Have China stocks bottomed? Why I bought more China stocks last week?

This is an FH Premium post written last weekend.

As I have been getting a lot of questions on my views on China, I wanted to make this post available to all readers.

Hopefully it would help you when deciding whether to invest in China.

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Okay so 2 key topics I wanted to discuss.

The first is on China, and whether China stocks have bottomed after last week’s policy action.

Second is a question from a reader on the outlook for Tech stocks and when to cut losses.

For ease of reading (and given the length of the article), we will focus only on China today.

And we’ll talk about Tech stocks tomorrow (article here).

Have China stocks bottomed? 

To recap the timeline (as shared in discussions in the Private Telegram Group last week).

When China unleashed large monetary stimulus on Tuesday, I was somewhat sceptical about whether this marked a policy bottom.

Investors have been once bitten twice shy calling the bottom in the past, so why would this time be any different.

However it was the fiscal stimulus announced at the Politburo on Thursday that changed my mind.

The fact that Beijing coordinated fiscal and monetary stimulus literally the weak after the Fed rate cuts, and the language / way in which they did it.

Led me to form a preliminary view that the worst of the China policy situation may be over, and policy makers may shift towards a more constructive stance towards the economy going forward.

In any case, I know not everyone agrees with me on China policy bottom (and I definitely could be wrong on this).

So let me share my reasoning / thought process below, and feel free to disagree with me in the comments below.

Why I bought more China stocks last week?

I know a lot of you question the upside for China stocks after last week’s monster rally.

But zoom out and you’ll realise that if indeed this is a policy bottom, there’s a lot of upside potentially in play here (especially given how cheap China stock valuations are).

The way I see it, I like the risk-reward, which was why I upped exposure to China stocks last week.

Of course, there is no way to know for certain with these things (the next few months are key to watch for policy follow through).

Which is why position sizing is crucial.

No matter what my views, the position is still sized in a way that I can take the loss if I am wrong on this.

Monetary Stimulus (on Tuesday)

On Tuesday last week, the China central bank (People’s Bank of China – PBOC) announced a fairly large set of monetary stimulus for the economy.

This is important enough that it’s worth reading in full, and I extract the Chinese text with English translations below (emphasis from me):

To maintain the stability of China’s capital market and boost investor confidence, Pan Gongsheng announced the creation of new monetary policy tools to support the stable development of the stock market.

为了维护我国资本市场稳定，提振投资者信心，潘功胜宣布，创设新的货币政策工具，支持股票市场稳定发展。

“This is the first time the People’s Bank of China has innovated structural monetary policy tools to support the capital market,” Pan Gongsheng said. The People’s Bank of China, in consultation with the China Securities Regulatory Commission and the National Financial Regulatory Administration, has created two structural monetary policy tools: The first is to create a swap facility for securities, fund, and insurance companies, supporting eligible companies to obtain liquidity from the central bank through asset pledges, significantly enhancing institutions’ ability to acquire funds and increase stock holdings. The second is to create special relending for stock buybacks and increased holdings, guiding banks to provide loans to listed companies and major shareholders to support stock buybacks and increased holdings.

“这是人民银行第一次创新结构性货币政策工具支持资本市场。”潘功胜表示，人民银行与证监会、金融监管总局协商，创设两项结构性货币政策工具：第一项是创设证券、基金、保险公司互换便利，支持符合条件的证券、基金、保险公司通过资产质押，从中央银行获取流动性，大幅提升机构的资金获取能力和股票增持能力。第二项是创设股票回购、增持专项再贷款，引导银行向上市公司和主要股东提供贷款，支持回购和增持股票。

It’s reported that the initial operation scale of the swap facility is 500 billion yuan, which may be expanded in the future depending on circumstances. The funds obtained through this tool can only be used for investing in the stock market. The initial quota for the special relending for stock buybacks and increased holdings is 300 billion yuan, which may be expanded after evaluating market conditions. This tool is applicable to listed companies of different ownership types, including state-owned enterprises, private enterprises, and mixed-ownership enterprises.

据悉，互换便利首期操作规模是5000亿元，未来可视情况扩大规模，通过这项工具所获取的资金只能用于投资股票市场。股票回购、增持专项再贷款首期额度是3000亿元，后期根据市场情况评估后可扩大规模，这项工具适用于国有企业、民营企业、混合所有制企业等不同所有制的上市公司。

Wu Qing introduced that in April this year, the State Council issued the new “Nine Measures”, and the CSRC has been earnestly implementing them. In collaboration with relevant parties, they have formulated several supporting documents and developed or revised more than 50 institutional rules, forming a “1+N” policy rule system together with the new “Nine Measures”. Some initial results have been achieved in strengthening supervision, preventing risks, and promoting high-quality development of the capital market.

