In recent weeks, China’s stock markets have experienced a dramatic reversal, with investors moving from despair to exuberance. After a period of sharp declines, optimism surged in late September when the Chinese government unveiled a series of measures aimed at stimulating the economy and stabilizing markets. This rapid shift in sentiment has led to significant gains, particularly in the CSI 300 Index, which tracks large companies in Shanghai and Shenzhen. By early October, the index had jumped nearly 35% over 10 consecutive trading days, marking one of the most dramatic rallies in recent Chinese market history.

However, the excitement quickly waned, culminating in a sharp 7.1% drop in the CSI 300 on October 9, the largest one-day decline since 2020. Outlook for corporate earnings in China remains uncertain. While government actions have bolstered optimism, analysts caution that the rally is based on “unrealistic expectations” of the impact of government stimulus, and that it may be too soon to make any substantial upgrades to Chinese equities. We will also look at how this will impact us, Indian stock market investors.

What Are The Chinese Government’s Stimulus Measures?

The catalyst for the turnaround came on September 24, when China’s central bank and top financial regulators announced a set of aggressive policy measures. These included interest rate cuts, reduced down payment requirements for mortgages, and an easing of lending restrictions for banks to encourage stock market investments. China’s Government followed with a rare, direct call for further action to boost the economy. Local governments quickly responded by loosening real estate purchase restrictions in an effort to stabilize the housing market.

These interventions were designed to halt a downward spiral in consumer confidence, which had been exacerbated by falling real estate prices and weak domestic demand. The Chinese economy had struggled for three years with declining property values, a critical sector that accounted for a substantial portion of household wealth. Many investors had lost confidence, with Chinese markets among the worst performers globally since early 2021. By the time the government acted, the CSI 300 had lost nearly half its value, and the Hang Seng Index in Hong Kong had plunged more than 50%.

Economic & Policy Uncertainty Ahead For China

Despite the recent gains, China’s economic outlook remains uncertain. No additional stimulus measures were announced during a national news conference on October 10, when officials from China’s National Development and Reform Commission offered reassurances about economic fundamentals rather than specific new plans for boosting growth. The Government’s uncharacteristic decision to act swiftly in September—rather than waiting for its usual quarterly meeting at the end of October—took many by surprise, but it remains unclear if this shift will lead to sustained economic improvement.

Economic data for September has yet to be released, but early indications suggest that little has changed in the overall economic trajectory. A survey from the China Beige Book, an economic research firm, showed no significant improvement over the previous month. However, the Government’s unusual call for immediate action suggests that China’s leadership may be willing to introduce further measures if the economy does not stabilize. For now, investors are riding a wave of optimism, but the sustainability of the current rally will depend heavily on whether the Chinese government follows through with additional policy support.

China's Central Bank Launches $70 Billion Funding Scheme

In a bid to provide additional support to its faltering capital markets, China's central bank launched a new funding scheme initially valued at 500 billion yuan (approximately $70.62 billion). This initiative, announced on Thursday, aims to ease liquidity pressures for financial institutions, encouraging greater participation in the stock market by offering easier access to capital. Institutions can use bonds, ETFs, and their holdings in companies listed on the CSI 300 Index as collateral. In return, they will receive highly liquid assets such as treasury bonds and central bank bills, which can help them maintain or increase their investment in Chinese stocks. The timing of this announcement comes as investor enthusiasm faded which led to a sharp sell-off on Wednesday.

Another $283 Billion Stimulus Package Announced By China’s finance Ministry

China's finance ministry unveiled a new fiscal stimulus package aimed at reviving the economy and achieving growth targets. Key measures include increased government debt issuance to support low-income households, recapitalize state banks, and boost the property market.

While the size of the stimulus was not disclosed, China plans to issue special sovereign bonds worth around 2 trillion yuan ($283 billion) and allocate 1.2 trillion yuan for local government debt resolution.

• Increased support to resolve hidden local government debt and a large-scale debt swap program.

• Using bond proceeds to recapitalize state-owned banks to improve their risk capacity and credit provision.

• Special bonds will help manage land supply and support affordable housing projects.

• Increased subsidies and doubled national scholarships for students to boost consumption.

The ministry emphasized its capacity to raise debt and increase the budget deficit, with a 2024 special bond issuance set at 3.9 trillion yuan.

