There are weeks when decades happen.
Chinese stocks have bounced off of the lows, now what?
On July 25, I started drafting an article on Substack. As a self annointed value investor, I wanted to write something along the lines of Warren Buffett’s famous “Buy American, I am” article in the New York Times in 2008. Selfishly speaking I wanted to call the bottom in Chinese equities - after a ~3 year downdraft (started with amortizing obviously crazy valuation in early 2021, then digesting Zero Covid Lockdown, and the continued erosion of investor, business, and consumer confidence in the Chinese economy and equity markets), things seemed to be poised to get better (or at the very least, less worse). Procrastination got the better of me and this article sat as that, a draft in progress.
Alas, no use crying over spilt milk - the past is the past, and what matters is what happens going forward.
Policy Announcements - Expectations and Confidence
On Tuesday, Sept 24, the PBoC, CSRC, and the National Financial Regulatory Administration jointly held a press conference where a ‘basket’ of monetary stimulus measures were announced. I won’t rehash the exact details as many others have already gone through this. While initial responses were positive, monetary stimulus in a liquidity trap has questionable effectiveness and in general investor consensus was to ‘fade’ the rally.
However, everything changed on Sept 26, when the September Politburo Meeting Readout was published. As background, the politburo meets ~10-12x a year, and economic issues are usually discussed 4x per year (April/July/Oct/December), with July/December being the most important meetings, as they set the tone for reviewing “economic work” results in the past 6 months and what is expected over the next 6 months.
So it was extremely unusual that the September Politburo meeting discussed economic issues. Notably, the meeting notes called out some key changes, most important of which outlined 1) for real estate markets to stabilize and stop dropping; 2) clear problems in the economy (as opposed to ‘teething pains of development’, which was the term used as recent as in July); 3) additional fiscal expenditure - more so than the current baseline.
What culminated was the rapid bounce off the lows of Chinese equity assets across the world - forget 3 year doubles - how about a 3 day double? (East Money, I’m looking at you)
To me the most important point from this ‘logjam’ of policy announcements was outlined by Governor Pan’s “if 500bln works out well, we can do another 500bln and next 500bln” statement. Ultimately, the PBoC has not yet lent out a single RMB of loans to corporates for buybacks - but expectations have been fully reset.
After a couple of years of “Confidence is worth more than gold” speeches, it seems that policymakers have fully grasped the importance of resetting expectations.
In addition, high frequency data in the real economy seems to point to a sharp recovery in some specific verticals:
Pork Demand was higher than expected - with some shortages from certain bovine producers. The Hongshaorou Indicator1 seems to be improving.
Shenzhen/Guangzhou housing sales activity has recovered meaningfully during the Golden Week holidays - it remains to be seen if this is sustainable.
Most meaningfully, the stock market participants have gotten significantly more bullish.
To be clear, there are still plenty of negative fundamental datapoints in the economy over the past week, but stocks obviously discount the future. Additionally, to the extent that the overall sentiment shifts, people (average Laobaixing and market participants alike) start to orient themselves around “Glass Half Full” mentality. Finally, it goes without saying that the market bottomed in the US *way* before the economy did out of 2008 as well.
After a crazy couple of weeks of trading, I would generally classify Chinese equity asset valuation as having gone from stupid cheap (gold nuggets on the ground everywhere) to somewhat reasonable (some still attractive, others less so). Alas, the easy money has been made.
Given the positioning/sentiment/flows, it is a high probability (I believe >75%) stocks will move up from here - but the question is - how high? Over what time period? How sustainable? These are the trillion dollar questions.
Rather than predict the outcomes, I will lay out a couple of scenarios:
Crazy Bull?
Long term observers of Chinese equity markets will obviously remember the crazy market bubble and subsequent implosion of 2007 and 2015. Irrational speculators took over rational investment decision making as Chinese A-shares traded more like tulips and clivia than they did fractional ownership of businesses.
This is what is commonly referred to as a ‘crazy bull’ market in Chinese. When stocks rapidly go from reasonable to crazy stupid expensive in a short period of time, retail speculators invariably cannot resist the urge to jump onboard and eventually get buried as they buy at exorbitant prices that make no sense. While some shrewd traders become newly minted millionaires/billionaires, a lot of others lose a significant portion of their savings. When the dust settles, what’s left over is disgruntled public and existential nihilism in stock market fundamentals.
To be clear, this scenario remains a serious possibility over the next weeks/months - and is something Chinese equity participants must remain diligent in observing/responding. I personally do not believe in top ticking, so the rational choice in this scenario is to take profit as Mr. Market offers stupid prices for your assets, without trying to figure out where the top will be.
The policy implication of a “Crazy Bull” scenario would be obviously negative - another round of chives2 retail investors would become harvested jaded (this time, the Post-2000 generation) by the speculative nature of the equity markets in China. The ultimate goal (see my previous piece which mentioned the Financial Works Conference) of creating a strong domestic capital market would be yet again delayed. As well, credibility of the PBoC would also be tarnished.