吴清介绍，今年4月，国务院出台了新“国九条”，证监会认真抓好落实，会同相关方面制定了若干个配套文件，制定修订了50多项制度规则，与新“国九条”一起形成了“1+N”政策规则体系，资本市场强监管、防风险、促高质量发展取得了一些初步成效。

Wu Qing stated that the CSRC will focus on “three prominences”: First, prominently enhance the inherent stability of the capital market, establishing a clear orientation towards rewarding investors. Second, prominently serve the recovery and improvement of the real economy and high-quality economic development, focusing on serving key areas such as new quality productive forces, making good use of various capital market tools, and taking multiple measures to activate the mergers and acquisitions market. The CSRC will release six measures to promote mergers and acquisitions, while also striving to work with all parties to smooth the cycle of “fundraising, investment, management, and exit” for private equity and venture capital funds. Third, prominently protect the legitimate rights and interests of small and medium investors, resolutely cracking down on illegal activities such as financial fraud and market manipulation, while at the same time striving to implement more demonstrative cases in areas such as representative litigation and advance compensation.

吴清表示，证监会将重点抓好“三个突出”：一是突出增强资本市场内在稳定性，树立回报投资者的鲜明导向。二是突出服务实体经济回升向好和经济高质量发展，聚焦服务新质生产力等重点领域，用好多种资本市场工具，多措并举活跃并购重组市场。证监会将发布关于促进并购重组的六条措施，同时努力会同各方面畅通私募股权创投基金“募投管退”各环节循环。三是突出保护中小投资者合法权益，坚决打击财务造假、操纵市场等违法违规行为，同时在代表人诉讼、先行赔付等方面争取落地更多示范性案例。

Summary of the monetary stimulus

Here’s a summary from the Financial Times:

Pan said the PBoC would reduce its short-term seven-day reverse repo rate, the central bank’s main policy rate, from 1.7 per cent to 1.5 per cent.
 
 The PBoC will also cut the reserve requirement ratio, the amount of reserves lenders must hold, by 0.5 percentage points, he said, while signalling a further potential cut of 0.25 to 0.5 percentage points this year. The RRR cut would add Rmb1tn ($142bn) in liquidity to the banking system, he said.
 
 Goldman Sachs said in a note the “rare simultaneous cut of policy rates and RRR, the relatively large magnitude of cuts and the unusual guidance on further policy easing indicated policymakers’ growing concerns over growth headwinds”.
 
 But economists said that with loan demand muted among households, more direct government fiscal spending would probably be needed to improve the growth outlook.

My take?

2 points from me:

1. The timing is key
2. PBOC support for stock buybacks?!

The timing is key

Its notable that the PBOC waited all year with minimal action, and then literally the week after the Feds cut 50 bps, the PBOC went ahead with this stimulus package.

I don’t believe in coincidences, and to me this is by design.

By waiting for the Feds to embark on their cutting cycle, the PBOC was able to get more “bang for their buck” so to speak, and avoid fighting the Feds.

You can see the USD/RMB pair above.

All year the RMB has been steadily depreciating against the USD, which is not good for China being a net importer of energy and commodities (priced in USD).

Had PBOC tried to stimulate earlier, this would have piled further pressure on the RMB earlier this year, and led to them “wasting their bullets”.

Then Powell went ahead to signal rate cuts in July, and the RMB strengthened from 7.28 to 7.00 in the span of 3 months.

And PBOC brought out the stimulus.

In fact even after last week’s stimulus package, the RMB is actually holding all its gains against the USD.

The timing was impeccable.

PBOC support for stock buybacks?!

Equally interesting, is the PBOC announcements for companies to conduct stock buybacks:

The first is to create a swap facility for securities, fund, and insurance companies, supporting eligible companies to obtain liquidity from the central bank through asset pledges, significantly enhancing institutions’ ability to acquire funds and increase stock holdings. The second is to create special relending for stock buybacks and increased holdings, guiding banks to provide loans to listed companies and major shareholders to support stock buybacks and increased holdings.

To my knowledge, this is the first time the PBOC has used stock buybacks as a potential policy tool.

The fact that the PBOC is busting out never before used policy tools, suggests a potential turning point in how policy makers view the problem.

