Can China rebound in 2024?

0:102023 was a pretty good year for most global stock markets, but there was a big glaring exception and that was China, which was down more than 10 % in the year, and has not had a particularly good start to 2024 either. Today on the show, why China is stumbling once again. This is Unhedged, the markets and finance show from the Financial Times and Pushkin. I'm reporter Ethan Wu here in New York, joined from London by markets columnist Katie Martin. Hey, man. How are you going? Not bad at all. Now that you are in your columnist role, you can think big thoughts about the world. And I think you need especially big thoughts to think about China, just because it's such a different system.

0:51The market works so differently. The economy works so differently. The policy responses work so differently. So we're going to try to think some, let's call them medium-sized thoughts today about what's going on in that country and what global investors should take away from it. We can achieve that. Medium-sized thoughts, we are on it. That's our highest aspiration here on the OnHedge podcast. guess. So I mean, maybe just to set the stage, Katie, I remember writing a whole bunch in the first few months of 2023 about the big China reopening boom trade. Goldman Sachs is into it. Bank of America is into it.

1:23All the Wall Street sell side people are into it. And they're like, well, zero COVID has ended. China's reopening. There's going to be revenge spending. There's all this pent up demand. There's savings, the trillions of yuan of savings. And there's going to be a huge economic boom, a huge stock market rally. Get in now. And it didn't happen. It so did not happen. It was a massive disappointment for a lot of different investors out there. So if you remember, it's a little bit difficult to remember because everyone's timeframes get like pushed out of whack by COVID and lockdowns. But China was in lockdown much, much, much longer than most other major economies.

1:59And yes, so as you say, there was this big idea that once they come out of zero COVID lockdowns, consumers are going to kind of revenge spend, as you say, and just splash the cash. They did not do this at all. And in addition, you've got this whole rewiring of global trade in the sense that a lot of companies globally are thinking, okay, we got our fingers burnt last time by having all of our manufacturing in China. Let's spread it around the world a little bit. Let's put some in some kind of friendly countries around the world, not rely so heavily just on China. And so for a whole bunch of reasons like that sort of near-shoring, friend-shoring thing, unlike that disappointment from the Chinese consumer that just meant that the China trade did not work last year at all.

2:44The really sad news is it's not working this year either. Yeah. And it sticks out like such a sore thumb, right? So the CSI 300 index is down 5 % already this year. Like, you know, last time I checked, we're still in January. This is such a long month. It's driving me bonkers. Like, I'm doing dry January and it's killing me. Oh, no. Get a kid, you drink ASAP. First day of the day, boys and girls. So, yes, CSI is down 5%. Hang Seng in Hong Kong is down 8%. The Shenzhen Composite is down 12%. These are not good numbers. Meanwhile, you look at Japan, for example, it's up 7 % in yen terms. And that's still two or three in dollar terms.

3:28That's pretty good. The S &P 500 is just like skittling records left, right and center. It's up like 3 % so far this year. Yes, there is a whole thing around, oh, it's just a couple of stocks doing the hard work. And that matters, but it kind of doesn't matter in this context in the sense that it's just that China is really out on its own here. Stocks are doing horribly. Yeah. There have been periods of Chinese stock market slumps before that tend to track general weakness in the economy. I mean, I think the one that's been coming up in some of my reading is in 2015, right? There was a big surge of Chinese retail investor interest in what people called the Uncle Xi bull market.

4:08And then the economy started losing some steam. There was a bit of a demand slump. A bunch of retail investors saw their investments falling. They got pretty discouraged. They had borrowed to get in. And the whole economy entered kind of a period of weakness and the stock market slumped. But then what happened, as often happens in China when there's a soft patch, is the authorities rode to the rescue. And they implemented a massive build-out project, basically just rebuilding, revitalizing all sorts of urban developments across the country. It was a multi-trillion Renminbi stimulus package. And this is historically what happens when the Chinese economy hits a bump.

4:45The problem now, Katie, and we wrote about this a bit today in the Unhedged Newsletter is just the stimulus response has not been quite like it's been in the past. There's not this bazooka or Big Bang style stimulus that we saw in 2007 or we saw in 2015 to 2018. They've been dripping it out. There's been like, we're going to reduce the park fees and we're going to slightly cut the interest rate and we're going to give a tax break to small businesses, like all this piecemeal stuff, right? But the really big, like the central government borrows a lot of money and spends it, that has been slower to come.

5:18It has been slower to come. And generally speaking, it's been trying to sort of fix the symptoms, which is how the stock market's been performing and not actually curing the underlying problems. The biggest of which, by a large margin, is the property sector. Property and construction, all of that stuff accounts for something mad like a quarter of the entire Chinese economy. This is a lot. That's a lot of money. And it's in trouble. So I don't know if you remember, like two years ago, Evergrande, one of the big property developers, defaulted on its debt. And there was this whole, oh, is this going to be the Lehman moment for the Chinese economy?

