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Snakes and Ladders

January 23, 2025


January 29th will usher in the year of the snake. According to Chinese geomancy snakes hold complex and varied symbolism. Unstable luck and challenges when the lunar new year begins on January 29th. That is because of the 12-year curse, or ben ming nian in Mandarin. Ominously for the stock market, the most infamous year of the snake was 1929. On the positive side, snakes are simultaneously associated with harvest, spirituality, and good fortune.

 

For some time, we have posed the question, “how much can a panda bear?”  China’s structural debt and growth challenges are widely appreciated. However, they are also genuine and a legitimate constraint on the capacity of policymakers to respond with a 2008-style fiscal thrust or “whatever-it-takes” stimulus. As noted by Morgan Stanley, the challenge for markets is that the gradualist approach is not working. As we often note, it is important how price responds to news. We know the policy response is insufficient (so far) because 10-year government yields continue to fall (chart 1). Put another way if markets anticipated effective “reflation” bond yields would likely be rising. Moreover, the credit impulse (rate of change in credit growth) also remains weak at -5% year on year.


Chart 1

Even more troublesome is that China’s deflationary condition has disturbing parallels with Japan in 1990. Indeed, private sector non-financial debt in China today is well above Japan’s in that earlier episode (chart 2). Moreover, total debt in China is now estimated to be over 300% of GDP. China’s 10-year government yield at 1.65% has almost converged with Japan (1.2%). While there has been some enthusiasm about the policy pivot in China since last September, the gradualist approach has failed to reverse the deflationary signal from the bond market.


Chart 2

Of course, as we (and others) noted last year, China does not have a lack of investment or savings. Rather, it has a complete absence of confidence and household consumption. We know that the PBOC and policymakers understand this. The politburo announcement last year said that the authorities must “vigorously boost consumption, improve investment efficiency and expand domestic demand in all directions.”


As Michael Pettis has highlighted, the problem with Chinese monetary policy until now has not been that its tightness has led to slow growth and inflation, but rather that its looseness, directed almost exclusively to the supply side (investment side) of the economy, has accommodated deeper imbalances and deflation.

 

As Michael also noted, the point about investment “efficiency” is especially important. The authorities seem to be saying, effectively, that consumption is too weak and that China has made up for this weak investment by expanding inefficient investment. But it also means that what China needs isn’t monetary loosening so much as a major shift in the direction of monetary support. Rather than have the PBOC accommodate more supply-side stimulus, the PBOC must shift to accommodating more demand side stimulus. Stated differently, China’s problem is not monetary, it is fiscal. The good news is that policymakers increasingly recognise that the key problem is insufficient domestic demand and confidence. However, to date, the approach has been too gradual.  

 

From our perch, more liquidity support for the stock market, cuts in mortgage rates, reserve requirements and lending standards would likely be insufficient without meaningful fiscal easing and reform. It is also somewhat rational that the Chinese policymakers have been waiting for the new US Administration to calibrate their own policy response to tariffs. The news on that front appears positive relative to fears or expectations last year.

 

The good news for investors is that Chinese equity valuations positioning, sentiment and consensus beliefs remain depressed. We continue to prefer the large platform, internet and technology names given their net cash on balance sheet position, strong profit margins and capacity for further share buybacks. However, the broad market might remain a potential value trap and a game of snakes and ladders for equity prices.




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