China stocks look attractive relatively to bonds as prospects of policy support emboldens risk-seeking investors

Chinese government bonds’ long streak of outperformance may be drawing to a close and gains could moderate as investors eye cheap valuations in the stock markets with the lure of a potential stimulus likely to drive an equity rally.

The performance divergence between the two asset classes could be ending as stocks become more appealing on prospects of supportive measures to revitalise growth in the world’s second largest economy. The CSI 300 gauge has slipped 0.1 per cent this year, while the 10-year government bond yields have dropped 19.9 basis point to a near three-year low of 2.639 per cent.

“China’s government bonds have outperformed stocks since 2010,” said Alpine Macro analysts in a report. “As for stocks, they could bounce back after being beaten down badly since 2021. Nevertheless, a sustainable rally in Chinese shares would first require aggressively pro-cyclical fiscal policy and persistent monetary stimulus.”

Such policy support has already triggered a bout of profit taking in the government bond market with analysts at Citigroup expecting the 10-year bonds to move sideways in the 2.55-2.75 per cent range.

“We are neutral on China rates and have tactically taken profit on long [dollar positions] ahead of potential policy support from the State Council,” they said in a note. “With rate cuts realised, market focus will shift to the potential policy combo that the State Council has indicated.”

On the heels of the 10 basis-point cuts in the policy and benchmark lending rates last month, China’s central bank is expected to slash borrowing costs by another 10 basis points and the reserve requirement ratio by a quarter of a percentage point, according to Goldman Sachs. The Politburo meeting at the end of the month will provide hints about growth-stabilising measures in the second half, according to economists.