China’s economy has been struggling, despite stimulus efforts by Beijing. Haining Zha, Director of Asset Allocation Research at TD Asset Management, discusses those efforts and why more may need to be done to restore investor confidence with MoneyTalk’s Greg Bonnell.
Print Transcript
[AUDIO LOGO]
After trading close to 5-year lows recently, stocks in China are bouncing back amid optimism that Beijing may make more moves to help the markets. Joining us now to discuss is Haining Zha, VP and Director of Asset Allocation Research at TD Asset Management. Haining, great to have you back on the program.
Thanks for having me.
China's been an interesting space. The markets have been interesting in terms of the doldrums they've been in. A little excitement today over rumors. Break it down for us. What are we seeing in the Chinese markets?
Right now, actually, in the Chinese equity market, there is clear lack of confidence right now. Just to give you an idea, MSCI China right now is trading at around 8 times 4 PE, which is 12%, 12.5% earnings yield. And right now, the Chinese 10-year government bond is trading at 2.4%. So if you subtract the 2, which will give you a sense of the equity risk premium that investors require, that's close to 10%.
So when you compare this number to some of the developed markets, let's say Japan or Europe, for them, those numbers are around 6%. So they're a full 4 percentage points higher. And that 10% equity risk premium is actually broadly in line with Russia. I.e., investors right now is treating China as Russia. So they are not pricing any growth and they are pricing a lot of potential policy risk.
They were seeing a bit of a bounce today. It's just one session. It seems to be on speculation that Beijing may step in and say, OK, this is a situation that we're not going to tolerate much longer.
Speculation, obviously, is key here. And who knows what the markets might do the next day? What could Beijing do? What could the country do to turn things around?
Actually, there is a lot that they can do. It's just, at the moment, they have been holding back in terms of all of their policy at the moment in a piecemeal fashion. So it is not enough to turn around investor expectation. So in order to restore market confidence, they definitely need to do a lot more than that.
What could the-- let's start breaking down some of the moves. You said it's been piecemeal, right? I think for a while now, investors in the global investment community has been waiting for some moves out of China. Oh, we're getting an announcement, and you're like, oh, they lowered this rate, or they tweaked this rate, or they did this, or they did that. What could the big moves look like?
Right. So first of all, just step back. What they have done recently at the end of last year, and also in January, is, at the end of last year, they actually increased the central bank PSL, which is pledged supplementary lending, which is a way to expand the balance sheet. So they expanded by around 500 billion RMB. So that's not a small amount.
But then in January, they kind of want to hold back a little bit. So when it comes to reset medium-term lending rate, they actually hold it unchanged. Then, all of a sudden, the equity market doesn't interpret that signal well, and then the market just goes straight down from there.
And then they sense the market perception changed. And then in the next opportunity, when they do the Reserve requirement ratio cut, they actually cut by 50 basis points, which is a little bit larger than the 25 basis points that investors are expecting. But all of these measures, when it translates into economies or equity markets, they are pretty slow.
And they have some big headwinds coming, for example, in the real estate, and potentially even on the trade front. This is a US election year. We could have some negative headline news on that front as well, which can change investor perception about the Chinese equity market. So in order to turn that around, they really should come with something that directly support equity market.
So that's why the national team is coming into the market buying some amount from the market. But the problem with that is, if you don't give very clear expectation of what you are going to do in the future, they are just-- it's not enough to give investor confidence. So they have to establish a consistent expectation, similar to what Mario Draghi did back in 2012. Essentially, China needs to have its own "whatever it takes" moment.
"Whatever it takes" moment, "whatever it takes" policy. It's often said that the stock market isn't the economy. But when you look at China, they have both underwhelmed for quite some time now.
They feel like they're stuck in the same holding pattern. What do you actually expect out of China's economy? And will that be the thing, if they can get the economy going, then the markets would follow, or vice versa?
