China’s stock market has experienced a meteoric rise, with the Shanghai Composite surging by as much as 36% from the September low at one point today. However the profit-taking started immediately, with the opening print today as the high.

The problem with this rally is that it’s been built on a shaky foundation and looks more like a short squeeze in stock markets rather than the start of an acceleration in the Chinese economy.

It kicked off just after the Bank of American fund manager survey highlighted that short-China was the second-most crowded hedge fund trade.

That begs the question about the sustainability of the rally and the critical implications it has for the global economy. Already, we’re seeing some of the air come out of oil and materials today.

The critical problem is that China hasn’t done enough for the real economy. This is something that’s been highlighted by Goldman Sachs and Ray Dalio among others. More could still come but the heaviest selling in Chinese equities today came after an economic press conference failed to deliver anything new.

It’s also important to understand the design of the stimulus:

1. Real economy measures: Mostly incremental, inconsequential and have been tried before and failed
2. Stock market support: New, significant and potentially unlimited

Real economy measures

Let’s run-down the real-economy measures and why they aren’t sufficient.

• 20-bps policy interest rate cut (limited due to bank-profitability concerns)
• 50-bps cut to required reserve ratio (potentially releasing CNY1tn in liquidity)
• Existing mortgage rate cuts (modest macro impact)
• Lower down payment requirements for second homes (previously ineffective, it will be tough to turn Chinese housing)
• CNY1tn for bank recapitalization (limited to largest banks that don’t really need it)
• CNY1tn in special bonds for local debt refinancing (certainly helpful but not a game-changer)
• CNY1tn for consumption support (an extension of the cash-for-clunkers programs)
• New monthly allowance for families with two or more children (estimated CNY500bn/year but still limited)

Stock Market measures

• CNY500bn facility for institutional investors to swap higher risk assets for safe assets
• CNY300bn re-lending window to finance stock repurchases by listed companies
• Both programs could be expanded significantly if successful

The strategy might be to inflate stock prices to boost household sentiment, potentially leading to lower savings rates and higher consumption. However, this approach will probably end badly and those who bought at the open today are already down 5%.

If the move flops, the public could further sour on Beijing’s economic management and the usefulness of equities.

Local sentiment

It’s tough to read local sentiment but there are certainly plenty of evidence that people are opening brokerage accounts. However there is plenty of pessimism as well with common phrases circulating (according to Desmond Shum) as:

• “刀口上舔血” (licking blood from the blade)
• “火中取栗” (retrieving chestnuts from the fire)

Locally, those hint that investors see this as something of a pump-and-dump to be ridden for the short term rather than a great time to buy-and-hold. I tend to think that all bottoms start that way but it will truly be hard to sustain without real stimulus.

Speedrun of 2015?

We have been down this road before as people piled into stocks in 2015 only to be crushed — the market still hasn’t recovered from this event (the high of 5166 is far below today’s levels of 3486).

• Mid-2014: SSE around 2,000 points
• June 12, 2015: Peak at 5,166
• August 26, 2015: Plummeted to 2,850

The stakes are very high here, not just for China but for global growth, commodities and reflation trades. Ray Dalio hopes/expects Beijing to deliver more on the real-economy side. At this point, the risk-reward is skewed towards waiting for that to be actually delivered.

Another lever that China can pull is in trade and western relations. That’s been a sore point but China could try to lay the groundwork for better relations with Washington now. A week ago, Justin reported that the US and China will hold talks on trade and economic ties at he ministry level. This could be a foray for a thaw or more of a panic move as China tries to shore up its economy at a delicate time in the Presidential cycle. Maybe there is something that Biden could do after the election and before the inauguration? Also, what does China have to offer?

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