Commentary
The latest news from China demonstrates once again how little economic and financial insight the nation’s communist leadership shares.
Having, for years, failed to stem the ill effects of China’s property crisis or overcome other impediments to economic growth, these leaders, it seems, have stepped in to support China’s stock market by ordering state-owned firms to bring home funds held overseas and buy stock. It’s rumored that the effort will involve 2 trillion yuan (about $280 billion). Unless the Chinese Communist Party (CCP) addresses the fundamental problems facing China’s economy, this effort will fail.
China’s stock market has done poorly for some time. Between February 2021 and last month, the country’s Shanghai Stock Index fell by more than 21 percent. Valuations have dropped accordingly. Price-earnings ratios—a well-established indicator of investor confidence in future gains—have dropped on average to 10.4 times current earnings, far below the 12.5 times averaged over the past 10 years. Rumors of Beijing’s big spending program did induce some speculative buying that pushed the index up by almost 5 percent in just three days, but stocks remain deeply depressed compared with where they were just a couple years ago.
Aside from this recent jump and its obvious cause, the depressed value of Chinese stocks offers a reasonable reflection of the economy’s fundamental problems. The pace of growth has slowed dramatically from historical averages, and earnings growth, the fundamental support for stock values, has slowed with it. A big part of this ugly picture is, of course, China’s ongoing property crisis.
The CCP’s decision some three years ago to remove active support for residential buildings suddenly precipitated the problem by effectively ensuring the failure of major development companies. Beijing then made matters worse by failing to offset the financial repercussions of those failures. The upshot is that Chinese finance lost the ability to supply the credit flow needed to support growth. Worse, the property failures and the financial constraints that regulators have imposed have caused a significant pullback in homebuying and, accordingly, a drop in real estate prices.
That’s not all. The decline in real estate values has detracted from households’ net worth so much that Chinese consumers have pulled back on their spending. At the same time, Chinese exports have suffered as foreign buyers have sought to diversify supply chains, and foreign governments have shown an increasing hostility to Chinese trade—most notably in Washington, Brussels, and Tokyo. If this were not enough, the CCP’s growing obsession with security has slowed the flow of foreign investment into China and limited investment growth among domestic private businesses.
With such troubled fundamentals, it’s little wonder that Chinese stocks have suffered. The fact that the CCP has not even begun to remedy these fundamental problems further explains why stocks no longer carry the optimistic valuations they did during the years when China’s economy was growing at near double-digit rates in real terms and gave every reason for optimism.
These troubled economic and financial fundamentals also ensure that Beijing’s buying program will have no lasting effect. If the rumors are correct, the buying surge will be sufficient to cause a stir. The mooted amount constitutes some 8 percent of the outstanding value of all Chinese stocks.
But unless the CCP also launches a convincing program to remedy the more fundamental problems, stocks will sink again as soon as the buying program runs its course. That is what happened in 2015, when Beijing used such an ill-conceived strategy. Then, stock prices fell even before the buying program ended.
For would-be investors in Chinese stocks, this situation carries considerable danger. Any initial rise in stock prices due to this official buying will tempt many to buy in order to ride the gains. But without fundamental remedies, the subsequent drop in prices will likely occur quickly and both foil the official buying program and hurt the investors who had joined for the ride.
