Is there still room in the stock market? Morgan Stanley: Retail investors have ample ammunition, lower leverage, and still far behind compared to 2015

Retail investors in China are driving the stock market rebound, with low leverage and high household savings in A-shares indicating the huge potential for household asset allocation to shift towards the stock market.

On Thursday, October 3, Morgan Stanley strategist Chiyao Huang and his team stated that if market sentiment remains high, nearly RMB 6 trillion of household assets could flow into the stock market. On Wednesday, analysts Katherine Lei and her team at JP Morgan Securities wrote that the stock market rebound has just begun. Both teams believe that retail investors are the main force driving the current A-share rebound. With low leverage in A-shares, increasing household savings, and assets being under-allocated in the stock market, further inflow of household assets into the stock market will continue to drive the A-share market rebound.

Morgan Stanley also pointed out that brokerage stocks may be overvalued in this round of rebound, while JP Morgan stated that brokerage stocks have a 37% upside potential in earnings per share.

Since the press conference held by the People's Bank of China on September 24, the MSCI China and CSI 300 indices have risen by 21% and 25% respectively. On September 30, trading volume reached a record high of RMB 2.6 trillion, with trading speed soaring to 751%.

Retail investors, not leverage, are driving this round of rebound

Both Morgan Stanley and JP Morgan believe that retail investors are driving this rebound, similar to the situation during the last retail bull market in 2015. JP Morgan additionally pointed out that the rebound in the offshore market is mainly driven by institutional investors, but domestic retail investors are the key driving force for domestic performance.

Firstly, in 2015, the average trading speed was 495%, peaking over 700%; while in this rebound, the average trading speed of A-shares in the past week was 465%.

Secondly, in the 2015 bull market, retail investors accounted for as much as 90% of trading volume; whereas in the current stock market rebound, retail investors play an important role, accounting for approximately 60% of trading volume.

It is important to note that unlike in 2015 where funds inflow was mainly driven by retail investors and leverage, this stock market rebound is not driven by leverage.

JP Morgan pointed out that the leverage ratio in the A-share market has dropped from around 8% at the peak in 2015 to about 2.0% by the end of September.

Morgan Stanley noted that margin financing activities lag behind the increasing trading participation. As of September 27, the balance of margin loans was RMB 1.38 trillion, almost unchanged from the beginning of the month. Therefore, due to the market rebound, the proportion of margin financing to market capitalization has decreased from around 2% before the rebound to 1.79%.

This indicates that the current stock market rebound and increased trading activity are not driven by leverage, as the overall risk appetite of investors has not increased to the level where more leverage is needed.

On the other hand, new investors typically do not use much leverage, and they may be the main contributors to the inflow of funds this time. Data shows that the number of new account openings in the past week has increased by 5-6 times compared to previous weeks.

In addition, brokerage ETFs saw outflows during the rebound, with major brokerage ETFs tracked by Morgan Stanley experiencing a net outflow of about 1.9 billion units in the past week. This may once again indicate that the buying of brokerage stocks is mainly driven by retail investors, as retail investors tend to prefer direct stock purchases rather than investing through ETFs.

Retail investors have sufficient power to continue driving the stock market rebound

Morgan Stanley believes that Chinese retail investors have sufficient power to continue driving the stock market rebound. JP Morgan also stated that the rebound in the A-share market has just begun.

Morgan Stanley pointed out that in 2022, Chinese household financial assets increased by 14.8 trillion RMB, and in 2023, it increased by 21.3 trillion RMB, with bank deposits growing by 17-18 trillion RMB annually. In the allocation of household assets, the proportion of deposits increased from 48% in 2021 to 55% in the first half of 2024.

This indicates that there is insufficient allocation of household assets in stock investments, due to poor performance of stocks and mutual funds.

Recently, the drastic changes in market sentiment in the A-share market and the rapid return of capital may be driving a rapid return of household funds to the stock market. However, compared to the bull market in 2015, the speed of this inflow of funds may be slower, as leverage was greater at that time, often leading to more concentrated inflows of funds.

Morgan Stanley also pointed out that if market sentiment remains high, there may be 6 trillion RMB of household assets entering the stock market, potentially bringing about 2-3 trillion RMB of reinvestment. The calculation method is as follows:

As of the first half of 2024, direct stock investments accounted for approximately 4.8% of household financial assets, while during the bull markets of 2020 and 2021, this ratio averaged 7.1%. With household financial assets at 264.7 trillion RMB in the first half of 2024, calculated based on a 2.2% difference, the potential funds flowing into the stock market are approximately 5.9 trillion RMB.

Assuming a 25% market increase driving stock appreciation, households may reinvest assets into the stock market, with potential funds of about 2.6 trillion RMBJP Morgan also believes that the retail funding pool is quite substantial.

As of August 2024, retail demand deposits amount to 39 trillion yuan, about twice the 20 trillion yuan direct stock investment. Equity investments account for only 6% of household financial assets.

In addition, from 2021 to the first half of 2024, the average annual growth rate of retail deposits is about 14%, significantly higher than the 11.6% during the period from 2010 to 2020. Assuming a normal growth rate of 11.6% for retail deposits from 2021 to August 2024, we expect the excess retail deposit balance to reach 8 trillion yuan by the end of August 2024.

Brokerage stocks may be overvalued in this round of rebound

Morgan Stanley points out that retail trading often leads to overreactions. The price-to-book ratio (P/B) of many H-share brokerage stocks is 10-20% higher than the levels of 2020-2021, but retail investment may still drive them further up. However, due to changes in business structure and relatively small scale of fund inflows, Morgan Stanley believes that brokerage stocks are unlikely to reach the valuation of over 2 times the price-to-book ratio in 2015.

Morgan Stanley stated that on Wednesday, October 3, after the rebound of H-share brokerage stocks, investors may consider the average daily trading volume (ADT) priced at around 1.4 trillion yuan as the operating benchmark. If market sentiment is high enough, Morgan Stanley even believes that retail investors may consider 2 trillion yuan as the operating benchmark.

When the average daily trading volume cools down, stocks usually experience a sharp pullback - Morgan Stanley says it is difficult to predict how long high sentiment and average daily trading volume can be maintained, and how high retail investors can push the valuation of brokerage stocks.

JP Morgan believes that China's announced monetary support measures and potential fiscal easing are positive for fund flows and macro outlook, with a 37% upside potential for earnings per share of brokerage stocks. Among H-shares, Chinese financial stocks are discounted by 39% compared to the peak price-to-book ratio of 2020 and 2021, and 65% compared to the peak discount of 2015