Fragmentation game: China cuts repo rate, more stimulus is coming Fragmentation game: China cuts repo rate, more stimulus is coming Fragmentation game: China cuts repo rate, more stimulus is coming

Fragmentation game: China cuts repo rate, more stimulus is coming

Peter Garnry

Chief Investment Strategist

Summary:  Chinese equities have underperformed equity markets such as Mexico, South Korea, India, Malaysia, Japan, Indonesia, and Vietnam by 12% this year as global investors are increasingly getting worried over Chinese growth and signs that some manufacturing is being moved away from China to mitigate geopolitical risks. We revisit our fragmentation game theory with a look at Chinese equity performance this year and news that policymakers are warming up to more stimulus to kickstart the Chinese economy.

Key points in this equity note:

  • Chinese equities started the year on a strong note as global investors were betting on the Chinese reopening to fuel equities and the economy.

  • Since late March the economy has slowed down further and global investors have increasingly been reducing exposure pushing Chinese equities lower against countries that are benefitting from the global risk-reduction moves in manufacturing.

  • China’s credit demand weakened further in May and the central bank cut the 7-day repo rate today while broader pro-growth initiatives are being contemplated.

Can Chinese stimulus finally get the economy going again?

It started so well this year as China lifted its strict zero-Covid policies with global investors betting on China’s reopening fuelling an equity market rally. Chinese equities outperformed a group of equity markets (*) by 8% by 27 January 2023, but optimism quickly faded. By late February relative outperformance had disappeared and until late March Chinese equities managed to hold on to gains at par with other key emerging markets as economists and investors were willing to give China’s economy the benefit of the doubt.

However, by late March the Chinese equity market has severely underperformed the countries that we deem are benefitting the most from our fragmentation game thesis which we presented in our Q2 2023 Outlook. The fragmentation game is basically the reorientation and reconfiguration of the global economy as the world is moving towards a bipolar world with two blocs led by the US and China. In this framework key manufacturing that is within national security policies of Europe and the US will be moved away from China and either back domestically or to other countries in order to reduce reliance on the other bloc.

China’s economy has continued to struggle and policymakers in China have increasingly voiced concerns and intentions of implementing policies to stimulate growth. Credit data for May showed that Chinese credit demand cooled in another sign that economic activity is not picking up. At the same time the country is confronted with high youth unemployment and structural weakness in its real estate sector. Recently, the government has cut the reserve requirement for Chinese banks and today the PBOC has cut its 7-day reverse repurchase rate by 10 basis points to 1.9% in a sign that the Chinese central bank is warming up to further monetary easing. Tax breaks and other pro-growth initiatives are being contemplated by the Chinese government our relative basket performance (see chart) will be a good future indicator on how the market is weighing the fragmentation game dynamics vs Chinese pro-growth policies to stimulate the economy.

(*) The group of equity markets that we are benchmarking Chinese equities against are Mexico, South Korea, India, Malaysia, Japan, Indonesia, and Vietnam

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