1 Stock market volatility bodes ill for Xi and the CCP
Stocks show sharp fluctuations, main funds exit markets
Oct. 8
On the first trading day after the PRC Golden Week, A-shares opened higher but saw volatility and closed lower.
- The Shanghai Composite Index opened 10 percent higher than the previous trading day at 3,674.40 points, a new record high since the end of the “zero-COVID” policy in 2023. The index closed up 4.59 percent at 3,489.78 points.
- The Shenzhen Component Index closed up 9.17 percent at 11,495.10 points.
- The combined trading volume on the Shanghai and Shenzhen indexes reached 3.45 trillion yuan, up from 858.9 billion yuan on the previous trading day and a record high.
- Net outflow of main funds (主力資金, or funds in the stock market typically controlled by large institutions that influence or even control short to medium-term market trends) from the Shanghai and Shenzhen markets for the day was close to 215 billion yuan.
Oct. 9
- The Shanghai index closed down 6.62 percent at 3,258.86 points, marking the largest single-day drop since February 2020 and snapping a 10-day winning streak.
- The Shenzhen index closed down 8.15 percent at 10,557.81 points.
- The combined trading volume on the Shanghai and Shenzhen markets was 2.94 trillion yuan, down 512.1 billion yuan from the previous trading day.
- Net outflow of main funds from the Shanghai and Shenzhen markets for the day was 214 billion yuan.
Oct. 10
- The Shanghai index rose by 1.32 percent to close at 3,301.93 points.
- The Shenzhen index fell by 0.82 percent to close at 10,471.08 points.
- Net outflow of main funds from the Shanghai and Shenzhen markets for the day was over 60 billion yuan.
Oct. 11
- The Shanghai index fell by 2.55 percent to close at 3,217.74 points.
- The Shenzhen index fell by 3.92 percent to close at 10,060.74 points.
- Net outflow of main funds from the Shanghai and Shenzhen markets for the day was over 97 billion yuan.
Young Chinese jump into stock trading
Oct. 7
Mainland media reported that almost all Chinese brokerage firms were offering 24/7 account opening services during the Golden Week. A relevant person in charge at Xiangcai Securities told mainland media that the number of new accounts opened recently increased by 97 percent month-on-month and increased by 164 percent year-on-year.
The person added that the investors who opened new accounts during the holiday period were noticeably younger. Of the investors who opened accounts between Sept. 23 and Sept. 30, 27 percent were those born in the 2000s, 23 percent were those born in the 1990s, and 24 percent were those born in the 1980s.
Oct. 9
1. The New York Times reported that young Chinese have been jumping into stock trading over the past two weeks.
2. Mainland media reported that Chinese residents are withdrawing bank deposits, redeeming financial products, or applying for consumer loans to invest in the stock market, resulting in a significant outflow of funds from banks. A branch of a bank in Shenzhen revealed that it lost 4 billion yuan in deposits in one day, of which more than 35 percent flowed into the stock market and the remainder to cash accounts at brokerage firms.
Mainland media added that in addition to deposit outflows, bank financial products are also facing redemption pressure. In the first two trading days before and after the Golden Week, Industrial Bank and Ping An Bank announced the suspension of quick redemptions for some cash management products because total redemption requests exceeded their respective internal limit.
Mainland media also reported that a consumer loan product from the aforementioned bank branch in Shenzhen saw loan disbursements exceeding 700 million yuan during the Golden Week, surpassing the amount during the 2024 Lunar New Year period. This sharply contrasted with the low withdrawal activity before the recent stock market rally.
Beijing rolls out more economic policies
Oct. 8
1. Mainland media reported that the PRC financial regulatory authorities have required financial institutions to strictly control leverage and strictly prohibited the illegal entry of bank loan funds into the stock market.
A local banking industry representative told mainland media that the requirement to strictly prohibit bank loan funds from flowing into the stock market has not changed, and there are clear purposes and specific loan targets for newly established special loans. The representative added that this is entirely different from retail investors illegally using loan funds for stock trading.
Mainland media added that some brokerage firms have reiterated to their employees the prohibition against illegal stock trading and strengthened compliance awareness across all business lines by issuing notices and verbal reminders.
2. Zheng Shanjie, the director of the National Development and Reform Commission, said at a State Council Information Office press conference that efforts are being made to boost the capital market. Zheng added that various policies are being introduced at an accelerated pace.
Zheng said that the central government budget investment of 700 billion yuan has already been fully allocated. Also, an additional 1 trillion yuan in super-long-term special government bonds have been fully distributed to projects and local governments.
Zheng expressed confidence that China will meet its economic growth target in 2024. He described the current economic situation as “stable with progress,” and added that China will “intensify the introduction of incremental policies to promote sustained economic recovery and improvement.”
