Is there a more capitalist concept in the world than economic stimulus? Surely not, yet China (run by the Chinese Communist Party) has used stimulus before and is doing so again. Communist in the streets, capitalist in the sheets?
The concept of communism is all relative. China may be willing to use economic stimulus, but there are many nuances that are well in line with communist thinking. These include a love of long-term planning and the goal of common prosperity.
Beijing’s policies aren’t always of a market-friendly nature, either. Anyone who was caught on the wrong side of the cancelled Ant Group IPO will know that!
Much as it may rub hard-core communists up the wrong way, the reality is that prosperity (common or otherwise) is best achieved through economic activity. Concerns about growth in China, prompted by recent disappointing numbers, a property sector in crisis and consumers under pressure, were drowning out a shrinking pool of China bulls.
These days, India tends to be spoken of as the brightest emerging market opportunity, not least because of its democratic government and its image as a more market-friendly investment destination.
For context, until the Chinese stimulus rally began, the iShares MSCI China exchange traded fund (ETF) was up just 4% for the year, while the iShares MSCI India ETF was good for 18% this year. Thanks to the stimulus announcement, the Chinese ETF is now up 33% for the year. India’s market hasn’t reacted to the news in China, so that ETF rise is still on 18%.
That doesn’t tell the full story, though. The Chinese market has been a face-ripper of note, at one point up 50% year to date before suffering a sharp correction as the market got nervous about the extent and effectiveness of stimulus.
The Chinese market has been a face-ripper of note, at one point up 50% year to date before suffering a sharp correction as the market got nervous about the extent and effectiveness of stimulus
The Chinese government spends its time thinking about the Chinese people, not how the West perceives the Chinese market. This can lead to inconsistent and unpredictable commentary that isn’t always market friendly. If the Chinese economy is a dragon, then it’s hard to predict whether it will be of the treasure-sharing magnanimous variety (in line with Chinese mythology around dragons) or the burn-you-to-a-crisp variety.
It’s also worth noting that the recent rally doesn’t come close to fixing China’s underperformance relative to India in recent years. Over five years, China’s market is down 9% and India’s is up 74%. There are major structural issues in the Chinese economy that are difficult to improve (such as the demographic crisis created by the now rescinded one-child policy), but this didn’t stop the market from getting excited at the prospect of stimulus.
It’s therefore worth giving more context to the concept of stimulus and just how important it is, as the mere mention of the word is enough to drive activity.
Imagine a braai fire made with wet wood on a cold day. Those big logs are capable of creating a fantastic fire, yet they are sitting there hissing and smoking and refusing to catch alight. The net result is a useless “fire” that can’t cook the meat. Another firelighter or two probably won’t improve things, as they don’t burn long enough to overcome the challenge of the moisture in the wood.
The best solution is to add smaller pieces of dry wood in sufficient quantity to get the big logs going. If you add too few, it won’t work. If you add too many, the fire gets too big and incinerates the meat.
Economic stimulus is the use of small, dry sticks on the braai. These sticks come in various forms, ranging from structurally low interest rates through to the extremes we saw in the pandemic when the US made stimulus payments directly to citizens. The Americans prefer to use a flame-thrower to get the BBQ going.
The net impact of stimulus is that it puts more money in the pockets of the average citizen. In countries that don’t have strong economies and supportive infrastructure for growth, this leads to inflation and devaluation. The economic graveyard is littered with emerging and frontier markets that tried to print money to solve their problems.
The US seems to operate by different rules, with an economic boom that has soaked up liquidity and flourished in the process, creating immense wealth for Americans by global standards.
Where does that wealth end up? Much of it goes into such asset classes as listed shares and venture capital. This feeds economic growth, as plucky entrepreneurs and corporate executives have access to deep pools of capital. As demand for these assets increases, so too will the prices.
It’s like a giant snowball of joy for US balance sheets, fuelled by expansionary monetary policies, otherwise known as stimulus.
