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Opinion

Do not mistake China's stock rally for a safe haven

Beijing is pumping stimulus into unreformed economy

| China
An officer takes body temperature measurement inside the Shanghai Stock Exchange on Feb. 28: the trajectory of China's coronavirus challenge is impossible to predict.   © Reuters

China's stock market certainly seems to be having a grand coronavirus crisis. As bourses from Tokyo to New York yo-yo wildly, mainland shares are on a tear, up 10% in just the last month.

This raises almost too many questions to list. Did the mysterious illness quaking global markets not emanate from Wuhan? Is it not true that 2020 is probably a lost year for supply chains, business confidence and Chinese demand? Can investors trust claims that China is winning the battle against new COVID-19 cases?

As the mainland rallies, these concerns and others are being supplanted by a new theory of mysterious origin: that Chinese stocks are a safe haven amid global panic.

What seems like easily refutable propaganda from state media, including Global Times, has made its way into newspapers more known for conventional wisdom. In reality, China is less of a safe-haven trade than a bet on a stimulus extravaganza -- one that could end badly.

True, investors have not gotten fantastically wealthy betting against Beijing. In 2008, hedge funds wagered Wall Street's stumble would hinder China. They thought the same when emerging markets suffered from a taper tantrum as the U.S. suggested it would start winding down its stimulus in 2013, and when the U.S.-China trade war began five years later.

At every turn, China confounded the naysayers thanks to aggressive stimulus. In 2008, credit in the banking system was about $9 trillion; by late 2019, it had swelled to $40 trillion. Between Beijing's fiscal rescue team, the central bank and local governments anxious to maintain rapid growth, China has proved an astounding ability to protect its markets.

Ask hedge fund manager Kyle Bass of Hayman Capital how his bet against the yuan worked out. In May 2019 he admitted defeat.

The swift rebound over the past month in China's CSI 300 Index, after a late-January panic, is a gamble on the Chinese Communist Party keeping this winning streak going.

Well before the U.S. Federal Reserve's surprise March 3 rate cut, the People's Bank of China was reducing key lending rates. President Xi Jinping's government has been cutting taxes, increasing business loans and prodding municipalities to boost borrowing to finance public works projects.

"Almost every day has seen a new supportive policy to help at the margin," says analyst Thomas Gatley of Gavekal Research. "This drumbeat of supportive policies is likely to continue, and to continue to support the market, despite the catastrophic near-term earnings outlook."

Careful targeting helps explain why China is leaving the Nikkei Stock Average, down 10% over the month, and the Dow Jones Industrial Average, down 9%, in the dust. Though the PBOC is not flooding China with liquidity, its funding schemes prioritize supporting large, influential companies instead of small-to-midsize enterprises.

Yet this a short-term boost at best. Beijing's largesse is not making companies more innovative, productive or transparent. It does nothing to strengthen corporate governance. And it does zero to turn domestic services into engines of growth instead of excessive credit and exports.

The risk is similar to one with which Japan Inc. still grapples. Since the economy's long descent began in 1989, Tokyo's most consistent policy is capping the yen. A weaker exchange rate reduced the urgency for CEOs to make their companies more competitive. The trade war, and now coronavirus fallout, caught Japan Inc. napping. The Nikkei's 11% loss so far this year is in part the price of decades of complacency.

The Nikkei's year-to-date loss of 11% is the price of decades of complacency.   © AP

China's own smugness is being bolstered by aggressive stimulus. But its costs will re-emerge soon enough to give the bulls serious pause.

The trajectory of China's coronavirus challenge is impossible to predict. Today's optimism that infections are trending lower could be replaced by another flare-up. COVID-19 could mutate. And, of course, Beijing has a checkered track record of providing credible information in times of crisis.

Then there is the bill for the new steroids Xi's government is pumping into an unbalanced economy. In 2012, he pledged to reduce the state sector's role in generating growth. Many of these reforms were embedded in the Made in China 2025 gambit to transition from world's factory to technological leader.

These reforms have taken a back seat to putting a 5% floor under the economy. Last year's 6.1% pace was the slowest in nearly 30 years. Xi is struggling to ensure gross domestic product growth does not end 2020 as four-point-something.

China's decision this month to rescue HNA Holding Group, one of its biggest conglomerates, reminds investors that stability is trumping modernizing the economy. Yet HNA's struggle to overcome a massive debt load during coronavirus uncertainties is a microcosm of where China finds itself in 2020.

China's economy is not less vulnerable to a potential pandemic than other countries', but its relatively closed system and sizable firepower make it easier to fight what is causing major stock markets to fall around the globe.

Nevertheless, in an unreformed economy, the dislocations caused by the coronavirus will leave investors holding shares in companies in anything but good health. Somehow, "safe" is not the first word that leaps to mind.

William Pesek is an award-winning Tokyo-based journalist and author of "Japanization: What the World Can Learn from Japan's Lost Decades."

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