Key Points:
- The a-share market continues falling due to current domestic policy favoring LG and corporates, neglecting direct household sector support.
- China’s primary economic issue is insufficient demand; aid to LG and corporations struggles to reach households, leaving demand unresolved.
- Pre-2020, the Chinese household sector continuously leveraged up. The relaxation of policies can drive recovery, but high debt-to-income ratios and pandemic impact halt leverage increases.
- Despite central government aid to the production side causing oversupply and deflation concerns, A-share investors await future policies directly supporting the household sector.
- The US treasury supply decline in November improves overseas liquidity, making the current overseas market asset prices favorable.
- shares reflecting pessimistic outlooks may rebound in 1Q24 with increased new loans and year-end payments, improving market liquidity.
- Domestic commodity market optimism results from policies favoring the production side, stabilizing overall upstream demand; downward pressure risk may rise after the Spring Festival.
Hou Zhenhai
Straits Financial (China) Chief Strategist
I. Why are A-shares still falling by itself?
Lately, positive changes have occurred both domestically and overseas. Notably, there has been a rapid decline in US Treasury yields since November, resulting in a marked improvement in liquidity and market sentiment globally due to reduced pressure from the supply of US Treasury bonds. Many countries, including the US and Indian stocks, have experienced substantial rebounds, reaching new highs.
Simultaneously, to alleviate pressure on the fiscal situation of local governments and address maturing debts, the Chinese central government has intensified efforts to refinance local government debts. It has also increased this year’s budget deficit ratio from 3% to 3.8% by issuing an additional 1 trillion RMB in treasury debts. Additionally, the central government has urged banks to enhance financing support for crucial property developers and small-medium enterprises.
Despite these measures and favorable market factors, A-shares did not experience a significant rebound. While the micro-cap sector rebounded with retail speculative funds, A-shares, on the overall index level, continued to see substantial declines. The primary reason, in our view, is that current domestic stimulus policies primarily support local governments and enterprises, with minimal direct support for the residential sector. This is evident in the notable increase in overall government and corporate financing since October (Figures 1 and 2).
Source：Bloomberg，CEIC，Wind
Source：Bloomberg，CEIC，Wind
However, the main problem of China’s economy today is the lack of demand, which is mainly reflected in the downturn in property sales and household consumption, although the bailout of local governments and large developers can help them maintain their cash flows and balance sheets to avoid systematic financial crisis and widespread bankruptcy and layoffs, it is still difficult for these funds given to the LG and corporates to repair the balance sheets of residential sector, especially those low- and middle-income people who mainly rely on wage income. In terms of total number, this group of people contributes the largest part of China’s domestic consumption and property sales, so due to the poor transmission efficiency, this group cannot directly benefit from the current central government’s fiscal and credit support to LG and corporates. On the other hand, although corporations have received a certain degree of financial support from the government and banks, the more important source of funding for most corporations is still operating income, the ultimate contributors of which are Chinese domestic residential consumers and exports.
Against the backdrop of negative overall exports this year, the domestic household sector has not been able to directly benefit from the current fiscal and monetary easing. For the corporate sector, even with increased support from the bank financing, their overall cash flow situation, especially free cash flow (because a large part of the new bank financing is only used to repay maturing debt and interest, but cannot form free cash flow), is unlikely to improve substantially. Before 2020, although the fiscal policy did not directly help the household sector, because the households had room to continue to leverage up, as long as the monetary policy is relaxed, they can also promote the continuous rise of its own consumption and investment (property) capacity through the continuous leverage on their debt-to-income ratio.
After 2020, the most notable change is the cessation of the leveraging process in China’s household sector. This cessation results from Chinese households having reached the highest debt-to-income ratio among major countries globally. The decline in household income caused by the Covid-19 pandemic has effectively halted the household leverage cycle that commenced in 2008. In essence, China’s household sector can no longer stimulate more demand through a further increase in their debt ratio, as was the case before 2020. Consequently, the efficacy of China’s monetary and property loosening policies has experienced a significant decline. Without direct fiscal policy assistance to household income, there will be an inability to enhance the consumption and investment (property) capacity of the household sector.