Actually, this year, there could be still quite a bit of headwind. So if you break down the economy into different parts-- for example, consumption, investment, and then export-- on the consumption, the latest retail sales data, although on the surface is pointing to 7.4% year over year growth in December, but that's because of a low base in 2022.
So if you take two-year annualized growth, that number has only come down to 2.7%. So before pandemic, their trend growth is anywhere between 5% to 8%. So there is still quite a bit of distance.
And in terms of investment, if you break down the investment, broadly speaking, there are three parts-- real estate, manufacturing, and infrastructure. So infrastructure, the government will lend out more support. So there will be enough credit.
So that part is probably growing at 6%, 7%-- not something to be worried about. But given their very large base, it's very hard to get high-growth number.
On the manufacturing part, as we know, we noticed right now in the economy there is deflation pressure. And in this kind of environment, it's very hard for the manufacturer to further invest because this kind of environment doesn't give them enough confidence. And as to the real estate investment last year, it is down 10% year over year. And this year, the best thing we can hope for is flat. So as you can see, there is still a lot of headwind on the investment component.
With respect to export, right now, the developed economy is going through the good spending slump. That's why the last year, year over year export actually decreased. But this year, given that the US stimulus is on the way down, and also consumers worry about consumer balance sheet is on the way up, there could also be headwinds as well.
Now, when it comes to politicians, policymakers stepping in to try to fix things, there's always the risk that they're going to make a mistake that can make it worse. So in terms of potential policy errors in China, what concerns you? What could happen?
Right. Our biggest concern is China could repeat Japan's mistake. So if you look at China, it has a lot of-- it bears a lot of similarity with Japan in the 1990s, be it demographic trends, be it real estate situation-- they also have trouble in real estate-- and even the hostile trade environment. Back in the '90s, the US was quite hostile to Japanese because of they have large export as well. So on all these fronts, you see the similarity.
And the biggest mistake, in hindsight, is Japan-- Japanese government-- did too little too late. And we worry that this could be the Chinese case as well. So that's why it's important for government to really step out and change that conventional thinking and hit it out of the park. [AUDIO LOGO] [THEME MUSIC]
After trading close to 5-year lows recently, stocks in China are bouncing back amid optimism that Beijing may make more moves to help the markets. Joining us now to discuss is Haining Zha, VP and Director of Asset Allocation Research at TD Asset Management. Haining, great to have you back on the program.
Thanks for having me.
China's been an interesting space. The markets have been interesting in terms of the doldrums they've been in. A little excitement today over rumors. Break it down for us. What are we seeing in the Chinese markets?
Right now, actually, in the Chinese equity market, there is clear lack of confidence right now. Just to give you an idea, MSCI China right now is trading at around 8 times 4 PE, which is 12%, 12.5% earnings yield. And right now, the Chinese 10-year government bond is trading at 2.4%. So if you subtract the 2, which will give you a sense of the equity risk premium that investors require, that's close to 10%.
So when you compare this number to some of the developed markets, let's say Japan or Europe, for them, those numbers are around 6%. So they're a full 4 percentage points higher. And that 10% equity risk premium is actually broadly in line with Russia. I.e., investors right now is treating China as Russia. So they are not pricing any growth and they are pricing a lot of potential policy risk.
They were seeing a bit of a bounce today. It's just one session. It seems to be on speculation that Beijing may step in and say, OK, this is a situation that we're not going to tolerate much longer.
Speculation, obviously, is key here. And who knows what the markets might do the next day? What could Beijing do? What could the country do to turn things around?
Actually, there is a lot that they can do. It's just, at the moment, they have been holding back in terms of all of their policy at the moment in a piecemeal fashion. So it is not enough to turn around investor expectation. So in order to restore market confidence, they definitely need to do a lot more than that.
What could the-- let's start breaking down some of the moves. You said it's been piecemeal, right? I think for a while now, investors in the global investment community has been waiting for some moves out of China. Oh, we're getting an announcement, and you're like, oh, they lowered this rate, or they tweaked this rate, or they did this, or they did that. What could the big moves look like?