5:56And is everything going to just collapse in on itself? The answer was no, but we have seen something of a slow burn since then. And so only this week, a Hong Kong court ordered the liquidation of Evergrande, which just tells you this whole thing has not gone away. And there's a whole big question here around, okay, so Evergrande is Hong Kong listed. What does mainland China do with that? How much of this is enforced? There could be like a whole load of lawsuits, all the rest of it. Will China respect the decision of the Hong Kong court? Again, these are details that kind of don't really matter as much as the Evergrande liquidation just reminds casual investors, if you like, that the property issues have not gone away.

6:42No, very much so. And real estate busts happen in all kinds of economies. This is not a feature of the Chinese economy necessarily. This is the story of 2008 in the US in a lot of ways. But there's differences. And one big difference is in 2008, when the US housing bust happened, the Federal Reserve cut interest rates to zero because there was a massive real estate bus going on. The People's Bank of China, by contrast, has cut. There are various interest rates that they control, but one of them you can look at is the so-called seven-day repo rate, which is one policy rate they use. They've cut it from 2.2 to 1.8%.

7:16That is not zero. That is 1.8. And that reflects, as the Goldman Sachs analyst pointed out in a recent note, constraints that Chinese officials are under. For example, with monetary policy. The government likes the renminbi to be stable. But the problem is when you cut interest rates, you tend to put pressure on currency, it can depreciate the currency. So on the monetary policy side, they're sort of caught between, we want to lower interest rates because that will help the real estate sector. But also, we want to keep the currency stable. So we can't cut it that drastically or that quickly. And then on the fiscal side, which would be kind of the main way that you stimulate a flagging economy, there's all this debt built up in local governments, which is traditionally a way that you would have enacted stimulus is borrow at the local government level.

7:59You do a bunch of infrastructure rollout. They're running out of room to do that kind of local fiscal spending. And so I think the story increasingly is one of constraints and conflicting objectives. And it might have to be a situation where there's kind of a muddle through. And muddle through is not quite what market's like. Market's like a ride to the rescue. That's like a vote of confidence. So in lieu of any confidence instilling measures, the authorities have done a bunch of weird stuff to the stock market. That's one way to put it, I suppose. They have made a whole series of seemingly good faith efforts to try and stop the rot here.

8:37So last week, they were talking about a need for forceful measures, and there were certain restrictions put on capital outflows. So making it more difficult for onshore Chinese investors to use various schemes that help them to put money to work overseas. This week, we've seen some limits on short selling. So sort of generally just making it harder to bet against stocks. And that's all well and good. We don't know how much worse the Chinese market would be at this point if those measures weren't there. But I don't know, if you were managing money, would it turn the dial for you? Yeah, there's just something about that, that probably melts the global investor's brain that you're like, people are losing confidence in your stock market because of problems with your economy.

9:23So you have banned people going short on the market and stopped capital outflows. It's bizarre. But on the other hand, in keeping with Communist Party interventions, they've also announced they're going to do the stabilization fund where it's like 2 trillion renminbi of state-owned enterprise money to come in and buy the dip. This is currently being planned and the money's being mustered. But this seems to me like kind of, like you said, Katie, the word is piecemeal. It's a bunch of different small to medium-sized interventions kind of cobbled together to hopefully in aggregate support the market, even though each individual one seems kind of lacking.

10:00But you asked the right question, which is, is it going to be enough that this kind of piecemeal cobbled together approach? Yeah. Is it going to be enough? Where is my bazooka? Where is the big splurge of fiscal and monetary policy response that makes all of this go away. We haven't seen that yet. So global investors are left thinking, okay, are we there yet? Are you ready to get this bazooka out and make this problem go away because it's got bad enough? Or has there been some sort of strategy shift on the part of the Chinese government that means that they're prepared to let this kind of run its course a little bit more before they do anything, if they end up doing anything more at all.

10:41So it's quite a tricky juncture for investors who I think a lot of whom kind of still look at China and say, look, it's got a 5 % growth rate. What's not to like? There's still obviously an investment case there, but timing is everything. And it just feels a little bit at the moment like trying to catch a falling knife in terms of getting in now. Market's down five. What's to say it's not going to be down 10 in another few weeks? The other thing that I think really eats away at global investors' urge to kind of get involved here is, look, why bother when you've got NASDAQ composite up four, you've got the S &P up three.

11:19There are just much - Japan, India. There are just so many easier ways to make money out of global markets where you don't have this hideous combination of structural, economic, regulatory, geopolitical risk. Why be a hero? Why try and pick this up here when you could just end up getting ironed out and not have a very good excuse for your boss at the end of the year as to why you took that decision? So I think a lot of investors, particularly those that had a bad time this time last year on this trade, not panning out, I think I'm just going to sit this one out until the bazooka does come out of retirement and then that could change things.

