Chart of the month: Is this China’s ‘whatever it takes’ moment?

In July 2012, the then President of the European Central Bank told the world his institution would do ‘whatever it takes’ to hold the euro area project together, a statement which marked a key turning point in the, until then, intractable euro crisis.

In that same year, Xi Jinping became the leader of China. He took power at a point at which the economy’s days of double-digit GDP growth were coming to an end, with growth slowing steadily ever since amid significant weakness in property markets. Despite that, policymakers have tended to ignore investor hopes for a ‘whatever it takes’ moment with Chinese characteristics.

Towards the end of September, however, it felt rather like that moment might have arrived. As my colleague Erik Lueth has discussed, the central bank surprised markets with a cut to policy rates, a cut in the required reserve ratio and mortgage rates. They also unveiled measures designed specifically to support the equity market, with funding to encourage banks and insurers to increase their equity holdings and for firms to finance buybacks. The effect was immediate and dramatic: the domestic Chinese equity market saw its strongest monthly performance since December 2014, rising by 21%.

Amid the economic challenges, investors had generally been avoiding exposure to Chinese equities, leaving positioning cautious and valuations depressed. That is quickly normalising: as at the time of writing in early October, valuations for the internationally tradeable Chinese equity market are now slightly above their average, and only around 10% below their 2015 peak of 10x earnings.

For all the enthusiasm, our economics team remain sceptical that the proposals will get traction on the real economy, as discussed in Erik’s blog. If the policy traction is indeed limited, it could in turn limit the upside potential for corporate earnings, which clearly will become key given the scope for further valuation expansion is now more limited in our view.

Whatever the outlook for the fundamentals, the path ahead is unlikely to be boring. Looking back to December 2014, the last month of performance comparable to the one just seen, Chinese equities went on to quickly fall 10%, before gaining 60% fuelled by leveraged margin buying by retail investors. They then halved over the next six months, leaving the index below the level seen before the big December 2014 gain.

Whether something similar happens this time around remains to be seen.