China's Incremental Easing Approach and Stock Discount Concerns

Alpine Macro has expressed concern over China's persistent reliance on incremental easing and its potential for policy errors, which has contributed to a significant discount in Chinese stocks relative to the thriving equities in the US and India. In a report, Yan Wang, Chief China Strategist at Alpine Macro, criticized China's belief that flooding the economy with policy stimulus would only result in temporary gains and further imbalances. Wang stated, "We have long viewed this as a profound policy error and a key reason behind China's structural deterioration in economic growth in recent years."

Wang highlighted the fundamental imbalance in the Chinese economy, which is characterized by chronic excess savings and insufficient aggregate demand. According to Wang, the government needs to offset this imbalance. However, China's stimulus measures, including policy rate cuts, have failed to dispel pessimism surrounding the country's economic prospects. The MSCI China Index experienced a six-day slump, wiping out over US$150 billion in market value, marking its most significant decline since April. The index tracks stocks worth approximately US$2.3 trillion listed both domestically and internationally.

Consequently, investors have been shunning Chinese assets in favor of better returns in India and Japan. Stock Connect data revealed that foreign investors purchased a net total of US$730 million in onshore Chinese stocks this quarter, significantly lower than the US$27 billion in the first three months of 2023. In contrast, Japan and India have witnessed substantial foreign net purchases, with inflows of US$45 billion and US$10 billion, respectively, this quarter, as reported by Goldman Sachs. Furthermore, hedge funds have withdrawn approximately 70% of the investments made during the optimistic reopening period in China.

BCA Research suggests that Chinese policymakers are falling behind the growth curve as they deliberate on how to respond to the waning recovery momentum. The research firm contends that unless Beijing implements "irrigation-style" stimulus, similar to substantial and comprehensive measures, Chinese stocks will continue to underperform as the economy disappoints. However, BCA Research clarifies that this is not their base-case forecast.

Failure to intervene and rectify the imbalances within the Chinese economy could potentially lead China down a path of its own "lost decades," comparable to Japan's policy mistakes in the 1990s when the burst of the real estate market resulted in economic stagnation and entrenched deflation.

Comparing stock valuations, the MSCI China Index currently trades at a price-to-earnings multiple of 10.5, while S&P 500 Index stocks have a multiple of 19.4 and MSCI India Index members have a multiple of 25.5, according to Bloomberg data. Furthermore, Chinese assets are valued at only 1.2 times their book value by investors, while markets in Japan, India, and the US are valued between 2 and 4.2 times their book value.

Yan Wang emphasized that Chinese stocks have become remarkably cheap compared to the high-performing markets of the US and India, stating, "As far as Chinese stocks are concerned, they have become extremely cheap, especially compared with the US and India, the high-flyers of developed and emerging markets."

By fLEXI tEAM