Oct. 10
The People’s Bank of China announced a securities, funds, and insurance companies swap facility to encourage financial institutions to increase their investments in the stock market. The central bank added that applications would be accepted effective immediately, with the first phase of operations amounting to 500 billion yuan.
Oct. 12
The PRC Ministry of Finance held a press conference attended by finance minister Lan Fo’an and three vice ministers. Lan introduced plans to “enhance the counter-cyclical adjustment of fiscal policies and promote high-quality economic development, as well as answered questions from journalists.
Key points in the press conference include:
- Lan Fo’an said that China’s fiscal system has “sufficient resilience” and China can achieve a balanced budget and 2024 budget goals through “comprehensive measures.”
- The Ministry of Finance will soon roll out a package of targeted incremental policy measures:
- The central government will issue more debt and increase the deficit significantly.
- There are plans to significantly increase the debt limit in one go and swap the implicit debt of local governments.
- Special treasury bonds will be issued to support large state-owned commercial banks in replenishing their core tier one capital.
- Tools like local government special bonds, special funds, and tax policies will be used to support the stabilization of the real estate market.
- The minimum standard for basic pensions for urban and rural residents will be further increased, with this being the largest increase to date. The pension levels for retirees will generally increase by around 3 percent.
- The central government will allocate more than 10 trillion yuan in transfer payments to local governments in 2024. More transfer payment funds would be directed towards enhancing local financial capacity and supporting the “three guarantees” (people’s livelihood, wages, and grassroots operations).
- The finance ministry emphasized the need to collect fiscal revenue in accordance with laws and regulations, while avoiding excessive taxation and protecting the rights of businesses.
- Local governments will be guided to use budget stabilization funds and other resources to meet fiscal spending needs.
- Localities are encouraged to revitalize idle assets and improve the management of state-owned capital returns.
- The use of various debt funds will be maximized, the use of government bonds will be accelerated, and ultra-long-term special treasury bonds will be progressively allocated for use. In the next three months, local governments will have 2.3 trillion yuan in special bond funds available for allocation.
- Future special bond measures will focus on expanding the scope of their use and improving management mechanisms.
- Research is being conducted to clarify and potentially abolish value-added tax policies for ordinary and non-ordinary residential properties.
- A batch of mature and tangible reform measures will be introduced over the next two years, such as those improving the budget system and refining the fiscal transfer payment system.
The number of national scholarship awards will be doubled in 2024.
Foreign investors sell Chinese stocks
Oct. 10
Bloomberg News reported that hedge funds sold a record amount of Chinese shares on Oct. 8 after a key policy meeting disappointed traders with no major stimulus, citing a note from Goldman Sachs.
The Goldman note said, “Hedge funds not only unwound their long positions but added shorts to their books as well, with long sells being double the amount of short sells.” The note also said that three-quarters of hedge funds’ selling was in A-shares and the rest were Hong Kong-listed shares.
Our take
1. China’s faltering stock market rally after the Golden Week holiday partially affirms our skepticism about Beijing’s latest round of economic support measures.
We previously analyzed:
- “Even greater financial risks could potentially be triggered should the current upward market trend fail to sustain (likely given the general lack of confidence in China’s A-shares market and economic prospects) and sharp declines follow.”
- “We believe that the PBoC’s latest policy measures are akin to applying a bandage without addressing the underlying issues plaguing the Chinese economy. The policies could also worsen existing problems further down the road as financial institutions take on more leverage.”
- “… clients of CITIC Securities, which include members of the Party and financial elite, would increase their short positions the day after the central financial regulators rolled out favorable policies. This suggests that they and CITIC Securities either believe that the central government’s measures to lift the stock market are insufficient, or they are acting in opposition to the central authorities.”
- “We believe that Beijing’s efforts to boost the capital market are unlikely to be unsustainable regardless of whether CITIC Securities intentionally or unintentionally carried out short-selling operations. This is because Beijing did not properly address the fundamental problems causing China’s economic downturn with its latest raft of economic support measures. Even if the market was buoyed by the support measures, those recent gains could quickly evaporate when the reality of China’s economic situation becomes apparent again after a couple of months.”
