Chinese investors’ animal spirits return as stock market soars

Chinese stocks soared after policymakers unveiled stimulus measures and reports suggested more could be on the way. While hedge funds and foreign investors have recently scrambled to unwind bearish bets on Chinese equities, there are signs that the retail investors who dominate the domestic market are gearing up to drive stocks higher, says Lu Sun, senior Asia macro strategist in Global Banking & Markets in Hong Kong.

“The onshore animal spirit has returned for the equity market for the first time since 2020 and 2021,” she says in an episode of Goldman Sachs’ The Markets podcast. Sun notes that local news is reporting a high level of brokerage account openings, with securities companies working extra days to accommodate the surge in interest.

The CSI300 Index of equities listed on the Shanghai and Shenzhen exchanges jumped 16% last week. The index had its best five-day return since the Great Financial Crisis in 2008 as policymakers announced a range of stimulus measures. These included a primary policy rate cut, an interest rate cut on existing mortgages, and an asset swap facility for non-bank financial companies to buy stocks. Authorities confirmed that a stabilization fund to support the equity market is under consideration.

Most of the policy announcements, particularly for monetary policy, were above market expectations, Sun says.

“The package has been above market expectations, telling you that the policy put has been triggered from the very top authority,” she says. “The next one to watch is really fiscal.”

Will these measures be enough? “That's definitely a very pressing question,” Sun says. Many of the policies discussed last week will make funding easier and cheaper for markets. “What we really need is demand-side policy, especially on fiscal, which is what the market is waiting for,” Sun adds.

News reports suggest China’s Ministry of Finance may issue RMB 2 trillion ($284 billion) of additional Central Government Bonds, on top of the already approved national budget, half of which could be used to support consumption. Reports also indicate the government may inject capital into the largest state banks.

It may not be enough. The Chinese economy is beset by a deep slump in a property market that is still in decline. “We really need more fiscal, more demand-side measures than what market is currently expecting,” she says.

Part of the reason Chinese stocks have surged so much is that many international investors were “extremely bearish” on the market before the stimulus announcements, Sun says. Hedge fund allocations to Chinese equities had fallen to multi-year lows, and mutual funds are deeply underweight China stocks, holding smaller allocations to these equities than their benchmarks. Hedge funds that were betting on a decline in Chinese stocks have been buying those equities to cover their short positions, causing an updraft in prices.

“A lot of this very fast rally is short-covering,” Sun says. When it comes to institutional investors, there are already signs of profit-taking in Chinese equities positions.

Domestic retail investors, by contrast, are probably trying to capitalize on further gains. While the fastest phase of the rally has probably already taken place, Sun expects domestic, or onshore, positioning and “animal spirits” to be the critical factors for the market going forward.

The change in valuations doesn’t appear stretched, she says. The price-to-earnings ratio has risen from about 8x in early September to 11x, near the high of January 2023 when the Chinese economy began fully reopening after the Covid pandemic. “Given the onshore momentum gathering, I would expect we could have further room and momentum,” Sun says. Historically, strong momentum has corresponded with substantial equity gains in China.

 

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