Chinese stock markets rally on improving profit outlook as we enter the Year of the Dragon

KEY DEVELOPMENTS

Chinese industrial firms’ profits surged in the second half of 2023, but businesses still suffer from flat demand and profits well below peak levels. This low profitability curtails firms’ spending and hiring plans, hurting consumer confidence.  Many Chinese tech and new energy stocks are looking cheap on global comparisons.

The Chinese government encourages local governments to issue large bonds to finance infrastructure spending to support demand. Despite various local schemes to boost activity, the housing market continues to be mired in a cycle of low transaction volumes and no price increases. All of this makes the Chinese consumer cautious and unwilling to spend, which, in turn, curbs economic growth.

Chinese New Year heralds the Year of the Dragon, specifically the Wood Dragon, from February 10, 2024, until January 28, 2025, symbolizing growth, progress, and abundance – all good signs for investors.

GLOBAL IMPACT

China’s increasing domestic bond issuance, and evidence that this is replacing the traditional purchase of US Treasuries, is a growing factor in the US bond market. With no sign that China will return anytime soon, the yield on US Treasuries might need to remain high to attract alternative buyers.

MARKETS

• China’s stock market witnessed the most robust bounce in five months, with the Shanghai and Shenzhen Composite Indexes up 2% and 3%, respectively, last week. Foreign investors returned and made the most significant buying, especially shares of China’s tech and new energy firms, but these markets ended 2023 down by 4.7% and 8.3%.
• The offshore yuan was up 0.4% last week versus the dollar, at $/CNH 7.1253, and ended the year down 2.8% (it had been down 5% at one point, hitting $/CNH 7.3650).

MAJOR NEWS

Economics and politics

Taiwan elections will raise tensions

• Taiwan’s 2024 election, scheduled on January 13, which the independence-leaning Democratic Progressive Party (DDP) is expected to win, will raise geopolitical tensions.
• Beijing recently levied more trade sanctions on the self-ruled island to warn against a declaration of independence.
• The DDP’s candidate, the current vice-president Lai Ching-te, has criticized his rival Kuomintang (KMT), Hou Yu-ih, warning that his embrace of Beijing could divide the island.
• KMT supports the one-China principle, seeking to improve ties with Beijing, while the DPP refuses to accept it.

Local government bond issuance surges

• According to the Ministry of Finance, China issued 9.14 trillion ($1.3 trillion) of local government bonds in the first eleven months, up a quarter on the same period in the last two years and more than double the level before the COVID-19 pandemic.
• Total local government debts topped 40.6 trillion yuan ($5.8 trillion) in November, 16% up from last year, more than 80% higher than the COVID-19 breakout in early 2020.
• Nearly half of local government-issued bonds were used to fund infrastructure projects, with the remaining half used to repay the old debts.
• Some local governments, such as Tianjin, Inner Mongolia, and Guizhou, which remain deeply indebted, saw bond issuance surging by 138%, 111%, and 93%, respectively.  The new bonds were mainly to swap old debts and to mitigate potential financial issues.

Local government bond issues are planned to support infrastructure

• The Chinese government is expected to announce another massive round of government investment to leverage private sector investment, with the next batch of local government bond quotas expected to be 2 trillion yuan ($280 billion).
• Money raised from these bonds will be used for local infrastructure construction, boosting China’s already hot demand for metals and other commodities.
• Demand for iron ore is already at all-time highs.

Xi’s shared prosperity vision to narrow the economic gap

• Two central government departments jointly released a plan to support the digital economy last week, echoing President Xi Jinping’s “common prosperity” vision. This is vital to avoid the middle-income trap where growth stagnates and incomes stall.
• The government aims to narrow the economic gap between urban and rural regions and among various groups.
• The plan will continue to drive infrastructure construction, specifically connecting remote areas with the developed eastern regions.
• The government plans to improve public services, promote better quality digital education resources and remote medical care services, and improve job prospects by reducing income inequality and attracting talent to live and work in inland cities.
• China's Central Bank highlighted financial aid to support government-prompted affordable flats in the new year, according to the readout after the quarterly meeting of its policy committee, advanced warning that government investment could be directed toward building affordable flats next year.
• The government could absorb unfinished or unsold property projects from cash-strapped.

Measures to boost housing demand are very slow to act

• Many Chinese cities have successfully introduced “old-for-new” plans to get the stagnant housing market moving, with many local governments in remote areas taking measures to help home buyers swap their old flats with new ones. 
• Local authorities set up flatforms connecting brokering agencies, property assessment agencies, and local real estate firms to prompt house swaps.
• Beijing’s housing stimulus measures have fallen short of expectations, and there are calls for more action along the same lines.
• The impact is expected as many Chinese families tighten their belts amid a bleak outlook for income and wealth.

Business

Industrial firms’ profits surge but remain well off highs

• Industrial firms’ profits surged 29.5% year-on-year in November, and revenues rose 1% year-on-year, according to National Bureau of Statistics data
• Total industry profits in the first eleven months of the year reached 6.98 trillion ($976 billion), still 4.4% lower than in 2022 and 12.5% down compared with the same period of 2021.

Tourism shows signs of a more confident consumer

• Tourism saw a remarkable boom throughout the year, with solid growth in sports, entertainment, products, and people’s leisure time. 
• According to China’s Civil Aviation data, domestic passenger traffic last month was 274% higher than last year, recovering to 97.2% of the pre-pandemic level 2019.
• Meanwhile, international passenger traffic rose to 64% of the 2019 level. 
• Travel bookings for the New Year's Day holiday had surged more than threefold compared to the previous year, with hotel reservations experiencing a remarkable increase of over fivefold.
• China’s immigration authorities predicted that cross-border travel over the New Year holiday would equal about 90 % of the level recorded in 2019.