Cause To Cheer, Cause To Jeer China Stock Bounce

Morgan Stanley analysts, in a note to clients, say that“markets are likely to remain volatile as the NPC fiscal package is insufficient to break the deflation concern and corporate earnings remain challenged.”

News that cash-strapped China Vanke is talking with banks on a debt swap is generating hope that a default can be avoided. Yet its stumble is a reminder that the property sector is still very much in distress. On Monday, Moody's Investors Service cut China Vanke to a“junk” rating.

“The rating actions reflect Moody's expectation that China Vanke's credit metrics, financial flexibility and liquidity buffer will weaken over the next 12 to 18 months,” says Kaven Tsang, an analyst at Moody's.

That's“because of its declining contracted sales and the rising uncertainties over its access to funding amid the prolonged property market downturn in China.”

The default watch surrounding Country Garden's onshore debt also continues to make unsavory headlines. Hence doubts that China's“around 5%” economic growth target this year is achievable without fresh bazooka stimulus blasts.

Hitting the 5% GDP goal will be“challenging,” says ING Bank economist Lynn Song, pointing to weak consumer confidence in Asia's biggest economy.“Trade is unlikely to be a major engine of growth as well, with global trade growth expected to remain below historical averages, particularly amid rising Sino-US trade protectionism .”

Economists at Nomura Holdings agree that“achieving the 'around 5%' growth target will be very challenging.”

They note that China confronts a“still faltering property sector, the crackdown on local-government debt accumulation in 12 high-risk provinces, the likely significant slowdown of investment in the new energy sector, and the lackluster data so far available for January and February.”

The local government debt piece of China's economic puzzle also faces rising and tougher scrutiny. Xi's regulators are prodding banks to curb their use of mechanisms involved with offshore bonds issued by local government financing vehicles (LGFVs).

The US$9 trillion mountain of LGFV debts is a major challenge to Xi's efforts to deleverage the economy. One recent transaction that raised concerns involved a state-owned company in Guizhou province selling bonds in order to service LGFV debt. The worry is that such practices are more common than many investors may realize.

It's“rare to explicitly issue debt just to repay debt of another entity but implicit subsidies of LGFVs through industrial state-owned enterprises happen all the time,” notes economist Victor Shih, director of the 21st Century
China
Center at the University of California-San Diego.

As Xi and Li seek to deleverage the economy, they face an increasingly precarious balancing act. As global headwinds intensify, Beijing could come under internal pressure to hit the gas anew on fiscal and monetary stimulus.

“China's economy is marred by insufficient domestic demand,” says Emily Jin, an analyst at advisory firm Datenna.

“For years, analysts have urged Beijing to boost consumption's role in China's economy, to little avail. The 5.2% increase in consumer demand in 2023, largely attributed to a low base effect from pandemic consumption levels, may not persist into 2024,” Jin says.

For now, China's deflation trend is cheering many bond investors. In early March, yields on 30-year bonds hit a record low of 2.4%.

Yet Beijing's fiscal spending plans – and its debt issuance plans – mean Xi and Li must tread carefully. China, for example, plans to sell a record 1 trillion yuan ($139 billion) of ultra-long-term bonds. That's more than two times the average issuance between 2019 and 2023.

“The risk of a correction at the long end is high,” notes Goldman Sachs analyst Xinquan Chen.

The recent spike in gold prices could be just as related to fears of Chinese deflation as US inflation, economists say.

“Gold is now the most overbought since March 8, 2022, where it peaked and declined from $2,050 to $1,650,” write Bank of America strategists in a recent note.“While we are not calling for that, it is rational to expect price momentum to slow at some point and/or price to dip in given stretched daily relative-strength-index conditions.”

Intensifying trade tensions ahead of the November 5 election in the US also could threaten China's stock market. The recent drop in Apple Inc's stock as iPhone sales in China fall is a“stark reminder of the ongoing trade tensions between the United States and China,” says Stephen Innes, strategist at SPI Asset Management.

But the most important missing link as investors take stock of the NPC is a bold and specific plan to fix the property crisis. It's vital, analysts say, that Beijing devises a mechanism to get bad assets off property developers' balance sheets.

Whether China cribs from Japan's 1990s bad-loan mess or America's 1980s savings and loan debacle matters less than authorities acting urgently and assertively.

In the short run, China's housing minister, Ni Hong, says regulators intend to support“reasonable” financing needs of real estate developers. Part of the endeavor involves a so-called“whitelist mechanism” to keep liquidity flowing to the property sector, one that can drive about a quarter of GDP.

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Last month, China Construction Bank, one of the nation's biggest state-owned commercial institutions, said it had handled more than 2,000 such projects, approving nearly $2.8 billion of pending disbursements.

Far more aggressive action aimed at ending the crisis once and for all, though, may be needed to keep the China stock bulls running and the confidence to up their bets.

That's not to say Team Xi's splashy pivot toward greater innovation and productivity isn't a“buy” signal. As analyst Tilly Zhang at Gavekal Dragonomics puts it,“facing high debts, the collapse of the real estate boom and the end of its demographic dividend, China needs more productivity gains to achieve decent economic growth in the future.”

Yet, the move upmarket is very much still a work in progress.“Admittedly, the NPC Work Report last week commits to keeping 'money supply and credit growth in step with the real GDP and inflation targets', potentially signaling policymakers will try a bit harder to boost inflation towards the 3% target compared to the previous year,” says Zichun Huang, economist at Capital Economics.

But, Huang notes,“we think China's low inflation is a symptom of its growth model built on a high rate of investment. As reducing dependence on investment is still far off, we expect inflation to stay low in the long run.”

The good news, though, is that efforts to raise China's economic game are beginning to pay some dividends.

“China's economy is weak but it's not that weak,” economist Shaun Rein at the China Market Research Group, told CNBC.

“If you're a multinational, if you're looking to drive growth over the next three to five years, the next China is China. It's not India - India's only a sixth of the GDP of China - it's not Vietnam. These are small markets. So I actually think investors should be looking long-term at China again, it's definitely investible,” he said.

“It's too early to call a bull market, you still have to be very cautious, the economy is still weak – don't get me wrong - again the D word – deflation – looms over China, there is still a weak job market, but the valuations are too low,” Rein said.

Follow William Pesek on X, formerly Twitter, at @WilliamPesek

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