Unrealistic Expectations of Stimulus-Driven Growth Boost Chinese Stock Markets

This rally was driven by the most substantial monetary stimulus measures China has implemented since the COVID-19 pandemic. It jolted markets into life, attracting a wave of retail investors eager to capitalize on the sudden optimism. Online trading platforms like Snowball and Tiger Brokers saw a rush of activity from both domestic and international investors. Many feared missing out on what was shaping up to be the largest stock market rally in China in years.

Indexes like the Shanghai Shenzhen CSI 300 and the Shanghai Composite hit 2-year highs. In the last 1 month CSI 300 is up 22.53% and Hang Seng is up 23.27% - on a YTD basis it is up 14.79% & 26.59%, respectively. The government reduced borrowing costs and took steps to enhance liquidity in equity markets, aiming to revive the sluggish property sector and spur broader economic activity. These moves were welcomed by investors, pushing Chinese stocks higher.

However, the exuberance was short-lived, as stocks suffered sharp losses in early October. The CSI 300 fell by 7.1% on October 9, marking its biggest one-day decline since 2020. This volatility highlighted investor skepticism about the long-term impact of the stimulus, especially as many had been hoping for more targeted fiscal measures to support the economy.

Sentiment Driven Chinese Stock Market Rally - Can It Continue?

The rally was largely sentiment-driven, as investors responded to a perceived shift in the government’s stance towards pro-growth policies. This marked a significant change after months of stagnation, where depressed valuations had left the market vulnerable to any positive news. This shift in sentiment has been largely digested by the markets, and now the government needs to deliver. Without more tangible fiscal measures to address China's deflationary pressures and fragile consumer confidence, the rally could fizzle out - as we saw this week.

Moreover, the sudden bullish sentiment has spread beyond China’s borders. There is a surge in requests for advice on investing in Chinese stocks from international investors as well. This renewed enthusiasm was evident as the CSI 300 surged, and even stocks in sectors that had struggled, such as real estate, saw significant gains.

Recent market pullback was to be expected following such a strong rally. Further volatility is likely as the market awaits clarity on future policies, especially on fiscal stimulus. The importance of coordinated fiscal policy, noting that monetary policy alone may not be enough to steer the economy out of its current struggles. Without significant fiscal support, investor confidence could wane again, leading to further sell-offs.

Investors are now facing increased uncertainty as they await further announcements from the Chinese government. The stimulus measures announced in late September helped lift market sentiment, but doubts have since emerged over whether these actions will be enough to fuel sustained economic growth. China’s elevated debt levels are a major concern, and this has dampened expectations for further large-scale fiscal interventions.

Lessons from 2015: The Risk of Overheating in Chinese Stock Markets

The rapid rise in stock prices has raised concerns of a repeat of China’s 2015 stock market collapse. Back then, a government-engineered rally in response to a weak property market led to unsustainable gains, with the CSI 300 more than doubling within seven months. Millions of retail investors opened brokerage accounts and borrowed heavily to buy shares, only to see the market crash in the summer, erasing most of their gains and leading to widespread losses.

The current surge shares some similarities with the 2015 bubble, particularly the influx of retail investors and the heavy reliance on government intervention to prop up markets. While Chinese state media has not yet encouraged investors in the same way as before, the potential for volatility remains high.

Deeper Problems for China’s Economy - Can They Be Solved By Government Stimulus?

China's growth target of "around 5%" for 2024 is increasingly at risk, with wage declines, weakening consumption, and persistent deflation threatening to derail the recovery. The recent drop in new-hire wages is a clear signal that the labor market is not improving as hoped, which could further erode consumer confidence. The longer wage growth stagnates or declines, the harder it will be for China to meet its growth ambitions and lift its economy out of the current slump.

Property Market Instability & Consumer Confidence At All Time Low

A significant issue underlying China’s economic challenges is the steep decline in real estate prices. Housing represents up to 80% of household wealth for many Chinese families, and property prices have fallen between 30% and 40% in recent years which has created a drag on consumer spending and confidence. During the peak of the housing boom in 2021, many middle-class families had invested heavily in second and third apartments, with expectations of continued price growth. However, prices have been dropping at an annual rate of about 10%, and some economists warn that this decline could accelerate to 15% next year unless more decisive action is taken.

The government’s latest moves included policies to stabilize the housing market, such as expanding loans for officially approved real estate projects. Yet, the leadership has simultaneously emphasized caution in new construction, trying to balance the need to prevent further market overheating while addressing concerns of overcapacity in industries like manufacturing.