Right. So first of all, just step back. What they have done recently at the end of last year, and also in January, is, at the end of last year, they actually increased the central bank PSL, which is pledged supplementary lending, which is a way to expand the balance sheet. So they expanded by around 500 billion RMB. So that's not a small amount.
But then in January, they kind of want to hold back a little bit. So when it comes to reset medium-term lending rate, they actually hold it unchanged. Then, all of a sudden, the equity market doesn't interpret that signal well, and then the market just goes straight down from there.
And then they sense the market perception changed. And then in the next opportunity, when they do the Reserve requirement ratio cut, they actually cut by 50 basis points, which is a little bit larger than the 25 basis points that investors are expecting. But all of these measures, when it translates into economies or equity markets, they are pretty slow.
And they have some big headwinds coming, for example, in the real estate, and potentially even on the trade front. This is a US election year. We could have some negative headline news on that front as well, which can change investor perception about the Chinese equity market. So in order to turn that around, they really should come with something that directly support equity market.
So that's why the national team is coming into the market buying some amount from the market. But the problem with that is, if you don't give very clear expectation of what you are going to do in the future, they are just-- it's not enough to give investor confidence. So they have to establish a consistent expectation, similar to what Mario Draghi did back in 2012. Essentially, China needs to have its own "whatever it takes" moment.
"Whatever it takes" moment, "whatever it takes" policy. It's often said that the stock market isn't the economy. But when you look at China, they have both underwhelmed for quite some time now.
They feel like they're stuck in the same holding pattern. What do you actually expect out of China's economy? And will that be the thing, if they can get the economy going, then the markets would follow, or vice versa?
Actually, this year, there could be still quite a bit of headwind. So if you break down the economy into different parts-- for example, consumption, investment, and then export-- on the consumption, the latest retail sales data, although on the surface is pointing to 7.4% year over year growth in December, but that's because of a low base in 2022.
So if you take two-year annualized growth, that number has only come down to 2.7%. So before pandemic, their trend growth is anywhere between 5% to 8%. So there is still quite a bit of distance.
And in terms of investment, if you break down the investment, broadly speaking, there are three parts-- real estate, manufacturing, and infrastructure. So infrastructure, the government will lend out more support. So there will be enough credit.
So that part is probably growing at 6%, 7%-- not something to be worried about. But given their very large base, it's very hard to get high-growth number.
On the manufacturing part, as we know, we noticed right now in the economy there is deflation pressure. And in this kind of environment, it's very hard for the manufacturer to further invest because this kind of environment doesn't give them enough confidence. And as to the real estate investment last year, it is down 10% year over year. And this year, the best thing we can hope for is flat. So as you can see, there is still a lot of headwind on the investment component.
With respect to export, right now, the developed economy is going through the good spending slump. That's why the last year, year over year export actually decreased. But this year, given that the US stimulus is on the way down, and also consumers worry about consumer balance sheet is on the way up, there could also be headwinds as well.
Now, when it comes to politicians, policymakers stepping in to try to fix things, there's always the risk that they're going to make a mistake that can make it worse. So in terms of potential policy errors in China, what concerns you? What could happen?
Right. Our biggest concern is China could repeat Japan's mistake. So if you look at China, it has a lot of-- it bears a lot of similarity with Japan in the 1990s, be it demographic trends, be it real estate situation-- they also have trouble in real estate-- and even the hostile trade environment. Back in the '90s, the US was quite hostile to Japanese because of they have large export as well. So on all these fronts, you see the similarity.
And the biggest mistake, in hindsight, is Japan-- Japanese government-- did too little too late. And we worry that this could be the Chinese case as well. So that's why it's important for government to really step out and change that conventional thinking and hit it out of the park. [AUDIO LOGO] [THEME MUSIC]