Bad news out of the way, what about the good news?
Slow Bull?
A critical component of Ray Dalio’s “beautiful deleveraging” scenario - the Slow Bull would be the ideal scenario over the next months/years. The notion of a slow bull is that the Chinese equity markets will grind higher slowly and gradually builds significant ‘belief’ among Chinese citizens as a place where wealth compounds over time. In this scenario, the deflationary forces of real estate deleveraging, local government debt management, and overcapacity would be offset by the inflationary forces of stock market appreciation over time. This is a policy goal that Huang Qifan has also outlined in his seminal book Structural Reform. The policymakers this time around also released policies intended to introduce long term patient capital into the domestic markets. Time will tell to what extent this will be successful.
For the ‘slow bull scenario’ to happen, the equity markets need to climb a wall of worry and skepticism over a long enough of a time where the vast majority of Chinese people start to automatically invest their savings into the markets. In this scenario, the rational decision is to buy a concentrated portfolio of high quality Chinese businesses (ideally with a self-rebalancing mechanism), go on vacation (so called “have a hunch, buy a bunch, and go to lunch”) and watch compounding perform its magic.
Policy Recommendation?
As some of my readers would note, there is frequently a ‘policy’ angle to my investment musings. At this critical juncture, what I would tell the regulators today is to expedite the rollout of the Stock Market Stabilization Fund (which Governor Pan mentioned is under consideration). In this sense, the Chinese financial regulators should fully embrace Sang Hongyang’s philosophy during the Salt and Iron Debates.
Initially, the National Team should, with its arsenal of some 3.2trln A-share holdings (According to Security Times), look to stabilize the expected rise in stock prices by selling and attempt to engineer a slow bull market over the next 3-5 years. With A-share market cap at about 85trln (after this rally) and ~50% liquid, a 3.2trln position should allow the National Team to heavily influence stock market especially pushing things lower if the urge to gamble gets too crazy.
However, if the urge to gamble outweighs rational investment thinking in the Chinese equity markets and overwhelms the National Team’s arsenal, it might work better to embrace the A-shares as a casino, with the National Stock Market Stabilization Fund as the House - buying low when gamblers are selling in disgust and selling high when gamblers are buying with gusto - trading profits (remember, the house always wins) should be directly injected into the National Social Security Fund. The added benefit of this approach is that it ultimately would be consistent with the philosophy of common prosperity - as those who are rich enough to gamble in the A-shares are by definition richer than those who are not. It also functions a bit as a Darwinian self-selection process - those who are stupid enough to gamble will be contributing their wealth to the National Social Security Fund.
To the extent that this Pavlovian training process becomes more effective (or that the Financial Darwin Award winners go bankrupt over time), the remaining participants will become more rational over time, and the A-shares can, by itself, become an rational value-investment driven market over time.3
I know some of you reading this publication are policymakers are likely in touch with Chinese policymakers - if you do read this far and find my perspectives interesting - do please let your contacts at the PBoC know! :)
Finally, I must emphasize with the usual precautions:
As a result of the enhanced market price volatility, I must again note that this publication does not in anyway construe as investment recommendation. I will absolutely change my mind as underlying security prices change in relation to what I perceive as the fundamentals of the underlying businesses. This is especially important for readers to understand given the likely market volatility in the coming days/weeks/months ahead.
Happy trading!
P.S - Since June 14, the date that our writeup on Atour Lifestyle was published, ATAT 0.00%↑has generated a stock price appreciation of 67%. I hope you joined me in this investment over the past 4 months.
Hongshaorou (红烧肉) - Red Braised Pork. This is another Moatless Capital Proprietary Indicator - which proclaims true middle class Chinese people as those who can afford to eat Hongshaorou at will (‘红烧肉自由’).
The term ‘chives’ in Chinese is used to describe a sucker in the stock market.
I quote, the CSRC/National Financial Regulatory Administration specifically stated as a goal that it wants to push for adoption of value investing principles over the medium to long term.
I disagree with your comment that: Alas the easy money has been made. I see many sectors of the China/HK markets where prices are still cheap. Companies in a business where the equivalent US/EU company p/e runs at 30+ and the China company sits at a p/e of 11-15.
The growth is just beginning, driven by the 80% of the global population who do not live in the West/G7. Billions of people who want what so many of us take forgranted. They live in countries that can never reproduce the economies of China manufacture.
Your approach is top down. And short term. In the Chinascape, 5 year horizon is short term. For the West, lead is gone, follow is disappearing, get out of the way is all that is left.
Thanks for the post, wouldn't it be interesting to look at it from a Minsky perspective where falling asset prices are the root cause of a debt-deflation spiral now China faces?