"Now or never"! Goldman Sachs truly deserves the title of "vanguard of foreign capital bull market"

Since the Political Bureau meeting in September, Goldman Sachs has issued multiple research reports bullish on the Chinese stock market, including upgrading the rating of the Chinese stock market to "overweight", stating that foreign capital is now flowing from India to China, making it the "off-balance sheet" leader of the Chinese bull market.

On the 7th, Goldman Sachs released another eye-catching research report, once again expressing the optimistic attitude of this Wall Street giant towards the Chinese stock market and putting forward ten reasons to buy Chinese stocks.

In the report titled "If not now, when? Ten reasons to be bullish on the Chinese stock market," Kinger Lau, Chief China Equity Strategist at Goldman Sachs, wrote that historically, the Chinese stock market has responded more positively to fiscal easing than monetary policy, and now that monetary policy has essentially been implemented, if there are further fiscal stimulus measures in the future, the Chinese stock market may react more positively.

Lau also pointed out that the repricing brought about by major policy shifts rarely stops at a 30% increase in stock prices and lasts for over 150 days, whereas the current rally has lasted less than 20 days since it began.

Furthermore, the fear of missing out (FOMO) among investors is still at play, not only among domestic retail investors, but also among foreign investors in the Chinese stock market. The report indicates that global hedge funds' net/gross positions in Chinese stocks are at or below the 5-year average, and are 4 percentage points lower than the recent peak in early 2023.

In terms of operations, Goldman Sachs has upgraded its rating on Hong Kong stocks to "overweight," but is more bullish on A-shares compared to Hong Kong stocks, expecting A-shares to have a further 14%-15% upside in the next year. Goldman Sachs also favors stocks related to shareholder returns, small and medium-cap stocks, and proxy stocks that represent the overall market performance (such as index funds or ETFs).

Ten reasons to be bullish on the Chinese stock market

1. Policies have been laid out

Goldman Sachs first pointed out that the series of policy measures recently introduced by the Chinese government aim to stabilize economic growth and the stock market. Since September 24th, more than 10 key measures covering monetary easing, fiscal stimulus, support for the real estate market, and stock market incentives have been unveiled, with their scale and breadth being considered milestone-like, comparable to the 2008 "four trillion stimulus plan."

2. Market reaction, this time is different

Goldman Sachs believes that compared to the past few years, the Chinese government has been more rapid and forceful in policy stimulus. Market expectations for policies were low, so the latest easing policies have exceeded investors' expectations, thereby changing market expectations for policies.

In the latest easing policies, the Chinese government seems to have shifted from previous supply-side measures (such as infrastructure investment) to more focus on demand-side policy tools (such as mortgage refinancing and other possible consumer-related subsidies and social security welfare), indicating that decision-makers are taking more effective measures to address structural issues in the economy This policy shift may mean that if further fiscal stimulus measures are introduced in the future, the Chinese stock market may have a more positive response.

III. Do not go against the central bank

The report particularly emphasizes unprecedented support from the People's Bank of China for the stock market. The central bank has sent a strong policy signal to the market through measures such as providing liquidity (a 500 billion yuan swap arrangement) and encouraging stock buybacks (a 300 billion yuan stock repurchase refinancing plan). Goldman Sachs wrote:

Although technically these plans are not quantitative easing (QE) measures, as the central bank has stated that these plans will not create new base currency, they allow market participants to leverage the central bank's balance sheet and redeploy the funds (potentially with leverage in some cases) at attractive funding costs to invest in stocks, thereby helping to restore market liquidity, boost stock demand (e.g. buybacks).

IV. Rarely less than a 30% increase due to policy U-turns

Goldman Sachs points out that the MSCI China and CSI 300 indices have risen by 36% and 27% respectively since their lows in September, making it one of the strongest rallies since the indices were launched in 1993 and 2005. History indicates that there may be more room for this rally. Goldman Sachs states:

MSCI China has experienced 25 rallies of over 20% in the past twenty years, with 4 bull markets triggered by (positive) policy changes and/or changes in market expectations of policies, averaging a 85% return and lasting 218 trading days;

The index price-to-earnings ratio (based on future consensus estimates) peaked at an average and median P/E ratio of 14.4 times and 13.6 times during these 4 periods, compared to the current 11.4 times.