There is a need for consumer-focused measures such as a $21 billion trade-in program for household appliances that have been helpful but too small in scale to make a significant impact. For larger initiatives, such as sovereign bond issuance to fund broader trade-in programs or cash-for-clunkers schemes, which could stimulate the purchase of electric vehicles and other big-ticket items.

Corporate Earnings Outlook Remains Muted With Weakening Labor Market

China’s economic outlook has turned positive due to the government’s interventions. This optimism has not extended to the earnings potential of companies. Without clear signs of an earnings rebound, any increase in exposure to Chinese equities within an emerging markets portfolio. Lack of evidence for a broad-based earnings recovery makes it premature to upgrade Chinese stocks at this time.

According to data from online recruitment platform Zhaopin Ltd., average monthly salaries offered to new recruits in 38 key Chinese cities fell by 0.6% year-over-year to 10,058 yuan ($1,423) in the third quarter. This decrease comes after wage growth of 2.2% in the first quarter and 0.5% in the second quarter. The drop in wages suggests that demand for labor is weakening, which could further dampen consumer spending and exacerbate deflationary trends.

The contraction in wage growth adds to a growing list of data that indicates a weakening job market in China. For instance, the employment sub-gauge of China’s non-manufacturing Purchasing Managers' Index (PMI) fell further into contraction territory in September, marking its lowest point since December 2022. The official unemployment rate reached a six-month high in August, and youth unemployment hit a record earlier this year. The job market deterioration is feeding into a cycle of lower wages, reduced spending, and deflation, posing a significant challenge to China's economic recovery.

Metals & Iron Ore Rebound

Iron ore prices surged briefly by over 3% before settling, driven by speculation amid new fiscal measures. Iron ore has been volatile, hitting a 2 year low in September amid pessimism over China’s economy, particularly its struggling property market. Signs of recovery are emerging in China’s steel market, with rebar prices hitting a 2 month high.

As of Wednesday afternoon, iron ore prices were up 0.2%, trading at $105.25 per ton in Singapore, following a 5% drop earlier in the week after China returned from a week-long national holiday. Copper, another commodity tied closely to China’s economic performance, also saw a modest gain of 0.2%, trading at $9,765 per ton on the London Metal Exchange.

Is There Opportunity In India?

Foreign Fund Outflows Increase, But Domestic Flows Continue To Drive Indian Markets

Foreign investors have pulled more than $5 billion from Indian equities this month, driving the benchmark index down over 3%. The exodus, which marks the largest foreign outflow since March 2020, reflects growing concerns about India's high stock valuations. Retail investments in India’s equity mutual funds continue to grow at an unprecedented pace.

In September, individual investors poured 245 billion rupees ($2.9 billion) into SIPs, marking another monthly record, according to AMFI. This steady influx of retail funds is helping offset the impact of foreign outflows, as global investors shift focus to cheaper markets like China.

Despite high valuations in Indian equities, household savings are increasingly being funneled into the stock market, reflecting a strong domestic investment trend. Hitesh Thakkar, acting chief executive at ITI Mutual Fund, emphasized that investors now recognize that market volatility is part of long-term wealth creation, leading to sustained investment in mutual funds. This resilience in domestic inflows is a key factor supporting India’s stock market amidst global uncertainty.

Sell India, Buy China?

With the MSCI India Index valued at about 24 times forward earnings—more than double that of the MSCI China Index—foreign investors are seeking cheaper opportunities, particularly in Chinese markets.

There is evidence that recent gains in China’s markets have come at the expense of Indian equities. Some foreign investors may be reallocating funds from India to China to capitalize on lower valuations. However, compared to other emerging markets, Chinese equities may not offer the best returns in the near term. Until China shows clear signs of an earnings recovery, cautious investors may be better off diversifying their portfolios away from China and toward other emerging economies.

Read our detailed analysis of Indian Consumption Theme Is Rising: India’s Growing Middle Class & Shift Toward Premium Consumption

Our View on India & China

Despite the foreign investors pullback, we see this correction as an opportunity to increase exposure to Indian equities, particularly large cap stocks in sectors such as financials, consumer discretionary, and industrials. We remain bullish on India's long term outlook. The long term outlook for Indian equities remains strong.

Double digit earnings growth expectations, strong return on equity, and resilient domestic inflows, especially through systematic investment plans, which hit a record in September. Along with that, India’s robust economic growth, favorable demographics, and resilient domestic investor base are key drivers for continued stock market strength. While China's stimulus may offer short term gains, we believe that India’s growth trajectory will remain intact over the long term.