In recent news, it appears that China's leaders are making an interesting move to support the country's stock market. Reports suggest that they are ordering state-owned firms to repatriate funds held overseas and use them to purchase Chinese stocks, with an estimated amount of 2 trillion yuan ($280 billion) being involved. While this may be seen as an unexpected move from a communist government, it raises concerns about whether it will be effective in addressing the deeper issues plaguing China's economy.
China's stock market has been experiencing a prolonged period of struggle. Over the past three years, the Shanghai Stock Index has declined by more than 21 percent, resulting in a significant drop in valuations. Price-earnings ratios, which indicate investor confidence in future gains, have fallen to an average of 10.4 times current earnings, well below the 12.5 times average of the past decade. While rumors of the government's substantial spending program initially sparked some speculative buying and led to a 5 percent increase in the index over three days, stocks soon turned downward again and remain significantly depressed compared to their 2021 highs.
These depressed valuations reflect the fundamental challenges facing China's economy. Economic growth has slowed considerably from historical averages, and this has had a direct impact on earnings growth, a key factor supporting stock values. The ongoing property crisis in China has played a significant role in this troubling situation. The crisis began three years ago when Beijing decided to abruptly withdraw support for residential building. This decision led to the failure of major development companies, and the lack of adequate response from Beijing resulted in a loss of credit flow, hindering growth. Additionally, the property failures and resulting financial constraints have caused a decline in home buying and a subsequent drop in real estate prices.
However, the property crisis is not the sole concern for China. The decline in real estate values has greatly affected households' net worth, resulting in reduced consumer spending. Simultaneously, Chinese exports have suffered as foreign buyers seek to diversify their supply chains and foreign governments display growing hostility towards Chinese trade. This includes major players such as Washington, Brussels, and Tokyo. Furthermore, Beijing's focus on security has greatly impacted business operations, leading to a slowdown in foreign investment. The centralized control in Beijing has also limited investment growth among domestic private businesses.
Given this backdrop, it is not surprising that Chinese stocks have experienced significant setbacks. The fact that Beijing has not taken adequate steps to address these underlying problems further explains the decline in stock valuations. Consequently, it is unlikely that Beijing's stock-buying program will have a lasting impact. While the rumored amount involved is substantial enough to cause some commotion, accounting for approximately 8 percent of the total value of all Chinese stocks, a lack of comprehensive and effective measures to address the core issues will result in stocks plummeting once the buying program concludes. A similar scenario unfolded in 2015 when stock prices began to decline even before the previous buying program ended.
These circumstances pose a warning to potential investors in Chinese stocks. While an initial rise in prices due to official buying may be tempting, the absence of fundamental remedies suggests that subsequent price drops will likely occur rapidly, thus undermining both the official buying program and hurting investors who joined in hopes of riding the gains.
In conclusion, China's efforts to stabilize its stock market through state-owned firms repatriating funds and purchasing Chinese stocks might provide some short-term relief. However, without addressing the underlying economic issues, this strategy is unlikely to have a lasting positive impact. The fundamental challenges, including the property crisis, slowed economic growth, and external trade tensions, continue to plague China's stock market. As such, caution and careful consideration should be exercised by those considering investing in Chinese stocks.
