A decisive policy pivot finally got markets excited again about China. But economic and earnings growth will only materialise if policymakers follow through with fiscal firepower.

A confluence of interest rate cuts, relaxations of rules on home purchases, and extra liquidity has finally seen China’s equity market escape its trough. But it has been the candid tone of the country’s leadership that’s sent shares into bull market territory. The politburo used its usually uneventful September meeting to reiterate China’s resolve to meet its annual GDP growth target of around 5 per cent, and address “weak links” in the economy - the strongest sign yet that they will do whatever it takes to get growth going again.

Underpinning investors’ optimism is officials’ increasing tolerance for exercising the central bank’s balance sheet, for example by launching liquidity facilities to prop up the stock market. There’s also an argument for potentially using the central government’s own relatively strong position to help alleviate local governments’ debt burden. Unlike after the Global Financial Crisis, when China supercharged supply through infrastructure construction, consumer demand appears to be Beijing’s preoccupation in 2024.

Fiscal test

What markets are pricing in, but has yet to transpire, is fiscal spending to the tune of trillions of renminbi. So far in this cycle, China has relied on supply-side measures - removing restrictions, lowering financing costs - to drive economic activity. US rate cuts will afford China more room to ease monetary policy. But cuts so far have had a limited impact on consumer prices, which have been pretty much flat.

That’s why China is following up with demand-side support - measures that put money directly into consumers’ pockets. In September, China issued 300 billion renminbi (USD $42.5 billion) of special government bonds to finance subsidies for consumers to trade-in and upgrade equipment and goods, from home appliances to automobiles. More cities may follow Shanghai and distribute consumption coupons to boost services. 

One thing that hasn’t changed - yet - is the role of real estate. With almost 70 per cent of household wealth locked in housing, home prices continue to be crucial to near-term consumer confidence, and some improvement on that front could compound any ‘wealth effect’ felt from the stock market’s turnaround. 

For consumers to feel better off, home prices must stabilise, but they need not return to all-time highs. China is still keen to wean itself off a reliance on property as the main growth driver and would guard against a full-on reflation of the housing market. Though audacious, we believe this mission of ‘controlled stabilisation’ - cushioning the economy into a soft landing - remains feasible.

Great divergence

Our recent research trip to China’s smaller cities gave us a taste of what’s to come. In the eastern port of Qingdao, we were surprised by heavy footfall in shopping centres on a normal weekday. While home prices in the city have fallen further and income is generally lower than in tier-1 cities, such as Beijing and Shanghai, mortgages also make up a smaller chunk of consumers’ disposable income. We were likewise encouraged by the opening of new stores by well-known consumer brands, including global names.

What’s clear is that the consumption ‘downgrade’ narrative is nuanced. True, Chinese consumers are spending with more caution. But they are also increasingly willing to save up for a small number of expensive, highly desired items. One apparel company has captured this barbell spending phenomenon by acquiring higher-end foreign brands to complement lower-end ones in its existing portfolio. Adaptive businesses like this, along with direct beneficiaries of fiscal support, such as breweries and home appliance manufacturers, will stand to gain from a recovery in consumption.

The hope is that such consumption will then trickle through to earnings and fuel the next stage of the stock market rally, which is built on a foundation of extremely cheap valuations. Market momentum will hinge on the effectiveness of policy support in the coming months and whether property prices can find a floor, which will in turn lead to a rebound in consumer confidence. Either way, Chinese policy has passed a milestone. Investors will expect more. 

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