China’s domestic A-share market has been on a bumpy ride since the Lunar New Year holiday, with many star stocks falling like stones. The big volatility has surprised many investors as the outlook on China’s economy remains stable.
In contrast, major global equity indices have been on solid footing this year with a recovery from Covid-19 expected in both the United States and the European Union. In comparison, China’s A-share market has become a clear underperformer. What are the causes of this gloom?
For a start, China’s economic growth has visibly decelerated after a promising V-shaped recovery in the second quarter of last year. The market consensus is that China’s economic growth rate is likely to have peaked in the first quarter of this year, and will gradually slow to around 5-6 per cent for the rest of the year. Corporate earnings would probably follow the softening trend over the coming quarters, suggesting that the market needs to adjust its expectations of companies’ profits accordingly.
Meanwhile, a tapering of China’s monetary policy is clearly on the cards. Compared to the “emergency mode” during the Covid-19 pandemic, monetary policy will become much less accommodating over the coming year. Recent crackdowns on illegal financing and new tough curbs on the property market have further shaken market confidence.
A few days before the National People’s Congress, Guo Shuqing, chairman of the China Banking and Insurance Regulatory Commission, warned of the risks posed by shadow banking and the rise in non-performing loans. He also made it clear that the authorities would tighten its grip on internet financing platforms. Guo is widely seen as a regulatory “hawk” among the top Chinese officials and has consistently expressed concerns about financial stability. So, his latest tough pronouncements sent a big shock through the stock market.
China’s economy has always been highly correlated with its credit cycle, as have its capital and real-estate markets. Add in China’s early-stage austerity policy, and it is understandable that the A-share market is selling off amid a lack confidence. China’s latest credit crunch is expected to stretch into the coming year and past experience suggests that risk events are inevitable during the credit tightening process.
On the geopolitical front, the souring relationship between China and the US is also rattling the market again. After the meeting between senior diplomats in Alaska, the risk of US-China tensions under Joe Biden’s leadership has re-emerged. Compared to Donald Trump’s approach, which was centred on trade issues, Biden’s China policy would cover more areas, including human rights and democracy.
Moreover, the US has reached out to its traditional allies to form a more concerted approach towards China, already incurring Beijing’s strong response on many fronts. Hence, geopolitical events will remain a drag on both the economy and the financial markets.
In the global markets, rising bond yields in the US have brought in valuation concerns, particularly for technology stocks. As the rates of return rise for relatively risk-free US bonds, riskier assets such as equities naturally come under pressure.
China’s stock market is not immune to this effect, even though the yields on China’s own onshore bonds have not changed much this year. As a result, there has been a massive sell-off in China’s stock market, especially of stocks with high price-to-earnings ratios.
This has disrupted the A-share market phenomenon seen over the past two years of investors huddling around certain star stocks. It is a tradition for A-share investors to cluster around certain stocks, propping up “stock deities” and then overthrowing them soon after. This is a sign of great impatience among investors, particularly retail investors. While truly solid stocks will prevail, most investors find it difficult to exercise patience.
For policymakers, a critical issue is to reduce the unpleasant volatility in the capital market, which is important for financial stability and economic development. However, the past few stock routs suggest that there is a communication gap between policymakers and investors.
In 2015, to prevent the stock market from crashing after a massive rally, Beijing had no choice but to directly intervene. While this “visible hand” might be helpful in smoothing out short-term volatility, the worrying communication gap exists and probably now looms larger, as it is impossible to predict when and how the authorities would step into the market. Interestingly, over the past few weeks when China’s stock market was in panic mode, rumours of state intervention emerged and helped to shore up investor sentiment.
All told, China’s stock market is open to influence from many factors and this helps explain the great volatility in the A-share market. While the A-share market recorded one of the biggest returns last year compared to its peers around the world, its bumpy ride in the first quarter of this year is a reminder of the complexity of the market and a reflection of a lack of clear consensus among investors, at least for now.
Hao Zhou is senior emerging markets economist at Commerzbank