications is a necessary survivor skill.

These manifestations coincide with the monetary and fiscal policies being gradually pushed out.

So I’m beginning to hope that the dire situation China is in now will result in pragmatism in the Ccp leaders (outside of the emperor’s circle) and will eventually push the waves of changes necessary to restore faith in China’s growth story (and importantly the legitimacy of ccp rule).

I like a good story and sometimes we live in a time where such stories abound and satisfy the inner urges in our lives 😂

If indeed the changes in leadership happens (not necessarily by a change or removal of emperor but but sideline or other consensual ways), then China will be able to move in a more cohesive and healthy pathway.   As opposed to the 拿石头砸自己脚 manner in the past years.

What is my view on China?

As you can see, the thought process is quite different from mine, but the conclusion is similar in that we both think we may have hit a policy bottom.

Is this the right view?

Frankly I don’t know and only time will tell.

My personal view continues to be the former school of thought, and it’s a bet I think is worth making because the risk-reward is attractive.

However, I could well be wrong on this, and hence the importance of position sizing.

Currently China is sized only at about 10% of my portfolio, which gives you some idea of how I am sizing it.

Alternatively another way to play this is to simply wait to see concrete steps from policy makers (if at all) in 2025, and then buy then.

Yes by doing this you’ll miss the bottom, but it’s also safer from a risk management perspective as you avoid buying a falling knife.

So how exactly to play this, and whether you want China exposure at all – I leave it for investors to decide for themselves.

Appointment of Marco Rubio as Secretary of State does not bode well for China

What I would add, is that the recent appointment of Marco Rubio as Secretary of State for Trump’s administration does not bode well for China.

Marco Rubio is a China hawk.

For reference, here’s a paper he wrote recently on China, and here is the introduction:

Communist China is the most powerful adversary the United States has faced in living memory. This is no exaggeration. We sometimes forget that past enemies, including Nazi Germany and Soviet Russia, had smaller economies than we did. Each tried to take over its neighbors and hurt our country in the process. Each failed because America outbuilt and outgunned it. 

However, the Chinese Communist Party is playing a better hand, as it controls the largest industrial base in the world, fuels its factories with market-distorting subsidies and rampant theft, and, as this report highlights, now leads in many of the industries that will determine geopolitical supremacy in the 21st century, from shipbuilding to electric vehicles. This means Beijing will have greater sway over which set of values defines the 21st century: liberty and representative government, or authoritarianism and oppression. 

To make matters worse, the United States is in a weaker position than it was in the past. Decades of overregulation and “free trade” with adversarial economies like China’s have eroded our industrial base. Shuttered factories, drugs, and illegal immigration have destroyed small-town communities. Four years of the Biden-Harris Administration appeasing our adversaries abroad, raising the cost of living at home, and undermining our economy with red tape, endless reviews, and woke diversity mandates haven’t helped. 

For years, I’ve raised the alarm about this. I’ve introduced countless bills to stop Beijing’s predatory behavior and start the process of rebuilding America’s factories and communities. These include efforts to protect American technology from espionage, empower the American auto industry to beat heavily subsidized Chinese competitors, and hold companies accountable for using Uyghur slave labor, among many others. 

This report is my latest effort. It’s a wakeup call about how serious the threat we face has become. No longer can we fall back on old dogmas and stale talking points. If we want to win, we must take bold action to rebuild our country, overcome the China challenge, and keep the torch of freedom lit for generations to come.

If this paper is any indication, it looks like more tension in US-China relations is coming, before it gets better.

As always – I’ll share my updated views on China, with updates on when and what I buy / sell, on FH Premium.

This is an FH Premium post written on 18 Nov 2024 and will not be updated going forward. My latest views on markets, my Stock watchlist and full Personal Portfolio, are shared on FH Premium.