As the Chinese zodiac turns to the Year of the Snake, investors are left wondering what the new year holds for its equity markets. Traditionally associated with wisdom, strategy, and adaptability, the snake offers a fitting metaphor for navigating the twists and turns of China’s economic landscape and geopolitical environment. Here are three pressing questions that will shape the trajectory of Chinese equities in the year ahead.
1) What would Trump 2.0 bring, on trade and more broadly?
China’s growth paradigm since late 2020 has been a two-speed model, a very strong export machine with poor domestic consumer demand. China’s trade surplus hit a record high of about $1 trillion in 2024, while its 10-year government bond yield hit a record low of 1.6% with its economy trapped in a deflationary cycle with weak consumer confidence. President Trump’s re-election and a new trade war, at the minimum, will threaten the sustainability of export growth, as exports to the US is about 3% of its GDP.
How the forthcoming trade war is fought matters a great deal. A modest and gradual increase in tariffs is unlikely to derail export growth, but a strong and swift tariff increase scenario would put considerable pressure on economic growth in the foreseeable future.
The range of outcomes is very wide, and the path to the end game is highly uncertain. Investors need to stay agile and prepared for volatility and opportunities.
2) Can policy stimulus offset tariff impact and rekindle animal spirits?
The narrative changed significantly after the critical policy pivot in the last week of September 2024. While we do believe that we have seen the inflection point in stimulus policy, the follow-through so far has fallen short of investors' expectations.
A crucial reason for the lack of a big bazooka so far is that policymakers don’t yet know which one to bring out. The size of the bazooka is dependent on the severity of the trade war. After the initial shots are fired following January 20th, when President Trump is formally sworn in, they will assess and adjust the size of the stimulus accordingly, and the National People’s Congress in March would offer a timely occasion for them to do so. Much bolder fiscal stimulus focusing on boosting domestic consumption would improve consumer confidence and rekindle the animal spirits.
3) Would capital market reform enhance shareholder return?
One policy directive that investors have not paid enough attention to is what Beijing calls to “invigorate the capital market” and “using the capital market as a lever (to boost economic recovery)”. A better and more efficient capital market serves to achieve two important goals.
First, Chinese households need a new avenue to store, invest, and grow wealth. This role was previously fulfilled by the property market. House ownership is high, and 60% of household assets sit in property. The best days of the property cycle are behind us, and the negative wealth effect of the property downturn is hurting consumers’ willingness to spend. A deep, efficient and transparent domestic capital market with a strong pool of high-quality public companies that can deliver good long-term shareholder return is a very convincing and much needed alternative.
Second, an ineffective and wasteful state-owned banks’ lending driven model is no longer fit for purpose in a technology and innovation driven stage of growth. The bank lending model works fine when growth is driven by funding manufacturers with tangible plants and equipment. However, when the new sources of growth are mostly in innovative industries with more intellectual property and intangible assets, a deep capital market with sophisticated risk takers from venture capital, private credit and equity, and patient long-term institutional investors plays a much more important role in allocating capital efficiently.
China’s efforts to reform its capital market would improve corporate governance, raise the quality of listed companies, and, in turn, boost shareholder return.
Domestic stimulus policy is more important than trade war
In the Year of the Snake. Trump's re-election brings the trade war narrative back to the forefront of many investors' minds. This year is going to be a tug-of-war between domestic policy stimulus and the trade war, which will bring plenty of good investment opportunities that may come with some manageable volatility. How policymakers will apply stimulus policy tools to boost consumer confidence to fight deflationary pressures, and respond to the trade war and its impact on export growth is the most critical driver of equity market returns in China.
The policy pivot at the end of September 2024 was a critical turning point. It signalled that, at long last, the policymakers acknowledged the long-term damage of the deflationary pressure and poor consumer confidence and signalled their willingness to fight. In essence, this put a floor on economic growth and asset prices. What remains to be seen is whether the policy goal is to merely arrest the downturn or to get the economic engine humming again.
A trade war would undoubtedly put pressure on external demand growth, but it could also serve as a much-needed final kick that policymakers need for unorthodox and bolder reflationary stimulus policies, which is a more important driver for asset prices in China.
