Why are China’s markets doing so well?

Editor's note: Read the latest on how the coronavirus is rattling the markets and what you can do to navigate it.

By all measures, the Chinese stock markets have resisted the global downturn. Year-to-date (to March 21), the Shanghai Stock Exchange Index (SSE Composite) has fallen by around 10% and the Shenzen Stock Exchange Index (SZSE) has fallen by 1%. The impact of the coronavirus brought down both indexes by 11% and 8.5% respectively in early February, but since then they have regained the lost territory.

Those are mild numbers if we compare them to major indices in the West. Year-to-date, the S&P 500 has fallen around 17% in Canadian dollar terms, while the S&P/TSX Composite is down over 30%. Those drops all happened since February 20th, three weeks after the Chinese markets had started their recovery.

Somewhat surprisingly, Asian markets have held up better than global markets, despite the COVID-19 pandemic originating in the region. Current infection rates appear to have slowed in China and South Korea, demonstrating they have been able to get the outbreak under control at this stage, notes Michael Malseed, associate director of manager research for Morningstar Australasia.

Not that “controlled”, maybe
It looks like the Chinese markets suffered nowhere near as much as their Western counterparts. The explanation that usually jumps to mind is that China’s is a “controlled” market, secretly held up by what is called a “national team”, that props it up when necessary. But that explanation doesn’t cut it, believes Jean-Pierre Couture, chief economist and emerging markets portfolio manager at Hexavest, in Montreal. “We observe that Hong Kong’s H-Shares, that the Chinese government doesn’t control, hold up as well as the A-Shares,” on the mainland market.

“No doubt the Chinese stock market is a managed market,” recognizes Chi Lo, senior economist at BNP Paribas Asset Management, in Hong Kong, “but retail sentiment is of paramount importance as over 80% of the daily stock trading comes from moms and pops, uncles and aunties.  Even institutional investors still have a retail mentality when investing in stocks.  And since the market is still relatively closed (foreign ownership is less than 4% to total onshore market cap), it is not much affected by external factors, unless external factors affect domestic sentiment.”

That “retail mentality” has very positively reacted to the Chinese government’s handling of the coronavirus crisis, a sentiment that events have supported since, by all accounts, the crisis in China is now definitely receding.

“Outside of Hubei Province where 96% of the Chinese population lives, the confirmed cases stabilised some time ago,” reports Mark Kruger, senior research fellow at Yicai Research Institute in Shanghai and a former senior policy director in the Bank of Canada’s international department, adding that 90% percent of those that contracted the virus have been cured and the death rate is less than 1%.

Such information causes Lo and Kruger to believe that the main reason explaining the robust standing of the stock markets is, in Lo’s words, “that the Chinese government’s management of the crisis has upheld domestic confidence and market sentiment, which later improved when the rest of the world showed chaotic reactions to the outbreak.”

Waiting for the bull market
But other factors, operating in the background, also played a part. Ren Zeping, one of China’s foremost economists, is of the opinion that the easing of monetary conditions led investors to chasing equity assets, while regulatory barriers and the unwillingness of banks to lend caused investors to shy away from real estate investments.

Another point to note is that over the past decade, the SSE Composite has returned 1.9% annualized. For the same timeframe, the S&P/TSX Composite has returned close to 3% annualized, while the S&P 500 has returned over 11%. Perhaps the question should be, when will the Bull market in China begin?

However, will the outperformance last? Both Chinese markets have been losing ground over the last week. Is it a sign that the international commotion is tarnishing mainland China investment sentiment? Impossible to say at this point.

However, the direction of the economy could be determining from this point on, and that direction depends largely on an upcoming National People’s Congress that was supposed to occur early March, but was postponed. Before the virus crisis, notes Lo, the government was set on a policy of deleveraging and rebalancing the economy which could potentially lead GDP yearly growth to slip below the declared target of 6%. (Chi Lo and Mark Kruger believe that, following the virus crisis, growth could reasonably be expected to be in the 5.5% range).

But that is if the government continues its policy of growth and stimulus it has switched to in the wake of the crisis. “The ultimate question is whether Beijing will revert back to its structural policy priorities after the crisis. My bet is that it will.” And that, believes the economist, could lead growth « to fall more sharply ». If it is the case, will that spook the Chinese markets? That remains to be seen.