Source：Bloomberg，CEIC，Wind
Therefore, to sum up, although the current government has increased fiscal and monetary easing efforts, evident in the notable acceleration of bond issuance and financing by local governments and corporations, the household sector has been unable to recover its income and repair its balance sheet. This situation has emerged as the primary obstacle to a demand pickup. Till the end of Q3, China’s household sector experienced a similar level of income growth rate as observed during the pandemic last year, indicating no improvement at all (see Figure 4).
Source：Bloomberg，CEIC，Wind
Persisting weak demand contributes to the unyielding trend of excessive oversupply, coupled with continuous declines in prices and profits on the supply side. Despite central government assistance and bank refinancing, corporate production activities may merely be sustained. In the context of A-shares, corporate revenue and profitability remain stagnant, while the household sector, the primary source of incremental investment funds, continues to reduce inflows into A-shares. This trend extends beyond A-shares to domestic property sales and prices, displaying a similar pattern. The driving force behind these trends aligns with the observed decline in A-shares.
A more critical issue is that, while refinancing and fiscal support for local governments and corporations can prevent financial systematic risks and sustain corporate production activities, ensuring real estate developers continue construction despite sluggish property sales, the deteriorating cash flow situation of households may lead to a potential further decline in property prices. This can occur due to weakening purchasing power and increased liquidation in the existing home market, subsequently impacting corporate and household incomes, along with local government land sales revenue. There has been a recent additional decrease in the listing prices of both the new home and existing home markets in major cities (see Figure 5, Figure 6).
Source：Bloomberg，CEIC，Wind
Source：Bloomberg，CEIC，Wind
Therefore, without additional external support, the acceleration in the decline of property prices may exacerbate the asset depreciation on Chinese household balance sheets, leading to a more pronounced suppression of household spending power. For A-shares, this represents the most significant uncertainty risk currently faced by the market.
II. A-share investors are looking forward to future favorable policies that directly support household income.
Compared to the policy of refinancing and reducing debts for local governments (LG) and corporations, A-share investors anticipate future favorable policies directly supporting households, especially measures to boost household income and repair balance sheets through fiscal and monetary support.
In terms of fiscal policy, the central government could consider increasing subsidies for household consumption and raising transfer payments to low- and middle-income families. On the monetary front, further interest rate cuts, especially on housing loans, could be considered to help the household sector effectively reduce its debt burden and interest expenses. For instance, since the beginning of the year, the interest rate of the 1-year MLF has been lowered twice from 2.75% to the current level of 2.5%. However, the interest rate of the 5-year LPR, determining the floating rate of residential housing loans, has only slightly reduced to 4.2% from 4.3% at the beginning of the year. Consequently, there has been minimal assistance for the household sector in easing debt costs.
Source：Bloomberg，CEIC，Wind
Simultaneously, with the recent issuance of incremental LG bonds and treasury debts and approaching year-end, the interbank funding situation is relatively tight. A-share investors anticipate further cuts in the reserve requirement ratio (RRR) and/or additional interest rate reductions. Additionally, due to the recent decline in US Treasury bond yields, external interest rate pressure has eased, and the RMB exchange rate against the US dollar has rebounded. Investors should pay attention around December 20th to see if the People’s Bank of China (PBoC) will further loosen monetary policy.
While more policies and market confidence in the long-term economic direction are needed to address China’s current weak consumption and household balance sheet pressures, it’s undeniable that if the short-term household cash flow deteriorates further, the recovery of overall consumer demand will be sluggish. Even in the absence of default risks on LG debts and assurance from developers regarding unfinished buildings, there may be increased downside risks due to mounting deflationary effects on household assets such as housing and stock prices.
