China’s deleveraging campaign is completely misguided and could constrain corporate profitability, says Canadian research firm
- Chinese equities are cheap, but over-saving, excessively tight funding and weak pricing power will continue to weigh on corporate profits, according to Alpine Macro
- A sustainable stock market rally would first require aggressive pro-cyclical fiscal policy and persistent monetary stimulus from Beijing, both of which are possible but unlikely
China’s corporate earnings have run below potential in the past decade due to a deleveraging campaign by authorities who believe excess stimulus promoted indebtedness and barring a reflationary push, bonds will continue to outperform stocks, a Canada-based global investment research firm said in a report.
“There is no question that Chinese equities are cheap, but over-saving, excessively tight monetary conditions and weak pricing power have and will continue to weigh on corporate profits,” the report from Alpine Macro said. “More worryingly, the secular pattern of the Chinese equity market resembles that of the Japanese equity market after the 1989 crash.”
It also warned that the economy runs the risk of Japanisation – a term that describes Japan’s two-decade battle against deflation and stagnant growth.
The Hang Seng Index has lost 7.1 per cent this quarter, while the CSI 300 Index of onshore stocks has fallen 10.2 per cent, according to Bloomberg data, making them the worst performers among stock benchmarks globally.
In this context, the Alpine Macro analysts said Chinese stocks could bounce after an underperforming streak since 2021 and that a sustainable rally would first require aggressive pro-cyclical fiscal policy and persistent monetary stimulus, both of which are possible but unlikely.
This is in light of the post-global financial crisis policy stimulus being blamed for the build-up of leverage that created economic and financial fragility, the report said.
“It is not an exaggeration to say that China has experienced a lost decade as far as corporate earning power is concerned, due in part to the misguided deleveraging campaign and tight money,” it said, adding that the country’s 45 per cent savings rate, the highest in the world, was driving up the debt-to-GDP ratio as the domestic equity market played a minor role in allocating domestic savings.
It contrasted the corporate financing structures of the world’s two biggest economies. In China, loans dominated with an over 80 per cent share, with the rest contributed by the stock and bond markets. In the US, it was the stock markets that dominated with more than half the financing coming from equities, with loan markets contributing a little below 40 per cent and bond markets bringing in the rest.
It estimated that China’s deleveraging campaign and overly tight money have caused the economy to undershoot its potential by half a percentage point per year for the last 10 years.
Still China’s debt ratios are not quite as high compared with the private and public sector debt of Japan and US, or the household debt of South Korea, France and Canada.
“Does China have a serious debt problem? No. The so-called Chinese debt problem is, in fact, a hoax.” it said.
Therefore the deleveraging campaign was “misguided” and “such a policy can only drive economic growth far below its potential, constraining corporate profitability and sustaining very low inflation or deflation,” said the firm’s analysts, led by Chen Zhao, chief global strategist.
“We don’t see the mindset of Chinese policymakers changing any time soon. Their recent response to anaemic growth has been abstemious rate cuts, which will do nothing to curb the country’s mounting over-saving problem,” he said.
The report comes as China’s reopening trade has lost momentum, with economic performance falling short of expectations after Beijing lifted its zero-Covid policy last December.
China’s measured response to its faltering economic data has forced investors to move to other markets such as India and Japan, with foreign investors having sold 2.6 billion yuan (US$358.4 million) worth of mainland stocks in the second quarter this year.
In addition, the geopolitical risks on Chinese stocks will remain high as “the US and its Western allies try to contain, and ‘de-risk’ from China”, Zhao warned in the report.