If you have access to a suitable market system, you can draw a chart of US company valuations since the global financial crisis to see what the impact of stimulus has been, with the world’s most famous companies trading at vast valuation multiples vs historical averages.
Costco is trading on a p:e of more than 50 at the moment, which is truly ridiculous. The 10-year average multiple for the company is 35. Walmart is trading at 42 vs the 10-year average of 27.
Grocery stores aren’t much better businesses than they were a decade ago, so this is purely the result of economic stimulus.
Despite having several historical examples of stimulus to work with, analysts are still struggling to put a tight range on the estimated size of the latest package
Stimulus is the rising tide that lifts all boats, which is why the Chinese market (and related markets and companies with look-through exposure to China) reacted the way it did in response to stimulus. These macroeconomic forces cannot ever be ignored by investors, with Covid having given us all a front-row seat to an accelerated example of the impact of stimulus. We were able to watch the exuberance in the market followed by the despair, all in the space of a couple of years. Talk about a learning opportunity!
As mentioned earlier, this isn’t the first time the Chinese authorities have taken steps to boost the economy. Under the current leadership, there was a package in 2015 to try to boost stocks. In 2020, Covid inspired an economic package in China just as it did in most economies. Back in 2008, before President Xi Jinping’s time, there was a major package in response to the global financial crisis.
Despite having several historical examples of stimulus to work with, analysts are still struggling to put a tight range on the estimated size of the latest package. This speaks to the unpredictability of China, with the authorities playing their cards very close to their chests in terms of what they plan to do.
At this stage, we know that the stimulus package will include initiatives to try to save the property sector. There will also be the usual suspect of changes to the reserve requirement ratio for banks, allowing them to lend more freely into the market.
Authorities have spoken of plans to encourage institutional investors to borrow liquid assets directly from the central bank and use them to fund investments in equities. Unlike when the Americans throw stimulus at their problems, it doesn’t look like there will be “stimmy” cheques in the mail for Chinese citizens.
That may change, of course, as the shape of this stimulus package is very much a developing story.
For investors, there is clearly going to be volatility. Any news that gives concrete details on the stimulus package will be a catalyst for significant market moves in either direction. While some analysts are talking about how this stimulus package effectively puts a price floor on the Chinese market, it would be foolish to think that this rally can’t reverse entirely if the stimulus measures are perceived to be inadequate.
It will be even worse if the measures don’t have the desired effect, with China’s GDP growth as the key metric to watch.
In single stocks, punters will pay close attention to commodity stocks, especially in areas such as iron ore. Be careful of share prices that run too hard, too quickly here — it’s going to take a while for the stimulus measures to drive domestic demand, so there’s a strong chance of “buy the rumour, sell the deal” approaches working well here.
In other words, the best returns will probably be made on the stimulus announcements themselves rather than on how the reality plays out in the Chinese property sector.
Another area of focus is consumer stocks, as weak demand in China has been a major problem for many large brands. This is less of a pure-play unfortunately, as China is a large market but certainly not the only market that matters for the likes of Nike and Starbucks. Though stimulus should put more money in the pockets of more than 500-million middle-income consumers in China, there’s too much other noise in those share prices.
The exception is luxury stocks, not because the mega-rich in China need stimulus to be able to afford the products, but because they were simply too embarrassed to buy them at a time when the government was encouraging frugality. If stimulus is on the cards, that’s great news across the spectrum of Richemont to BMW.
Of course, the most obvious play on the local market is Naspers/Prosus, with the share price up roughly 20% in the past month. At least you get the added benefit of a new management broom sweeping clean there, just in case the Chinese stimulus doesn’t work out quite as planned.
It’s also a safer bet to believe that Tencent will reap the benefits of improved sentiment in China, as transactional activity is practically a certainty, whereas a construction market recovery is a risk.
Sometimes, the obvious approach is also the right approach.
Would you like to comment on this article?
Sign up (it's quick and free) or sign in now.
Please read our Comment Policy before commenting.