Chinese stocks rally, then crash – what happens next?

The Year of the Dragon is said to bring good fortune, but investors in Chinese stocks may be wondering whether this year will also bring adversity and market volatility.

In late September, China's central bank announced its most dramatic stimulus measures since the Covid-19 pandemic, cutting borrowing costs to boost the struggling real estate market. Meanwhile, measures to increase stock market liquidity boosted domestic equities, with the CSI 300 and Hang Seng witnessing rapid rallies. This spread to stocks exposed to China, such as European luxury companies.

But the exuberance didn't last, as questions about what Beijing wanted to do next grew. Chinese stocks suffered huge losses on October 9, with the CSI 300 plunging 7.1% – the biggest one-day decline since 2020. All eyes now turn to Saturday, when the Finance Ministry will hold a press conference to make the announcement what additional business support measures are available to increase consumer and business confidence.

Expect higher volatility in Chinese stocks

Nicolò Bragazza, Associate Portfolio Manager at Morningstar Investment Management, believes that after such a strong market performance, a decline is to be expected. “The rally was driven by a significant shift in market sentiment, which was at very low levels following the announcement of new support measures,” he says. “An example of how depressed sentiment has been in China is the performance of Chinese stocks during the stock sell-off in early August. Chinese stocks were little moved due to already low valuations.”

As the market waits for more clarity on the impact of future policies, Bragazza does not rule out the possibility that significant fluctuations will once again lead to sharp swings in sentiment. “The role of fiscal policy is particularly important, not only because investors pay close attention to it, but also because balance sheet recessions require this type of support, as monetary policy could prove less effective without coordination with fiscal policy,” he explains.

He continues: “If the government disappoints, we may see a further decline in Chinese equities, but we believe the long-term rationale for such a position remains intact, largely driven by the strong disparity we see between the “See company fundamentals and company fundamentals.” their valuations.”

What triggered the rally?

The rebound, which sent China's stock market soaring after years of stagnation, was fueled by authorities' announcement of several measures, including a cut in mortgage rates for existing homeowners and additional liquidity for stock purchases to investment firms and asset managers

“What has developed in the last two or three weeks is a change in the narrative. “It's more of a shift in sentiment because policymakers finally capitulated and changed the policy narrative to be more pro-growth and stimulative,” said Jerry Wu, manager at Polar Capital China Stars Fund, which has a Morningstar Medal Rating of Silver. “But much of this narrative shift has now been digested. Many of these reassessments occurred very quickly and in a short period of time. “We have now reached the point where politicians have to act,” he adds.

Wu believes Chinese authorities still need to provide concrete fiscal stimulus to deal with deflation and fragile consumer sentiment: “We're confident that the kind of narrative U-turn a few weeks ago means they're pretty decisive are to get out of this deflationary downward spiral.” Spiral.”

In this policy-driven market, Wu hopes Saturday's announcement will lead to further recovery for Chinese companies. However, he attaches great importance to China's policies towards consumers and property owners ensuring a sustainable recovery for the economy and the stock market.

“The reason consumer confidence is very low is because their balance sheets are declining. 60% of the Chinese population owns real estate assets. But in the last two to three years, real estate prices in China have fallen by 30 to 40 percent across the board,” says Wu. “So if 60% of your balance sheet goes down and you don’t see the end of the downward price reduction, you’re not going to spend even if you have quite a bit of savings.”

What do Chinese investors want to see?

Sharukh Malik, portfolio manager of the bronze-rated Guinness China A Share Fund, welcomes these initiatives but believes consumer support should be a priority as it has been neglected in the past.

“When the government has tried to help the economy, it has tried to help businesses first and not consumers directly. A trading program was announced a few months ago. If you have an old washing machine or TV, you can trade it in and get a subsidy to buy a new one,” he says.

Although he supports this trade-in program, Malik notes that it is only worth 0.3% compared to retail sales last year. In his opinion, this package needs to be significantly expanded. “There are other ways to support consumers, so consumer vouchers are fairly new,” he says. “The government distributes cash that can be spent on restaurants, hotels and cinemas. We've seen Shanghai donate $71 million to its residents in recent weeks. That sounds like a big number, but it’s tiny compared to retail sales.”

Malik expects the government to expand its support through the issuance of government bonds that will allow it to raise capital for a larger trading program, as well as “cash-for-clunker” programs that could enable the public , to trade used cars for lump sums to encourage the purchase of used electric vehicles.

“What they have done so far makes sense, but it needs to be expanded. And of course, no one really knows (what they're going to do). Will it be announced tomorrow or next week? But I can see the path to growth because the government makes this clear in its statements,” explains Malik.

Is China the next Japan?

For Sandy Pei, portfolio manager of the bronze-rated Federated Hermes China Equity Fund, any decisions on fiscal stimulus must address deflation to prevent China from following in Japan's footsteps. “The stock market is about trust, and we talk about how cheap China is,” she says. “Then why are people still not buying? Because they don't have trust. When trust is regained, the economy can function on its own. But if you let things continue on their own, we will become like Japan, because the market will slowly digest itself, and once this perception takes hold, things will become cheaper every day.”

Pei points to the Japanese real estate market, where yields of 20% are still not appealing to new buyers worried about housing price weakness. “In Japan, they don’t believe property prices can ever rise because they’ve seen it for so long. And that is very dangerous.” According to Pei, Chinese authorities need to act as quickly as possible to ensure that consumption is a greater driver of economic growth.

Which Chinese stocks should you pay attention to?

One stock that boosted Pei's portfolio during the rally was digital brokerage and asset management company Futu Holdings FUTU. Year to date, the stock's share price has increased by 115.42%. “Their business is leveraged in nature, so their profits will increase exponentially because trading volumes have increased so much. They opened so many new accounts. So far, the two-week rally has been driven by retail investors and passive buying,” she says. Pei also saw its investment in beer and dairy companies increase during the rally as the market priced in a possible consumer recovery.

Malik also saw many of the lesser-known names in his portfolio pushed to the top. Manufacturer Jing Chang Mechanical, consumer chip company Syna Wealth and industrial automation equipment maker Shenzhen Innovision Technology rose during the bull run.

The top 10 stocks in the Morningstar China Index also saw their total returns increase, with JD.com JD (56.58%), PDD Holdings PDD (55.26%) and Meituan MPNGY (51.56%) leading the way .