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"Mad Cow" Market Turmoil: Global Capital's Perspective
Stimulated by an unprecedentedly strong market-stabilizing signal, by the end of the National Day holiday, the MSCI China Index and the CSI 300 Index had rebounded by 36% and 27% respectively from their September lows, shocking the international market. According to Goldman Sachs' calculations, this is one of the strongest and most concentrated rebounds since the launch of the two indices in 1993 and 2005. This wave of gains is equivalent to 8 standard deviations, adding over $3 trillion in market value to the market, calculated based on the average weekly return since the establishment of the indices, equivalent to 20% of China's nominal GDP in 2023.
However, after the National Day holiday, market sentiment changed dramatically. On October 8th, A-shares opened with a daily limit up, and then the "crazy bull" fell into turbulence, with the Shanghai Composite Index retreating from 3674 points to 3301 points at the close on October 10th.
Morgan Stanley's Chief Equity Strategist for China, Wang Ying, recently mentioned at a client meeting that before this round of pullback, the valuation of the MSCI China Index quickly recovered from 9 times to 12 times at the time of the "pandemic restart trade", fully recovering to the average of the past 5 years, even slightly exceeding it. However, earnings have not improved, so further rebounds must rely on further support from fiscal policy, especially the improvement of economic fundamentals and deflationary trends, the stabilization of quantity and price in the real estate market, and the transmission to the recovery of corporate earnings.
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Hot money comes in and out quickly, while long-term money waits and watches.
This round of increases mainly started with the joint press conference on September 24th, with reserve requirement ratio cuts, interest rate cuts, existing mortgage interest rate cuts, and the sudden emergence of 800 billion yuan of swap facilities. A series of major moves contrast sharply with the previous cautious policy stance, igniting the market.
First Financial Daily reported at the time that international funds (especially hedge funds) began to flood in on the 24th. Between September 25th and October 2nd, about $6 billion in passive funds had flowed into the Chinese stock market. However, the incremental funds of active funds (especially public funds) were very small, only about $300 million, indicating that active investors have not yet entered the market on a large scale.
"Wall Street's FOMO sentiment towards the Chinese stock market was very strong before, with the share prices of Hermès and LVMH soaring, and the expectation of a rebound in China's wealth effect driving luxury consumption sentiment. The positions related to China were too low before, and now they think they should make up some positions. Overseas funds that can't buy A-shares will buy more Chinese Internet companies or consumer goods companies in the offshore market, with Meituan, Baidu, JD.com, Pinduoduo, etc. being the main targets," said a U.S. mutual fund mid-cap fund manager to First Financial Daily reporters around the National Day holiday.
Data before the National Day holiday showed that hedge funds' positions in the Chinese stock market were only 6.8%, a five-year low, lower than in February this year, and about 1% lower than the high point in April-May this year, leaving plenty of room for increase.
However, hot money also showed signs of profit-taking during the National Day holiday. According to a trader report from Goldman Sachs Group, hedge funds sold a record amount of Chinese stocks on Tuesday (October 8th), which was a selling wave caused by the lack of stronger stimulus policies after a week-long holiday.The report indicates: "Hedge funds not only closed their long positions but also added short positions to their portfolios, selling long positions at twice the rate of shorts." The largest single-day withdrawal of funds in hedge fund history intensified market volatility on Tuesday as traders returned to the market after the National Day Golden Week holiday. The National Development and Reform Commission (NDRC) failed to meet market expectations for more aggressive stimulus policies, leading to sharp fluctuations and record trading volumes in mainland and Hong Kong markets.
The intense market movement during the National Day holiday also led to subsequent profit-taking. Hong Kong stocks saw record trading volumes from October 2nd to 4th, with the Hang Seng Index rising by 7.59% during this period, and the Hang Seng Technology Index increasing by 10%. The "bull market flag bearer" securities stocks普遍 saw gains ranging from 50% to 100% or even higher.
Goldman Sachs stated that on October 8th, the NDRC's press conference did not announce any significant incremental policies. The only quantified incremental information was the NDRC's mention of planning projects for 2025 in advance, with plans to initiate 100 billion yuan worth of strategic and national security projects in 2024 ahead of schedule, along with 100 billion yuan of budgeted investments. This is quite modest compared to the market's expectation of an additional fiscal stimulus of 2 to 3 trillion yuan. When asked about new quotas after the distribution of 2024 local government special bonds at the end of October, NDRC officials did not indicate new quotas for November and December, but mentioned "focusing on the use of bond proceeds."
