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After two consecutive days of declines, the Chinese stock market looks set to halt its losing streak on Wednesday, October 12th. The benchmark Shanghai Composite Index, which tracks the top blue-chip stocks on the Shanghai Stock Exchange, sits just above the 3,075 point level after falling 1.2% over Monday and Tuesday.
As investors turn their attention to the prospects for interest rates, optimism is mounting that the worst may be over for Chinese equities following a turbulent year. Dovish comments from policymakers have softened expectations for further hikes, easing pressure on overvalued stocks. With inflation potentially peaking and growth steadying, markets are hopeful the People’s Bank of China can begin cautiously unwinding its tightening cycle.
Markets Upbeat Despite Geopolitical Uncertainty
Remarkably, the improved outlook comes against a backdrop of considerable geopolitical uncertainty. The ongoing war in Ukraine and tensions across the Taiwan Strait have weighed on sentiment for much of 2022. However, stocks in China and globally have proven resilient this week, shaking off the uncertainty.
Progress on the war remains elusive, but markets are focused on the long-term trajectory for interest rates and inflation. Central banks continue walking a tightrope, trying to avoid tipping economies into recession while bringing prices under control. For now, investors are encouraged that the worst-case scenario of runaway inflation has been avoided.
On Wall Street, the Dow Jones, NASDAQ and S&P 500 all posted gains on Tuesday, rising between 0.4% and 0.6%. European and Asian indices also closed higher. The mood surrounding Chinese stocks is their most positive in months, although gains remain vulnerable to negative headlines.
PBOC Cautious But Optimistic on Rates
At a key congress of the Chinese Communist Party this month, leaders emphasized the need for proactive fiscal policy and prudent monetary policy. This suggests the People’s Bank of China will continue taking a measured approach to interest rates, aiming to balance multiple objectives.
China’s benchmark lending rate, the one-year loan prime rate (LPR), stands at 3.65% after the PBOC raised it in August and September. However, senior officials have hinted the tightening cycle may be nearing an end. Liu Guoqiang, deputy governor of the central bank, said recently they will avoid flooding the economy with excessive stimulus and maintain “reasonably ample” liquidity.
With inflation pressures fading, the PBOC has scope to pivot toward supporting growth. Consumer price growth slowed to 2.8% in September, comfortably below the official 3% target. The Caixin manufacturing PMI also remains in contraction territory at 48.1. While lockdowns have eased across China, the property market slump and weak global economy continue dragging on activity.
eyes will be glued to upcoming economic data and PBOC communications for clues on rates. The central bank is striving to engineer a soft landing, but uncertainty remains high. Markets are optimistic China can achieve a Goldilocks outcome, where growth rebounds moderately without fueling inflation.
Chinese Stocks Still Face Uphill Climb
Despite this week’s resilience, Chinese equities remain deeply depressed after a nightmare year. The Shanghai Composite Index has shed over 15% in 2022 and is one of the worst performing major indices globally. While valuations look increasingly attractive for long-term investors, many risks remain.
The property sector crisis has weighed heavily on consumer confidence and construction activity. With titans like Evergrande defaulting on debts, confidence in housing as a stable investment has eroded. Local governments are stepping up efforts to complete projects and boost infrastructure spending, but a quick turnaround looks unlikely.
Meanwhile, the zero-COVID policy continues exerting a major drag on consumption and mobility. Recent easing has buoyed hopes activity can rebound once restrictions are lifted decisively, but unpredictable lockdowns persist. The outlook for exports also appears challenging with key markets like the EU and US flirting with recession.
Overall, analysts see rocky trading ahead but believe valuations have fallen to reasonable levels. The price-to-earnings ratio on the Shanghai Composite has dropped below 10x earnings, making blue-chips like China Mobile and Sinopec attractive bargains. But with growth stuck below 3%, upside remains limited barring clear policy pivots.
Key Drivers for China Stocks
In summary, here are the key drivers and risks investors will be monitoring as the fourth quarter unfolds:
- Inflation trajectory and PBOC’s policy response
- Progress on infrastructure spending and property market support
- Path of COVID restrictions amid evolving economic impact
- Global recession risk weighing on exports and sentiment
- Geopolitics, particularly US-China relations over Taiwan
While risks remain elevated, the People’s Bank of China has room to adjust policy if needed. With inflation pressure abating, officials can take a nuanced approach rather than resorting to blanket stimulus or tightening.
There are still hurdles ahead, but with valuations resetting lower, China’s stock market looks well positioned to leave its losing streak behind. Savvy investors will be watching for entry points to capitalize on the brighter outlook for rates.
