Equities: New extremes and a challenging opportunity set
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Chief China Strategist
Summary: Summary: The press release statement from China’s Politburo generated much excitement among investors and analysts about ending of crackdown on Chinese internet companies and stepping up of fiscal and monetary stimulus. Much of the hype, however, is prone to fade.
The Politburo meeting on April 29 generated much hype about Chinese internet companies. The Chinese Communist Party’s (CCP) Politburo held a meeting chaired by President Xi Jinping on April 29 to review the talent and human capital development in the country’s 14th Five-year Plan. The news release from the meeting came in noon time, earlier than the more typical time at the 7p.m. national news broadcast. The earlier than usual timing gave the market time to react to it before the three-day labour day holiday. The news release sent the Hang Seng TECH Index (HSTECH.I), which consists of mega-cap Chinese internet companies, surging 10%. E-commerce giants Alibaba (09988), JD.COM (09618) and Meituan (03690) climbed over 15%.
Investors rushed to buy Chinese internet stocks as they found in the release that the CCP spoke about intending “to facilitate platform economy (i.e. e-commerce and other internet platform) to develop healthily, to complete the targeted reconfiguration of platform economy, to implement regular supervision, and to launch practice guidelines in support of the regulated and healthy development of the platform economy”. Some analysts cheered “green light” from the Chinese authorities and claimed that buying Chinese internet stocks representing asymmetric upside potentials.
China started tightening regulations over internet companies in second half of 2020, aiming at cracking down on anti-competition and monopolistic behaviors, data security risks and predatory online lending. Moreover, the move was probably rooted in the CCP’s desire to regulate private capital in a political regime and governing ideology of collective ownership of the factors of production remaining the foundation of the economy. After over a year of crackdown which had sent shares of Chinese internet stocks much lower, President Xi remarked in the CCP’s Central Economic Working Conference in December 2021 that private capital was to shrink or grow in according to the red light green light spelled out by the CCP. Private capital’s positive functions are to be recognized while negative impacts are to be minimized. Did the CCP just say green light last Friday?
On April 27, 2022, the Standing Committee of the State Council convened. In its news release, the State Council mentioned facilitating the healthy development of the platform economy so as to create more employment. It did not create much hype back then in the stock market. The Politburo news on April 29 had a much larger market impact probably because investors gave much weight to the remark that targeted reconfiguration was to become regular supervision. However, on Saturday, April 30, 2022, a news release was announced that on the very afternoon of April 29, President Xi led a study session of the CCP’s Politburo and proclaimed the importance of regulating and guiding the healthy development and positive function of capital as a factor of production. President Xi said that the CCP had strengthened anti-trust and prevented private capital from disorderly expanded. He reiterated the need to set up red light and green light and to further strengthen the supervision against monopolistic and anti-competition behaviors. The Chinese companies, and their investors likewise, are basically put on the game of red light, green light. The regulatory environment of Chinese internet companies has not become as certain and risks have not turned as asymmetric as some analysts suggested last Friday. The hype may not last.
Greenlight to local governments to boost the property market if they can. While the April 29 Politburo meeting reiterated the principle of “housing is for living, not for speculating”, it gave greenlight to local governments to devise customized local based policies to support basic as well as upgrading demand for housing. The Politburo’s statement also mentioned optimizing the regulation of presale deposits, making it easier for developers to get access to such deposits which could account for as much as 50% of those developers’ funding need for projects. The endorsement for local governments’ efforts to support the struggling property sector is a positive development, which will embolden more local governments to roll out all kinds of piecemeal support measures to home buying and boost home sales.
However, the Politburo was silent on the three-red-lines policy (debt to asset ratio after excluding advance payments >70%, net debt ratio >100%, Cash to short-term debt ratio <1x) that keep weaker developers from getting financing and the two-red-line policy (limits of real estate loans and individual housing loans) that cap banks’ lending to developers and home buyers. Given the Chinese authorities’ determination not to blow up a real estate bubble again and their goals of restructuring the economy and maintaining stability, it is unlikely for them to relax those red lines.
