Contrarian Perspectives PART 2: A Case Study in Evaluating Risk-Reward of 2024 China
Contrarian Perspectives: Correlation & Causation
In Contrarian Perspectives: A Case Study in Evaluating Risk-Reward of 2024 China, we explored the critical importance of asset strategies and allocation in the face of market uncertainty. The article delved into the intricacies of assessing risk-reward variables, emphasizing the need for a thorough evaluation of expected return, expected loss, covariance, and volatility in investment decisions.
Through a detailed case study of Hong Kong Exchange (HKEX)-listed companies from November 2023 to March 2024, we highlighted how differing analytical approaches led to diverse perspectives on China’s economic outlook, especially amidst its ongoing property sector struggles and government policy responses.
Building on this foundation, we now turn our focus to the period from March through August 2024—a time marked by significant policy shifts and heightened market volatility. During this period of China's economic developments, the intricate connections between global markets become evident, offering a valuable case study on the complexities that arise in such an environment. Amidst widespread uncertainty and skepticism, the events from March through August 2024 provide important insights into how market dynamics evolve in response to policy shifts and external pressures, highlighting the delicate balance of risk and reward that investors must navigate.
A Turbulent Market Performance
From March to July 2024, Asia-Pacific stock markets experienced notable fluctuations. The Shanghai Composite Index, CSI 300 Index, and Hang Seng Index each saw a significant recovery from their February lows, reaching their interim peaks in May.
The Shanghai Composite Index climbed by 14.53%,
the CSI 300 Index increased by 11.17%, and
the Hang Seng Index surged by 22.02% during this period.
This upward momentum was driven by a combination of investor optimism and supportive policy measures, leading to a brief period of stability and growth. However, this recovery was short-lived. Starting in June, market sentiment began to shift, as concerns over the sustainability of China's economic recovery grew. By early August 2024, the markets began to descend sharply, reflecting growing uncertainty and external pressures.
The Shanghai Composite Index, CSI 300 Index, and Hang Seng Index each retraced much of their gains, with the markets hitting new lows around the end of July. This downturn was exacerbated by broader Asia-Pacific market turmoil with the Nikkei 225 Index plunging over 12.4% in a single trading day, leading to significant losses across global markets - The Shanghai Composite Index, CSI 300 Index and Hang Seng Index all fell at a range of 2-4% during this period of time, highlighting the intricate correlation between regional economic shifts and global financial stability.
Economic Performance: Mixed Signals
GDP Growth:
China's GDP growth during this period reflected a somewhat uneven recovery, characterized by fluctuations in economic momentum:
1Q2024: The first quarter of 2024 saw a robust GDP growth of 4.5%, largely driven by post-pandemic recovery efforts and a resurgence in consumer activity.
2Q2024: However, this momentum slowed considerably in the second quarter, with GDP growth decelerating to 0.7% quarter-on-quarter.
Manufacturing and Exports:
The manufacturing sector, which is critical to China's economic health, faced ongoing challenges during this period:
Contraction: The manufacturing sector experienced several months of contraction, a reflection of global economic uncertainties and weakened external demand. This contraction highlighted the vulnerabilities in China's industrial base, which had yet to fully recover from previous downturns.
Export Growth: Initially strong in early 2024, export growth turned negative by mid-year. This shift was in line with trends observed in neighboring trade partners, further complicating China's economic outlook.
Fiscal Policies
In response to these mixed signals in economic performance, China's fiscal policies from March to August 2024 were adjusted significantly to bolster domestic demand and address structural economic issues.
Third Plenum Meeting: Held from July 15-18, 2024, the Third Plenum was a critical event that set the tone for China's long-term economic strategy. The meeting emphasized structural reforms with a focus on innovation, green energy, and boosting domestic consumption. However, despite the high expectations surrounding the Plenum, the absence of immediate fiscal stimulus measures led to disappointment among investors who had anticipated more direct government intervention to stabilize the economy.
Stimulus Measures: In the aftermath of the Third Plenum, the government did introduce a series of fiscal stimulus measures aimed at supporting key sectors such as housing and technology. These measures included increased government spending and targeted tax incentives designed to boost consumption and investment. While these initiatives were a step in the right direction, they came later than many market participants had hoped.
Monetary Policies
Alongside fiscal adjustments, the People's Bank of China (PBOC) played a crucial role in attempting to stabilize the economy through monetary policy interventions.
Interest Rate Cuts: In late July 2024, just one week after the Third Plenum, the PBOC surprised markets by implementing key interest rate cuts. These included a 10 basis points reduction to the seven-day reverse repo rate, bringing it down to 1.7%. Additionally, the one-year and five-year loan prime rates were cut to 3.35% and 3.85%, respectively. These measures were aimed at injecting liquidity into the market and supporting economic growth at a time of increasing uncertainty.