The fluctuation mode has begun, with limited downside space.
The pullback was not unexpected. On the eve of the National Day, international investment banks generally believed that the MSCI China Index and A-shares had a technical upside potential of 10% to 15%, which was achieved in just one or two trading days.
Wang Ying stated that before the pullback occurred, A-shares, Hong Kong stocks, and the MSCI China Index had fully recovered to the average of the past five years in terms of forward price-to-earnings ratios from 12 months ago, even slightly exceeding it. This indicates that the overall market valuation has returned to the historical average state.
However, the significant pullback in recent days may also mean that the market will regain space for upward movement or range-bound fluctuations. Morgan Stanley believes that compared to the broad market, the valuation repair of growth stocks is relatively lagging. For example, the Hang Seng Technology Index valuation is still discounted by 27% to 37% compared to the average of the past five years. This means that although the broad market valuation has recovered, growth stocks still have a considerable repair space.
BlackRock's outstanding fund manager, Bi Kai, told reporters: "Unlike the situation in the first half of 2024, we tend to believe that this round of upward movement has strong policy objectives to support it, and there is still room for policy to exert more effort. Therefore, we tend to believe that the possibility of the market moving down rapidly in the short term is not very high."
However, he also believes that the recent rapid rise in the stock market, driven by a series of pro-economic policies, is mainly characterized by an increase in valuations, with no significant changes in the earnings expectations of listed companies.
"Looking forward to the next 2 to 3 months, we expect the market to enter a phase of observing the trend of economic fundamentals' improvement. If there is a clear improvement in economic fundamentals, the index still has room for further upward movement. On the contrary, if the economic fundamentals do not effectively respond to the policies, then further policy efforts will be needed for support; otherwise, the index will face certain pressure for adjustment."Fiscal Expansion and Profit Improvement Are Key
Major investment banks believe that corporate earnings will continue to face pressure in the next two quarters, as the market can only ignore this fact if there is fiscal stimulus that meets or exceeds expectations, and the realization of profits is necessary to maintain the rebound.
Wang Ying stated that in the past five rounds of stock market increases, only the one from 2016 to 2018 was driven by profit growth, while the other four mainly relied on valuation repair. Supply-side reforms, consumer expansion, and the development of the internet were the main drivers of profit growth from 2016 to 2018. The average performance of the five stock market trends: from the bottom to the peak, it took an average of 231 days, with an increase of 66%, of which valuation repair accounted for 50% to 60%.
The current bull market is characterized by a scale and market performance that cannot be compared with the historical average of the five times, but it has already exceeded the wave of the market from February to May this year.
The first stage of the current market rise was driven by low-cost funds and stock buybacks for valuation repair, but this stage has ended; the second stage is confidence-driven valuation repair, that is, the market gradually believes that China has the ability to recover from deflation, and the valuation discount has narrowed from 30% to 13%. The rise in this stage mainly relies on the promotion of market sentiment, without actual profit repair; further rises in the future need to see signs of macroeconomic stabilization, especially focusing on real estate inventory and sales, as well as data on consumer and credit demand. Although profits in the third and fourth quarters may be disappointing, the market hopes to see a recovery in profit growth in the first half of 2025. If there is no profit support at that time, the bull market may be difficult to sustain, similar to the past few rounds of short-term increases driven by valuations.
On October 12, the Ministry of Finance will hold a press conference, and the scale of fiscal stimulus policy will become the focus of attention.
UBS China's special chief economist Wang Tao said to reporters: "We believe that a more reasonable expectation is that the government will introduce a relatively moderate fiscal stimulus policy of 1.5 trillion to 2 trillion yuan in the short term; at the same time, on the basis of previous forecasts, the broad fiscal policy support in 2025 may expand by an additional 2 trillion to 3 trillion yuan. Important policy timelines may include: fiscal stimulus policies this year may be introduced after the 'National Day' Golden Week holiday or around the release of third-quarter data on October 18, and fiscal stimulus policies for 2025 may be discussed and decided at the Central Economic Work Conference held in December 2024."
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