V. Insights from the Japanese experience

Drawing from the Japanese stock market experience, Goldman Sachs points out that strong rallies may occur even in long bear markets.

Over the fourteen-year period from 1989 to 2003, the Japanese stock market cumulatively plummeted by 73%, but experienced two distinct bear market rallies, one from 1992 to 1996 and the other from 1998 to 2000, both triggered by repricing of political or policy expectations.

Goldman Sachs notes that both bear market rallies were very strong (rising 39% and 65% in yen terms; 67% and 119% in dollar terms), lasting over a year each.

VI. Chinese stocks remain cheap

Goldman Sachs points out that as of October 3rd, the forward price-to-earnings ratios for MSCI China and the CSI 300 were 11.2 times and 13.3 times, respectively. These ratios were 0.2 standard deviations below and 0.5 standard deviations above the average levels over the past 5 years, and 0.2 standard deviations below and 0.6 standard deviations above the average levels over the past ten years, essentially at or slightly above medium-term levels.

China still shows significant valuation discounts compared to major global stock markets, with benchmarks 40% and 15% lower than developed markets and emerging markets (excluding China), respectively. Looking at the forward P/E ratios and earnings growth rates (PEG), overseas Chinese stocks and A-shares are at 0.9 and 1.1, while developed markets are at 1.5 and emerging markets (excluding China) are at 1.2 Goldman Sachs pointed out through model analysis that the positive impact of policies and the market's excessive concerns about extreme negative scenarios are providing upward potential for the valuation of Chinese stocks. Excluding extreme negative scenarios, the true value of MSCI China should be 15% higher than the market's valuation in mid-September.

Seven, FOMO sentiment is high, foreign capital continues to flow back

The Chinese stock market has recently experienced a significant increase, with trading activities surging. The daily turnover of A-shares reached 1.5 trillion yuan, and on September 27th, excessive trading volume led to the Shanghai Stock Exchange being unable to trade temporarily. Goldman Sachs observed that market participation is increasing, and capital is shifting from developed markets to emerging markets.

Goldman Sachs pointed out that investors' FOMO sentiment is rising, although hedge funds and global mutual funds' holdings of Chinese stocks are still below recent peaks. Domestic retail participation is increasing, with a rise in new account openings and ETF inflows. Capital flows show that despite the pessimism of developed market investors towards the Chinese stock market leading to many of them exiting, southbound funds continue to flow in, and interest in purchasing emerging markets is rising.

Goldman Sachs data shows that global hedge funds' net/gross positions in Chinese stocks are currently at or below the 5-year average, and are 4 percentage points lower than the recent peak in early 2023.

Eight, profit prospects have moderately improved

Although more stimulus measures may be needed to turn the situation around, corporate profit prospects have moderately improved.

Goldman Sachs has raised its earnings per share (EPS) growth forecasts for MSCI China in 2024 and 2025 by 4 and 2 percentage points respectively, reaching 12%.

This reflects the potential stimulus impulse of macro growth, a 1% appreciation of the renminbi against the US dollar so far this year, moderately recovering consumer demand due to wealth effects, and favorable base effects in the second half of the year. Our EPS growth forecasts for this year and next year are still slightly below Wall Street consensus.

Nine, impact of the Federal Reserve's policy

The Federal Reserve unexpectedly cut interest rates by 50 basis points in September, providing more room for China's stimulus policies. Goldman Sachs wrote:

The futures market now expects the Fed to cut rates by 50 basis points for the remainder of this year and by 100 basis points in 2025. US bond yields are at near-year lows, and the People's Bank of China's accommodative decisions should be less restricted by the Fed's policy in the context of interest rate differentials and bilateral exchange rate effects.

Ten, the important position of the Chinese stock market in global investment portfolios

As the world's second-largest stock market, the Chinese stock market will still have a place in the portfolios of global investors. Goldman Sachs stated:

In just the past two weeks, the 30% sharp rise in the Chinese stock market has taught investors focused on the Chinese market a lesson, that if they are overly pessimistic about Chinese policies or deviate too much from the trend of the Chinese stock market, they may pay a heavy price. Especially when stock valuations are not high and investors' positions are not large, this risk is particularly significant