Pro-Growth Shift: The PBOC's actions were part of a broader pro-growth shift that had begun in response to sluggish economic performance in the second quarter of 2023. This shift included the first key policy rate cuts since August 2022 and signaled the central bank’s readiness to provide further fiscal stimulus if needed to maintain economic stability.
These combined fiscal and monetary policy measures underscore the Chinese government's ongoing efforts to navigate a challenging economic landscape, marked by both internal and external pressures. As China continues to adjust its policies in response to evolving conditions, the impact of these measures on the broader Asia-Pacific region and global markets remains a critical area of focus for investors.
Conclusion
In this issue of Contrarian Perspectives, we examined the impact of global forces and their correlation with China’s markets, highlighting how these dynamics influence investment strategies. While much of our analysis focused on the direct effects of China’s fiscal and monetary policies on its markets, it’s crucial to recognize that China’s markets are still deeply intertwined with global market forces due to these correlations.
The recent decline in the Nikkei 225 Index serves as a prime example of how interconnected global markets have become. The sharp drop in the Nikkei was triggered by the unwinding of the yen carry trade, where investors borrow from low-interest rate environments like Japan and invest in higher interest rate markets such as the US. This strategy is highly sensitive to interest rate changes, and when the Bank of Japan (BOJ) raised interest rates to combat currency depreciation—combined with growing fears of a US recession increasing the likelihood of an interest rate cut—the investing thesis fell apart, leading to a rapid unwinding of these positions.
The resulting plunge in the Nikkei 225 Index had a ripple effect across global markets, including China, as investors re-evaluated their positions in response to the sudden shift in market conditions. Despite China’s independent fiscal and monetary policies aimed at stabilizing its economy and creating a better risk-reward environment, the interconnectedness of global markets means that significant moves in one market can trigger broader market declines, as seen in the early August downturn.
This recent market turmoil bears similarities to the opportunities observed in January-February, as discussed in our earlier analysis. While there appears to be more potential upside in Chinese markets, supported by room for further monetary and fiscal stimuli, the future remains uncertain. The key question is whether the correlation between these markets will decouple or if China's policy measures will successfully attract fund flows, shifting the balance in favor of its markets.
Measuring Market Correlations
Understanding these correlations is critical for developing effective portfolio and risk management strategies, as they help investors anticipate how market dynamics might evolve in response to various economic and policy shifts. Beta is a widely recognized measure used to quantify this correlation. It indicates how much an asset or portfolio is expected to move in relation to a broader market index. A beta of 1 suggests that the asset or portfolio will move in line with the market, while a beta greater than 1 indicates higher volatility, and a beta less than 1 suggests less volatility.
However, while beta is a useful indicator, it is not the only measure of correlation. Other metrics, such as covariance and correlation coefficients, provide additional insights into the relationships between different assets, strategies, and markets. By analyzing these factors, investors can better navigate the complexities of global markets and make more informed decisions that align with their strategic objectives.
The recent market events, including the decline in the Nikkei and its impact on global and Chinese markets, highlight the need for a deep understanding of market correlations to manage risk and capitalize on potential opportunities.
Links & References:
https://www.reuters.com/world/china/what-is-chinas-third-plenum-2024-07-15/
https://www.reuters.com/markets/asia/china-central-bank-cuts-short-term-policy-rate-2024-07-22/
https://www.japantimes.co.jp/business/2024/08/05/markets/nikkei-plunge/
Related Articles
Contrarian Perspectives: A Case Study in evaluating risk-reward of 2024 China - https://www.ray-kok.com/blog/contrarian-perspectives-a-case-study-in-evaluating-risk-reward-of-2024-china
Disclaimer
The information provided on this blog is for informational and educational purposes only and does not constitute financial, investment, or professional advice. The content is provided “as is” without any representations or warranties, express or implied.
The author of this blog is not a financial advisor, broker, or investment professional. All investment strategies and investments involve the risk of loss, and past performance is not indicative of future results. Readers should not rely solely on the information presented here and must do their own due diligence before making any investment decisions. The author will not be liable for any errors or omissions in this information nor for the availability of this information. The author will not be liable for any losses, injuries, or damages from the display or use of this information.
The views, thoughts, and opinions expressed in this blog belong solely to the author, and not necessarily to the author's employer, organization, committee, or any other group or individual. The information presented is subject to change without notice.
This blog does not provide legal, financial, accounting, or tax advice. The reader should consult their own legal, financial, tax, or professional advisor regarding matters referenced in this blog. Any action you take upon the information on this website is strictly at your own risk.
By using this blog, you agree to this Disclaimer. If you do not agree with the terms of this Disclaimer, please do not access or use this blog.