2. The exit of major funds from the capital market suggests that institutional investors are cautiously pessimistic about the CCP authorities’ economic support and stimulus measures, particularly as Beijing faces significant constraints in realizing those measures.
i) The Ministry of Finance’s press conference on Oct. 12 did not offer specifics on how it plans to significantly expand debt. This is likely to disappoint investors who are more concerned with the details, and not the broad strokes, of what the CCP authorities plan to do to revive economic growth.
ii) Beijing’s plan to increase the fiscal deficit appears to be primarily aimed at addressing local government fiscal and debt problems rather than the real estate issues that investors were hoping for. In particular, the finance ministry’s measures to support the property market were focused on acquiring affordable housing, and not resolving the issue of unfinished housing projects.
iii) The finance ministry’s plan to issue special treasury bonds to support large state-owned commercial banks suggests that those banks lack capital. The shortage of capital at those banks makes it very difficult for Beijing to “significantly increase” debt to stimulate the economy because such a move would drain trillions of yuan in liquidity from the banks that underwrite the bond issuance and increase financial risks.
iv) If Beijing allows the PBoC to print money to purchase trillions of yuan in special treasury bonds in the absence of further rate cuts by the U.S. Federal Reserve, it could lead to further renminbi devaluation and trigger more capital outflows.
As of Oct. 10, the yield on China’s 10-year government bonds was 2.127 percent and the yield on U.S. 10-year government bonds was 4.073 percent, leaving an interest rate gap of 194.6 basis points. Meanwhile, the Fed is estimated to continue its program to shrink its balance sheet until the second quarter of 2025, and only then could it shift policy towards quantitative easing. The Fed’s expected moves appear to make the CCP authorities hesitant to implement large-scale monetary easing policies.
3. Unless the CCP authorities unveil promising specifics in the near future, the policies announced by the finance ministry at the Oct. 12 press conference are unlikely to excite investors and sustain the technical bull market. Xi Jinping and the CCP could find themselves under increased pressure if the stock market declines in the next trading session and the rally fizzles out.
i) The recent stock market rally likely increased financial risks in China without resolving underlying issues.
The CCP authorities likely intended to create a buzz about the rally in the hopes that residents would channel some of their savings into the stock market. However, an unintended consequence of the technical bull market was the entry of young investors into the market. Reporting from mainland media suggests that these young people are participating in the market through illegal loans and leverage. Chinese banks could see bad debt levels creep up if the loans of young investors are tied up in stocks and they cannot unwind their positions later.
Concurrently, institutional and veteran investors appear to be taking the opportunity to cash out on their stocks. Publicly available data shows that the net outflow of main funds from Oct. 8 to Oct. 11 reached nearly 590 billion yuan. The persistence of this trend would suggest that seasoned and institutional investors are pessimistic about the market and the economy in general despite the recent rally.
ii) The Xi leadership’s “common prosperity” policy is in danger of being affected should a large amount of retail investor funds get trapped in the market. The turnover of shares resulting from the recent inflow of retail investors funds and exit of main funds indicates that money is being transferred from the people into the pockets of financial institutions, large shareholders who reduced their holdings, and the Party and financial elite. This undermines Beijing’s likely intention to have the wealth effect from the market rally boost household consumption, and instead further suppresses consumption due to rising household debt and widens the wealth gap.
iii) Xi and the CCP face a quandary on how to handle the capital market.
If Beijing fails to implement fiscal policies that would satisfy investors, many investors could proceed to unwind their stock positions. Nomura Securities warned in an Oct. 3 note that a market crash after the recent mania could result in rampant capital flight akin to the 2015 market turbulence. The note further warned that worse could follow a busted rally, with Beijing potentially resorting to printing money and the renminbi could come under depreciation pressure. We believe that a share-dumping stampede would severely undermine market confidence and weaken the public’s faith in the CCP authorities’ ability to rescue the economy.
If Beijing instead caves to investor expectations and introduces many of the policies that the latter demands (regardless of their actual effectiveness), Xi and the CCP would find their “quan wei” (authority and prestige) weakened. Such moves would create the impression that the Party’s leadership over the economy has failed and Xi has to bow down to market forces after years of trying to get the better of it. Xi and the CCP could technically get away with serious erosion of their “quan wei” if the policies meant to placate investors work for a period. But the Xi leadership would struggle to resolve fundamental issues plaguing the Chinese economy because it cannot turn back to deleveraging and derisking, and the CCP regime would be set up for a greater fall when concentrated financial risks are eventually triggered. Meanwhile, failure of the policies would shred the public’s confidence in the CCP authorities and more quickly trigger economic and financial crises.
Regardless, Xi Jinping is unlikely to escape unscathed from any financial or economic debacle. During the 2015 market turbulence, there was still an understanding that Xi did not have everything under control during his first term and the financial sector was dominated by “anti-Xi” Party elites. However, Xi cannot easily blame his factional rivals or find other scapegoats for the current economic and financial problems as most of them are the direct consequence of his actions (even well-intentioned measures meant to address problems left behind by his predecessors) over the past decade, including “zero-COVID” lockdowns, efforts to strengthen the Party’s control over the economy and financial sector, and the CCP’s “wolf warrior” diplomacy.