This was followed up with Fiscal Stimulus from the Politburo (Thursday)

The big surprise for me, was when the Politburo followed up with fiscal stimulus on Thursday:

China plans to issue special sovereign bonds worth about 2 trillion yuan ($284.43 billion) this year as part of a fresh fiscal stimulus, said two sources with knowledge of the matter, adding to a string of measures to battle strong deflationary pressures and faltering economic growth.

As part of the package, the Ministry of Finance (MOF) plans to issue 1 trillion yuan of special sovereign debt primarily to stimulate consumption amid growing concerns about a stuttering post-COVID economic recovery, said the sources.

Part of the MOF proceeds raised via special bonds, which are floated for a specific purpose, will be used to increase subsidies for the trade-in and renewal of consumer goods and for the upgrade of large-scale business equipment, said the two sources.

The proceeds will also be used to provide a monthly allowance of about 800 yuan, or $114, per child to all households with two or more children, excluding the first child, the first source said.

Introduction of new policy measures

Compared to the July Politburo meeting, this meeting introduced several new ideas and measures, including:

Emphasizing the counter-cyclical adjustment of fiscal policy and clearly stating the need to “ensure necessary fiscal expenditure.”

First mention of “promoting the stabilization of the real estate market,” with specific policy measures such as adjusting housing purchase restrictions and lowering interest rates on existing mortgages.

Not only “boosting confidence in the capital market” but also concretely “revitalizing the market.”

对比7月政治局会议来看，本次会议有诸多新提法、新举措，主要包括：

一是强调财政政策的逆周期调节力度，并明确要“保证必要的财政支出”；

二是首提“促进房地产市场止跌回稳”，并提出了具体政策措施，如调整住房限购政策、降低存量房贷利率等；

三是不仅要“提振资本市场信心”，而是要切切实实“提振市场”。

Forgive mistakes in implementation

Now a big problem the past 2 years was that policy set by Beijing was not properly implemented at the state level.

Let’s put it this way – if you’re a party cadre, you can go out of your way to implement reform based on what you interpret Beijing / Xi’s message to be (which most of the times is sweeping and not very clear).

And if you get it wrong you lose your job. 

With a setup like that – Why take the risk?

This led to poor policy transmission the past 2 years, where local governments did not fully implement policy set by Beijing.

Which was why this next measure from Beijing was equally important as the fiscal stimulus.

Per SCMP reporting:

“The vast number of party members and cadres must have the courage to take responsibility and dare to innovate,” said a readout from the meeting, which was chaired by Xi.

The readout also mentioned the term “three exempts” – exempting well-meaning officials who make mistakes due to lack of experience; exempting officials who make mistakes in experiments, especially those in new domains without clear restrictions; and exempting officials who inadvertently err when promoting development.

“The fact that this ‘responsibility and punishment waiver’ is reaffirmed at today’s Politburo meeting, at which Beijing issued the most urgent call-out to fire up economic growth, is significant,” said a political scientist with Peking University who declined to be named as they were not authorised to speak to non-state media.

“It is aimed at assuring officials that they can go bold in helping the economy and need not worry about the consequences, as many cadres have chosen to lie flat or not to vigorously push for reforms in recent years.”

My Take? Is this a policy bottom?

Some simple numbers on the stimulus:

1. RRR cut 50bps (lowest since Feb’07) = 1tn yuan ($142bn) in bank liquidity 
2. Cuts in mortgage rates = 150bn yuan ($21bn) savings for households 
3. 2tn yuan ($284bn) government debt issuance (per market expectations) to stimulate consumer (cash handouts) & local governments 
4. 800bn yuan ($113bn) liquidity for stock market 

Total =  potential $560bn of stimulus for China (>3% of China $18tn GDP)

All in, this stimulus package is not small.

But let’s not kid ourselves, by itself this is not going to be sufficient to turn around the China economy, more reform/stimulus will be required.

The million dollar question is whether Beijing will follow through with more stimulus/reform to come.

Like I said these things are an art and not a science.

But putting together all the pieces that come together last week:

1. Coordination of fiscal/monetary stimulus, 
2. Introduction of new policy tools and strong language from policy makers
3. “Exempting” mistakes from cadres in implementation
4. Timing of the move right after the Fed rate cut

It suggested to me that this may mark a potential policy bottom for China, or at the very least, a tradeable bottom.

This is not Mario Draghi’s “Whatever it takes” – concrete policy action is required

What I would add, is that this is very different from Mario Draghi’s whatever it takes in 2012 to end the Euro Debt Crisis.