12:00Yeah. There's been this kind of grand discourse about is China uninvestable? And I feel like it's a little overwrought because there are no markets that are strictly uninvestable. There's always going to be room for some specialist investor to come in and really, really know the details of this market. But I think the question for a generic asset allocator, your big pension funds of the world, is like you said, Katie, can the risks to the Chinese market be slotted into a traditional asset allocation framework? Are the political risks entailed ones that you can quantify or account for? And I think increasingly the answer for a lot of people is no, there is going to be a valuation level at which it makes sense to buy Chinese stocks, but it might just be worth not bothering, especially given plenty of opportunities elsewhere.

12:49You hinted at this in your previous answer, Katie, but there is this complicated mix right now of cyclical economic risks in the sense that do consumers bounce back? How does the recovery go? Can they stimulate the economy? That's kind of like a short to medium term question. And there is also this kind of broader structural conversation about can China pivot from an investment-driven model, right? One driven by like you build a bunch of bridges and rows and infrastructure to a consumption-based model, which is what economists have thought China needs for a long, long time, but China has struggled to pivot to.

13:22The interaction of all those different risks, political, structural, economic, cyclical economic, that's incredibly complex. And it just might be something where picking the bottom is going to be too hard for all but the most focused China specialists. Yeah. I mean, one other thing to think about here, and I'm being sort of slightly galaxy brain on this, but nonetheless, is investors have choices. They don't have to put money to work in China. They do have sort of seemingly safer, easier, more straightforward calls that they can make elsewhere. And if anything, those calls should get easier in the sense that if China keeps suffering economically as it is, then it remains stuck in a deflation problem.

14:06And that is something that it can export all around the world. You know, you have this huge economy, one of the biggest in the world. If it's in deflation, that has to have an impact on other economies around the world. If you take that a stage further, you say, okay, well, this helps to clamp down on inflation in other major economies. And therefore, central banks are on a slightly firmer footing in terms of being ready to cut interest rates, which makes other global markets perform better, which in turn makes China a less appealing investment option. So on the margins, I would say this kind of exporting of deflation just hurts it on two fronts.

14:45First of all, from the domestic economy point of view, and second of all, from the point of view of helping other big markets. Again, I might be overthinking that, but I think it's something to bear in mind. Katie, this is a thought too big for the Unhedged podcast. We promise the medium-sized thoughts only, and you've gone far too big beyond our mandate. I don't know if I can handle this. You can do it. I'll try my best. All right, Katie, we'll be back in a moment with Long Short.

15:13Welcome back. This is Long Short, that part of the show where we go long, a thing we love, short, a thing we hate. Katie, I'm keeping the China focus going. I am short snowballs. And this does have to do with China. It's not just me being annoyed with the New York weather this time of year. But we had a story in the FT a couple of days ago about so-called snowball derivatives, which are these contracts that make money as long as Chinese stocks do not go down too far. What's happened in the past couple of years, Chinese stocks have gone down too far. A bunch of retail investors who bought snowballs, which give you kind of a certain income payout, again, given stocks trading within a certain range, they've not done so well.

15:50People are nursing losses on these derivatives. I think, rule of thumb, if someone's trying to sell you a derivative contract and it has a cute little name like snowball just say no yeah i'm short yeah it sounds bad i'm also short snowball derivatives i am limit long however the pastor in colorado who he and his wife got dinged by the colorado sec which i confess i did not know was a thing but anyway they got dinged for running a crypto scam and the pastor made a video i don't know, about a week or 10 days ago or something, who was saying, the accusation against me is that we sold a cryptocurrency predominantly to Christians and that the whole thing was a scam.

16:35And I'm paraphrasing here, but he said, that's true. This is all true. However, the Lord told me to do it. Which, as defenses go, I'm very much here for. This is very good. So he and his wife siphoned off like$1.3 million or something from this scheme that they used on a home extension. Allegedly. Again, he did that because it was the specific instruction from God, who I would have thought would be a bit busy to really get too deeply involved in people's home renovation plans, but apparently not. I believe the latest he said on this is that he might have misheard God. It happens to the best of us.

17:18The Lord told me marble countertops. What can I do? Maybe I misheard him. Crypto is the gift that keeps on giving. And, you know, if it wasn't for this, where would we get our kind of laughs? You know, I just... What would we have for long short if not for crypto? What would we have for long short? You're along like the never-ending bountiful stream of long short content that comes from the crypto world. The Lord told me to be long this in long short. Such are the mysterious ways that he works. All right, Katie. Thanks for being here. We'll have you back very soon. And listeners, we're back in your feed on Thursday with another episode of Unhedged.

17:58Catch you then. Unhedged is produced by Jake Harper and edited by Brian Erstad. Our executive producer is Jacob Goldstein. We had additional help from Topher Forges. Cheryl Brumley is the FT's global head of audio. Special thanks to Laura Clark, Alistair Mackey, Greta Cohn, and Natalie Sadler. FT premium subscribers can get the Unhedged newsletter for free. A 30-day free trial is available to everyone else. Just go to ft.com slash unhedged offer. I'm Ethan Wu. Thanks for listening.