[SCMP Column] 3 Reasons Why Investors Should Be Cautious About China's Stimulus Measures

Low Trust in China Policy
US Economy Not a Soft Landing but a 'No Landing'
Increased Uncertainty Over US Presidential Election Results

Nicholas Spiro, Advisory Partner

Up to the third quarter of this year, the S&P 500 index broke its all-time high more than 40 times, closing at a record level. In contrast, Hong Kong's main stock index, the Hang Seng Index, was a staggering 36% lower than its all-time high recorded in January 2018.

However, the headline was made by what happened in the third quarter. According to Deutsche Bank data, the S&P 500 index posted a 5.9% return, but the Hang Seng Index rose 21.7% in local currency terms, becoming the highest-yielding major financial asset in the world. The Hang Seng Index recorded an 18.3% return in September alone, the highest among major financial assets.

During the last three weeks of September, market momentum shifted sharply in favor of Asia. A massive stimulus package announced by China in the last week of September triggered a huge rally in the Chinese and Hong Kong stock markets. HSBC analysts described the stimulus as a "psychological shift by policymakers, especially the People's Bank of China."

The impact of the stimulus package on market sentiment was greatly amplified because investors had been extremely pessimistic about China since 2021. Goldman Sachs pointed out in a report on October 5 that the market situation "started with overselling, undervaluation, and under-positioning."

Shortly after the U.S. Federal Reserve (Fed) initiated a monetary easing campaign by cutting interest rates more than expected despite relatively strong growth, China announced an aggressive stimulus package. Some analysts are confident that conditions have been set for a sustained rally in emerging market stocks. JPMorgan stated, "The Fed's easing policy and China's stimulus are reviving expectations for a reflation trade in the late stage of the economic cycle."

There is solid reason to be optimistic. Just a month ago, few would have predicted that Chinese authorities would talk about a 'fiscal policy to counter recession' and that China's response to a downturn would become stronger. The rhetoric of Chinese policymakers has also changed significantly, suggesting that this time is different.

If stock prices can surge 30% in just a few days on promises alone, concrete policy measures and stimulus being actually implemented and impacting the economy could further boost investor sentiment.

In the U.S., investors seem to be enjoying the benefits of both. With the labor market still strong and the Fed easing monetary policy, the possibility of a 'soft landing'?a gentle economic slowdown?has increased. Global data firm TS Lombard noted, "The Fed is easing policy without waiting for a true economic downturn. This is bullish for risk assets." It also shows that the Fed is much more sensitive to growth, the top priority for the global economy.

However, there are much stronger reasons to be cautious. First, China suffers from a policy credibility deficit that is difficult to overcome. Meanwhile, investors expect too much too quickly. The combination of these two factors makes managing expectations difficult, which is why the rally following the stimulus reversed.

More importantly, tensions around the size and design of China's stimulus policy decisions are severe. This partly stems from the government's prioritization of investment over consumption. However, as Morgan Stanley pointed out, it is also because China has seen the most rapid increase in public debt burden among advanced and developing countries since 2019.

Considering the structural problems China faces, there is skepticism about whether China can successfully stimulate its economy.

The reason foreign investors have flocked to the Chinese stock market since the stimulus announcement may be due to passive exchange-traded funds (ETFs) rather than active managed funds. Soci?t? G?n?rale pointed out that, excluding China, emerging Asian stocks rose only 3.3% last quarter.

Second, while the market expects a soft landing in the U.S., a 'no landing' scenario without a recession is more likely. Last month, higher-than-expected employment and wage growth pushed bond yields and the U.S. dollar higher. According to Bloomberg, emerging market currencies experienced their worst week since January this year.

This occurred at a time when concerns were growing about inflation rebounding due to rising oil prices amid rapidly escalating Middle East conflicts. Expectations that a U.S. economic soft landing would help reduce borrowing costs across Asia have begun to diminish.

Third, it is hard to argue that the Asian market is in an ideal situation?especially with the possibility of former U.S. President Donald Trump returning to the White House in a month. Vice President Kamala Harris and former President Trump are in a tight race in several key battleground states. Worryingly, the likelihood that Trump will concede defeat in such a close election is low. The market is underestimating how much worse the situation could become after election day.

Moreover, protectionism will continue regardless of who wins. This will dampen global growth and sustain economic and geopolitical uncertainty. However, if Trump is inaugurated for a second term, the damage could be much greater. A combination of increased trade tariffs, immigration restrictions, and tax cuts could trigger inflation, and depending on how the Fed responds, could also lead to a sharp recession.

The impact on Asian economies like Taiwan and South Korea, which earn a significant portion of corporate profits from the U.S., would be severe. China and the Fed have injected significant vitality into the market. With a bit of luck, the rally could continue. However, caution is especially needed in Asia.

Nicholas Spiro, Partner at Loresa Advisory

This article is a translation by Asia Economy of the South China Morning Post (SCMP) column titled ‘3 reasons investors should be cautious on China’s stimulus surge.’

This content was produced with the assistance of AI translation services.