For those who recall:

ECB President Mario Draghi gave the so-called “whatever it takes” speech, today widely considered as the turnaround point in the European sovereign debt crisis. Shortly after, the European Central Bank (ECB) announced the details of its outright monetary transactions programme (OMT) tool. The speech, together with the OMT announcement, were enough to remove re-denomination risk from sovereign bond markets. OMT was never actually used. 

In 2012, Mario Draghi committing to do whatever it takes to support Euro sovereign debt was by itself sufficient to stem the rout in Euro debt (private markets did the rest once a ECB backstop was in place).

I think the situation with China today couldn’t be more different.

The problem with China today is structural, in that:

1. There is a hole in the economy caused by the real estate deleveraging (a lot of unsold homes, with market prices much lower)
2. Given how much of the household balance sheet is tied to housing, this has led to poor consumer sentiment
3. At the same time the job market is weak due to the need to replace jobs created by real estate/construction (there is only so many EVs you can export before other countries enact trade barriers, and the tech/finance crackdown is not helping with job creation)

These are real structural problems, that cannot be solved simply by nice words from Beijing.

So I am under no delusions here.

If in the weeks/months ahead, Beijing does not follow up with concrete fiscal/monetary reform and stimulus, then the deflationary spiral for the Chinese economy (and Chinese stocks) will continue.

The flip side to this argument

The flip side is of course as per below, which a FH Premium subscriber shared in the private telegram group:

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I absolutely do not deny this is possible.

Investors have tried to call the bottom many times in the past 2 years, only to be proven wrong by Beijing.

Why is this time any different?

We’ll never know of course, as this is a question that can only be answered with hindsight.

By as an investor I get paid to take calculated risks.

And the way I see it is that if I am right on this call China stocks have a lot of upside potential.

And if in the next few weeks / months it turns out I am wrong, I can just cut the loss.

That’s a bet I would take, as long as it’s sized properly.

Marko Papic

One of the few geopolitical strategists that I listen to is Marko Papic (he wrote a fantastic book “Geopolitical Alpha” for those who are keen).

This was what he had to say last week on China:

I think that China has reached a “policy bottom.” The PBoC stimulus was relatively “meh.” More monetary policy won’t change anything in an economy stuck in secular stagnation. But, Politburo’s focus on fiscal policy was important.

What is a “policy bottom?” It is when policymakers shift their focus from limiting risks of “moral hazard” to limiting risks of “political hazard.” Every society finds this point eventually and pivots to fiscal.

As shared above, I hold broadly similar views.

But like I said, only time will tell who is right on this – these things are by their nature grey.

What China stocks to buy?

Following up on the weekend Stock Watch, some of you asked this question:

Further specific China stocks laggards where value still exist will help greatly 🙂

Here was my response for the record:

If this is a policy bottom, I dont think you need to bother with stock picking, the whole market will go up. It’s like what David Tepper said. If China is going to stimulate, you want to buy everything, even after the rally everything is still cheap on a valuations basis.

Just to add, I would probably just ETF it for the broad macro exposure. But I get your point, let me look deeper into single names with value after the rally.

David Tepper Buys ‘Everything’ China-Related on Beijing Easing

I don’t know if you guys saw the interview by David Tepper last week.

Where he basically went on CNBC and said to buy “Everything” China-related (the last time he made such a call was in 2010 for US stocks, and we know how that turned out).

Jokes aside – he’s not wrong in that if you think this is a China policy bottom.

You really don’t need to get too caught up in stock picking, because everything will go up in a rising tide lifts all boats dynamic (given how cheap China valuations are).

Here’s the Hang Seng Index (2800) for example:

Here’s Hang Seng Tech ETF (3067)

Here’s US Listed KWEB (China Tech ETF)

Here’s US listed MCHI (MSCI China).

All 4 ETFs above are acceptable, based on whether you want US/HK listed, and whether you want to focus on Tech or China stocks generally.

As shared previously, my preferred way to play this is via the banks or China tech (see stock watchlist on FH Premium).

After the recent rally the banks trade at 7% dividend yield, and at these prices I don’t think the risk-reward is as attractive anymore (whereas at a 9% yield I thought they were a good buy).

So if you ask me, my preferred way to play the rally today would be via China tech, as a proxy play on the strength of the China consumer.

You can just build broad exposure via the Hang Seng Tech or KWEB.

But I know some of you guys want single stock analysis, so let me look into this in a further article.

As always – happy to discuss further on any point below, even (especially) if you disagree with me!

This is an FH Premium post written last weekend (29 Oct) and will not be updated going forward.

My latest macro views on China are shared on FH Premium, together with the stocks / REITs I am buying.

If you found this article helpful, do consider signing up for FH Premium!

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