After the Chinese stock rout, here are two glimmers of hope

While Beijing’s close ties to Moscow have fanned fears that Chinese firms could be hit by Western sanctions, the war has exposed the limits of the China-Russia relationship
Moreover, the economic and financial fallout of the war will accelerate the shift towards looser policy

Nicholas Spiro

Published: 1:30pm, 17 Mar 2022

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There have been many headwinds bearing down on Chinese stocks over the past year. This is why the underlying cause of the dramatic sell-off at the beginning of this week is hard to pinpoint.

Was it mostly attributable to reports that, according to the US, China’s government had indicated a willingness to provide military aid to Russia after its invasion of Ukraine, or did it have more to do with Beijing’s draconian measures to contain the country’s biggest Covid-19 outbreak since the pandemic began?

Then again, given that technology shares bore the brunt of the declines, were escalating tensions over US-listed Chinese companies the main culprit?

Regardless of which of these factors contributed most to the sell-off, the geopolitical fallout from Russia’s invasion of Ukraine exacerbated the selling pressure. China has emerged as the biggest casualty of the spillover effects of the war on global equity markets.

02:24

US-China meeting focuses on Ukraine, Beijing’s alleged support of Russia

On Monday, the Hang Seng China Enterprises Index, a gauge of mainland Chinese shares listed in Hong Kong, plunged 7.2 per cent, its sharpest daily fall since the depths of the 2008 global financial crisis.

The Nasdaq Golden Dragon China Index, which tracks Chinese companies listed in New York, has lost 19 per cent since the beginning of this month. It has declined 65 per cent since February 19, 2021, approaching the 78 per cent peak-to-trough drop in US tech stocks during the bursting of the dotcom bubble in 2000-01.

Ukraine crisis could mean the party is over for financial speculators

Big bets by prominent Wall Street firms that Chinese shares would enjoy a fierce rally this year have backfired. Even other asset classes have come under pressure. Foreign investors sold a net US$5.5 billion of Chinese government bonds last month, the largest monthly outflow on record.

Chinese sovereign debt has become less attractive due to its diminishing yield advantage over US bonds as both nations’ monetary policies diverge.

The economic disruption wrought by China’s zero-Covid policy has increased sharply since Shenzhen – a major manufacturing and export hub whose container port is the fourth largest in the world – was placed under lockdown.

03:46

No respite for Covid cases in Hong Kong as infections surge in mainland China

Not only has the resurgence of the pandemic intensified concerns about the efficacy of Chinese vaccines and the vulnerability of China’s health care system, it threatens to deal a severe blow to a struggling economy and exacerbate supply chain problems that increase the risk of stagflation in advanced economies.

Yet, while expectations of a sharp rebound in Chinese stocks were always too high, given the acute challenges facing the economy, the war in Ukraine has accentuated a number of key sources of support for Chinese equities, which boast attractive valuations.

First, although Beijing’s close ties to Moscow have fanned fears that Chinese firms could be hit by Western sanctions, the war has underlined the importance of China’s two main export markets – the United States and Europe – when domestic demand is being crimped by pandemic-induced restrictions and the downturn in the property sector.

President Xi Jinping, who is focused on ensuring that his third term in office is ratified by the Communist Party Congress in the autumn, prizes stability above all else. His Russian counterpart’s war on Ukraine only creates further instability, exposing the limits of the Russia-China partnership.

02:54

China’s delicate position on Russia-Ukraine crisis and its opposition to Western sanctions

Second, the economic and financial fallout of the war will accelerate the shift towards looser policy. Markets have spent the past several months speculating about the scope and efficacy of easing measures. The conflict in Ukraine appears to be the long-awaited trigger – or at least an important part of it – for more clarity on the direction of policy.

On Wednesday, the State Council’s Financial Stability and Development Committee, ignited a ferocious rally in equity markets by issuing a statement that addressed most of the big concerns of investors. Beijing promised to shore up markets, facilitate overseas stock listings, shelve the expansion of a property tax trial and bring its overhaul of the tech sector to a close as soon as possible.

While the government must now follow through on its pledges, and its “zero-Covid” policy remains in place, the focus on supporting markets has turned sentiment around.

Furthermore, it has revealed sharp differences in the policy environment between China and leading Western economies. On the same day that the US Federal Reserve raised interest rates and signalled six more hikes this year, Beijing gave its strongest assurance yet that it would loosen policy in a meaningful manner.

A lot could still go wrong for Chinese stocks, particularly since it is unclear whether a more forceful policy shift will be sufficient to stabilise markets. Yet, while Russia’s invasion of Ukraine has heaped more pressure on Chinese equities, it has forced Beijing to take investors’ concerns more seriously, potentially providing a more secure foundation for a rally.

Nicholas Spiro is a partner at Lauressa Advisory