Cycle Trading: Where is the A-share market headed?

Author: Cycle Capital, Lisa

Since the "924" new policy, the Chinese stock market has experienced an epic surge. The policies from the three financial ministries and the Central Political Bureau meeting have exceeded expectations, boosting market sentiment, leading to a strong rebound in the A-share and Hong Kong stock markets, which have outperformed global markets. However, after the National Day holiday, the market turned downward amid overly optimistic expectations. Is this round of market activity a fleeting moment, or has a bottom already formed? This article will attempt to make a judgment from the perspective of analyzing the domestic economic fundamentals, policies, and overall valuation levels in the stock market.

1. Fundamentals

Overall, the domestic fundamentals remain relatively weak, showing some signs of marginal improvement, but no obvious turning signals have been observed. During the National Day holiday, consumer sentiment improved both year-on-year and month-on-month, but this has not yet been reflected in major economic indicators. In the coming quarters, China's growth may show a moderate recovery under the boost of policies.

In September, the Manufacturing Purchasing Managers' Index (PMI) was 49.8%, an increase of 0.7 percentage points from the previous month, indicating a recovery in manufacturing sentiment; the Non-Manufacturing Business Activity Index was 50.0%, a decrease of 0.3 percentage points from the previous month, showing a slight decline in non-manufacturing sentiment.

Affected by high base factors from the same period last year, in August, profits of industrial enterprises above designated size fell by 17.8% year-on-year.

In August 2024, the national consumer price index rose by 0.6% year-on-year. Among them, food prices increased by 2.8%, and non-food prices rose by 0.2%; consumer goods prices rose by 0.7%, and service prices increased by 0.5%. From January to August, the average national consumer price index rose by 0.2% compared to the same period last year.

In August, the total retail sales of consumer goods reached 38,726 billion yuan, a year-on-year increase of 2.1%.

In August 2024, the sales price index of second-hand residential properties in 70 large and medium-sized cities

From the perspective of financial leading indicators, the overall financing demand in society is relatively insufficient. Since the second quarter, the year-on-year growth of M1 and M2 has slowed, and the gap between the two has risen to historically high levels, reflecting insufficient demand and some inefficiency in the financial system. The transmission effect of monetary policy is hindered, and the short-term economic fundamentals still need improvement.

2. Policy

Combining the characteristics of the A-share market's phase bottoms over the past 20 years, policy signals generally need to be strong and exceed the expectations of investors at that time. Historically, this has been a necessary condition for the stabilization and rebound of A-shares. Recently, policies have exceeded expectations and signals have already emerged.

On September 24, 2024, the State Council Information Office held a press conference where the central bank governor Pan Gongsheng announced the establishment of new monetary policy tools to support the stable development of the stock market.

The first measure is to create a swap facility for securities, funds, and insurance companies, supporting eligible securities, funds, and insurance companies to use their own bonds, stock ETFs, and stocks of the CSI 300 as collateral to obtain liquidity from the central bank. This policy will significantly enhance the funding acquisition capacity and stock accumulation ability of institutions. The initial operation scale of the swap facility is 500 billion yuan, which may be expanded in the future depending on the situation.

The second measure is to establish a special relending facility for stock repurchase and increase, guiding banks to provide loans to listed companies and major shareholders to support stock repurchases and increases. The initial quota for the repurchase tool is 300 billion yuan, which can also be expanded depending on the situation.

On September 26, 2024, the Central Financial Office and the China Securities Regulatory Commission jointly issued the "Guiding Opinions on Promoting Long-term Funds to Enter the Market," which includes measures covering 1) cultivating a capital market ecosystem for long-term money and long-term investment, 2) vigorously developing equity public funds and supporting the steady development of private equity funds, and 3) improving supporting policies for long-term funds entering the market, totaling three points and 11 key points.

The root cause of the current growth problem in China is the ongoing credit contraction, with the private sector continuing to deleverage, and the credit expansion of the government sector failing to effectively offset this. The reasons for this situation are primarily low expected investment returns, especially the sluggish prices in the real estate and stock markets, and the financing costs are still not low enough. The core of this round of policy changes is focused on reducing financing costs (by lowering multiple interest rates) and boosting investment return expectations (stabilizing housing prices and providing liquidity support for the stock market). This is a targeted approach, but whether it will effectively cure the problem and achieve sustainable re-inflation in the medium to long term will require subsequent structural fiscal stimulus and the actual implementation of policies. Otherwise, the market's recovery may be fleeting.

On October 8 (Tuesday) at 10 a.m., the National Development and Reform Commission held a press conference where the director Zheng Zhanjie and deputy directors Liu Shushe, Zhao Chenxin, Li Chunlin, and Zheng Bei introduced the situation regarding "systematically implementing a package of incremental policies, solidly promoting economic upward structure optimization, and continuously improving the development trend," and answered questions from reporters. The upward sentiment was fully fermented during the National Day holiday, and the market generally believes that A-shares have bottomed out and reversed. Morgan Stanley believes that the policy volume needed to rebalance the economic structure from investment to consumption is about 7 trillion yuan within two years. Market participants have high expectations for fiscal policy, so there was significant attention to this press conference by the Development and Reform Commission. However, there were no large-scale counter-cyclical fiscal adjustment policies that the market widely expected, which is also a major reason for the market reversal after the National Day holiday.

3. Valuation

Reviewing the characteristics of previous market bottoms, this round of market activity has already shown bottom characteristics in terms of the duration of the decline, the degree of decline, and valuation levels.

Note: This decline involves market data as of September 27, 2024. Source: Wind, CICC Research Department.

As of October 9, the valuation levels of A-shares have recovered to near the median.

Historically, the rebound at the end of September was relatively high, reaching the PE multiples expected for economic acceleration post-pandemic restart in early 2023. In a horizontal comparison with major global markets, the valuation of the Chinese market relative to emerging markets is still the lowest in the Asia-Pacific region, close to that of South Korea.

In summary, the key to the market reversal lies in the confirmation of mid-term fundamental signals, which have not yet been evident in the fundamental data. The recent short-term rise has mainly relied on expectations and capital, and the fear of missing out (FOMO) has led to a rapid incorporation of sentiment. Technical indicators such as the RSI (Relative Strength Index) are somewhat "overdrawn" in the short term. Markets with high volatility often accompany excessive reactions, and a correction after a historic surge is both a technical necessity and a reasonable expectation. After the monetary policy has been proactively intensified, whether subsequent fiscal policies can follow up will be the main factor affecting the upward pace and space of the stock market in the near term. Just like the art of expectation management by the Federal Reserve, it is not appropriate to add fuel to the fire in a frenzied and aggressive market environment, but what should come will come in due time. From a long-term perspective, I believe the recent decline is an adjustment rather than a trend-ending, and the bottom of A-shares in the medium to long term has already been seen, while the main rise has yet to come.