III. Sharp reduction in the supply of US treasury debts is the main driving force behind the decline in yields.
Since November, the supply of US Treasury debts has significantly decreased compared to October. The net issuance of US Treasury in November was only $149.6 billion, a substantial decline from $532.2 billion in October. The US Treasury Department has reached its $750 billion TGA replenishment target. Despite the US Congress postponing the final vote on the FY24 budget bill and averting a government shutdown, we anticipate an ongoing deadlock in FY24 budget negotiations between the two parties, introducing uncertainty about the US economic performance next year. If the actual deficit in FY24 remains around the current budget of $1.5 to $1.6 trillion, the net issuance supply of US Treasury in the coming months may hover around a relatively low monthly level of $150 billion. The Congressional stalemate on the budget deficit implies lower US Treasury financing requirements and relatively stable fiscal deposit TGA levels. This situation will help restrain medium- and long-term US bond yields from rising quickly, as seen in October. Therefore, in the short term, improved liquidity will be relatively beneficial to global asset price trends. Figure 8 illustrates the increased pressure on US Treasury supply, causing rising yields in September and October. However, in November, as the pressure on US Treasury issuance eased significantly, liquidity conditions in the US financial market quickly recovered, returning to their best level of the year. Consequently, US stocks rebounded swiftly, recovering all losses incurred from September to October.
Source：Bloomberg，CEIC，Wind
IV. Market strategy
The recent sharp rebound in US stock and bond prices primarily results from a substantial improvement in liquidity in the US financial market. This improvement is from the significant weakening of supply pressure on US Treasuries since November. Fed fund futures indicate the market’s expectation of the Fed cutting interest rates five times in 2024. However, the potential tightening of the US fiscal deficit and its negative impact on the US economy and corporate profits post-fiscal tightening have not been factored into the current market. Therefore, we assess that the current overseas market is in a stage most favorable for asset prices, reflecting expectations of rate cuts and improved liquidity without significant concerns about economic and earnings decline. The duration of this situation depends on the direction of the Fed’s liquidity control and whether US fiscal deficits genuinely start to tighten. In summary, when market liquidity improves, asset prices will reflect the benefits of interest rate cuts; when market liquidity worsens, asset prices will reflect the risks of economic and earnings decline. Overall, as long as the expectation of a “soft landing” for the economy holds, the absolute downside room for US stocks is very limited.
A-shares rebounded slightly and then sold off again, mainly reflecting a lack of market confidence. This lack of confidence primarily results from current policies focusing more on repairing the balance sheets of local governments and corporations, with limited direct assistance for improving household income and repairing residential balance sheets. Whether from the perspective of incremental funds in the stock market or corporate profit expectations, this emphasis has increased pressure on A-shares. Despite A-shares reflecting a very pessimistic economic and policy outlook, we believe that future marginal improvements from financial and policy perspectives can drive a rebound, especially in the first quarter of next year, with increased new loan quotas and year-end payments to households improving market liquidity to a certain extent. Although we consider this insufficient to completely shift current market expectations to optimism, a reduction in pessimistic expectations is anticipated to lead to an A-shares rebound early next year. The main risk for A-shares is the potential lack of further policies to support the household sector, causing the deterioration of household cash flows and expectations to spread to the property market, resulting in greater depreciation pressure on household balance sheets.
Relatively speaking, the domestic commodity market reflects much more optimistic expectations than the A-share market. This difference arises from current policy supports primarily favoring the production side, ensuring overall stability in upstream demands for commodities. However, demands for downstream finished consumer goods and services are sluggish. As we are currently in the off-peak season at the end of the year, weak demand typically does not immediately impact commodity and near-month futures prices. Therefore, the risk of downward pressure on commodity prices may not become more significant until after the Spring Festival next year.
About the Author
Dr. Hou holds an MBA from the Wisconsin School of Business at the University of Wisconsin–Madison and has a rich history of leading strategic teams. At China International Capital Corporation, he was instrumental in guiding both the overseas and A-share strategy teams, earning several top honors in strategy research. Later, he significantly contributed to macro strategy research at Shanghai Discovering Investment, where he played a pivotal role in achieving exceptional market returns. His expertise is particularly recognized in financial strategy and market analysis within the Chinese market.