With many having characterized China as “uninvestible” just a few months ago, investors’ enthusiastic response in recent weeks to a perceived shift in the authorities’ policy reaction function is also likely to be an overreaction. It grossly oversimplifies the competing priorities of a country with internal imbalances, inefficient resource allocation channels, and exposure to further geopolitical tensions.
“Buy everything China” is how one investor argued should be the markets’ reply to signs out of Beijing that the leadership was more open to adopting major stimulus measures. The value of Chinese stocks soared by almost 40% in 10 trading days. Massive inflows of foreign investor funds suddenly replaced what had been persistent and cumulatively large outflows for well over a year.
Judging from history, investors had good reasons to exchange their protracted caution for a sudden bout of exuberance. If finally willing, China has the ability to deploy a “bazooka” type of policy response centered on large fiscal stimulus which, judging from the experience of the Global Financial Crisis, promises to have a meaningful effect on the economy. The resulting market moves would be seriously augmented by portfolio positioning which had foreign investors significantly underweight Chinese exposures relative to their benchmark.
As compelling as this seems, it runs against China’s economic logic.
Encumbered by serious imbalances in some sectors such as property and local governments, the country needs a patient period of careful deleveraging and reforms. Absent that, a bazooka would risk accentuating pockets of overleverage, add to excessive indebtedness, and further undermine the efficient allocation of resources throughout the economy.
Given this reality, it should not come as a great surprise that the authorities opted for a limited stimulus that has disappointed markets. Rather than the big stimulus to energize household consumer confidence and shake the economy out of its funk, the policy response seeks to contain the risks of a serious economic slowdown — that is, more of an insurance policy than a bazooka, and one that makes sense in view of China’s persistent and possibly worsening tensions with the US.
Yet markets still seem to be holding out for a lot more. In doing so, they are failing to recognize two realities. First, and as a friend said recently, China cannot fix its micro problems with macro tools. Second, the required micro tools need time for formulation and impact.
Absent these two things, investors will be disappointed — either because the bazooka never materializes or, if it does, worsens the structural and financial imbalances that had led them to deem China uninvestible only a few months ago.
A message from Advisor Perspectives and VettaFi: To learn more about this and other topics, check out some of our webcasts.
Bloomberg News provided this article. For more articles like this please visit
bloomberg.com.
More Asian/European Markets Topics >