Despite the effort of the local governments to boost home sales, home sales in yuan fell 22.7% in Q1, 2022. Home sales area fell almost 50% in the 30 largest cities in April 2022. With household income suffering and people’s mobility being restricted in the midst of Covid-related lockdown, local governments’ initiatives are having limited effects on stabilizing the property market until the pandemic fades somewhat.
Comprehensively stepping up infrastructure construction. On April 26, 2022, President Xi Jinping chaired a meeting of the Central Committee for Financial and Economic Affairs, in which, he told officials from a number ministries to comprehensively strengthen and increase infrastructure construction, especially for transportation, energy, and water management. He also called for broadening of long-term financing channels for infrastructure projects. The April 29 Politburo meeting reiterated this strategy of rolling out infrastructure to support the faltering economy.
We have no doubt that China attempts to step up infrastructure construction. Nonetheless, with depressed land sales revenues and Covid outbreaks, local governments are having difficulties in securing the necessary financing to spend on infrastructure construction. The central government is encouraging local governments to front load their borrowing but the room for the latter to maneuver is limited given the stretched fiscal conditions of many of them. To bring about meaningful increase in infrastructure construction, China may need to adjust its fiscal budget and issue long-term special infrastructure bonds to finance infrastructure projects as it did between 1998 and 2000 and in 2008. Moreover, in areas that are affected by lockdown, infrastructure construction are simply impossible to carry out. When we see China making adjustments to the 2022 budget and issuing more bonds, and fading of the Covid-19 outbreaks, we will be more constructive to investing in companies that are going to benefit from the infrastructure boom in China.
What are inside the monetary toolbox. In its statement of the April 29 meeting, the Politburo pledged to use well all kinds of monetary policy tools. It emphasized the use of quantitative measures to create credits and increase liquidity. The People’s Bank of China (PBoC) currently still have RMB 500billion retained earnings that it has planned to transfer to the Government which can in turn spend on infrastructure construction. Relending is another tool that the PBoC will use increasingly to provide structured credits to designated segments of the economy. Last week, the PBoC rolled out a RMB 200 billion relending programme to refinance banks’ lending to innovative small and medium-size technology companies. It is also going to provide a RMB 40 billion in a relending programme for old-age care. It is also launching factoring programmes to support the transportation and logistic industries. Having revealed in its action of withholding from cutting policy rates in April and shedding the reserve requirement ratio (RRR) by a uncharacteristically small amount of 25 bps, the PBoC seems adopting a highly measured approach in more broadly based monetary tools as the U.S. Federal Reserve is taking to high gear in tightening monetary policy.
China’s PMIs signal accelerating contraction of the economy. China’s April manufacturing PMI fell to 47.3 from March’s 49.5. Non-manufacturing PMI dropped to 41.9 from 48.1. The service sector was hit the hardest by the pandemic. The services sub-index fell to 40.0 from 46.7. Shippers’ delivery time sub-index fell to 37.2 from 46.5, signaling serious worsening in the disruption to supply chains. New export orders sub-index declined to 41.6 from 47.2, showing increasing likelihood of plummeting exports in the coming months. April Caixin Manufacturing PMI, which has a sample covering more small and medium private enterprises in the coastal areas came at 46.0, versus 48.1 last month.
Dynamic Zero-Covid policy unwavering. China’s politburo reiterated its dynamic zero-Covid policy while pledged to minimize the pandemic’s impact on the economy and society. Currently there are more than 40 cities accounting for approximately 35% of China’s GDP are under lockdowns or some restriction on people mobility. The damage to the economy is enormous and the secondary goal of minimizing the pandemic’s impact on the economy is difficult to meaningfully achieve. After the number of local cases has been falling, Shanghai has relaxed its restriction on people mobility somewhat. Of its 25 million residents, now 15 million of them are allowed to leave their homes and move within their restricted local communities. The Covid breakouts and China's reaction function to such breakouts remain the key driver for the direction of the Chinese economy.
What happened to the future?
What happened to the future?
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