Guo Lei: Macro background and trend analysis of the rapid revaluation of the current stock market

Abstract

First, In late September 2024, the stock market saw a concentrated rebound. Measured by the change from September 23rd to September 30th, the Shanghai Composite Index, the CSI 300 Index, the STAR 50 Index, and the ChiNext Index rose by 21.4%, 25.1%, 35.7%, and 42.1% respectively. During the National Day holiday, the Hang Seng Index and the Nasdaq Golden Dragon Index continued to rise.

Second, We understand that there are four direct driving factors for the rapid revaluation of the current stock market: (1) In late September, a series of macroeconomic policies were introduced, targeting the three key macro aspects of consumption, real estate, and credit, reversing short-term growth expectations;

(2) The Political Bureau meeting emphasized the serious implementation of the "three distinctions", "supporting those who take responsibility, and backing those who do practical work", indicating that after a concentrated risk prevention of local government debt resolution, the flexibility and subjective initiative of local governments in solving economic problems are expected to expand again, which will also have an impact on medium-term growth expectations;

(3) Stabilizing the capital market is considered one of the important means to stabilize growth in this round, showing the policy's emphasis on its resource allocation and expectation guidance functions, which is conducive to the premium of risk assets; the wealth effect brought by the upward trend in the capital market also helps to boost consumer spending.

(4) The combination of overseas "rate cuts + no recession" has emerged, and historical experience shows that this combination is favorable for emerging markets.

Third, Changes in valuation assumptions are another important background. From the equity split reform in 2005 to 2019, the nominal GDP's average compound annual growth rate was 12.8%, while the annual compound return rate of the Wind A-share Index during the same period was 12.2%, roughly equivalent. The average compound annual growth rate of nominal GDP from 2020 to 2024 is 5.8% (with a 4.1% expected growth rate in 2024), while the average compound growth rate of the Wind A-share Index (as of September 30, 2024) during the same period is only 2.7%.

One of the reasons is that the nominal GDP growth rate fluctuated downward from 2022 to 2024, leading to equity asset pricing to some extent incorporating a linear extrapolation of the medium to long-term nominal growth rate. If there are changes in the expected nominal growth rate, valuations are likely to readjust.

Looking back, the pressure on the nominal growth rate over the past three years is mainly due to adjustments in the real estate market (2022-2024), cautious local fiscal policies under a new round of debt reduction background (2023-2024), and the contraction of residents' balance sheets squeezing consumption (2024); from this perspective, the trigger point for the current reversal of expectations is precisely the adjustment of real estate policies (reducing down payment ratios, relaxing home purchase restrictions), the potential release of residents' balance sheet (adjustment of existing home loan rates), and the expectation of active fiscal expansion.

Fourth, Currently, there are still relatively clear favorable factors for the market: firstly, the PPI (representing nominal growth and corporate profit cycle) and M1 (representing micro activity and narrow money supply cycle) are both in the bottom range of experience, indicating that if the macro fundamentals form a positive cycle, there is considerable room for improvement in the fundamentals; Secondly, the policy space remains unfalsifiable. The Political Bureau meeting pointed out the need to "increase the countercyclical adjustment of fiscal and monetary policies." The fourth quarter involves setting economic targets and policy direction for 2025, leaving room for imagination in fiscal policy. The "introduction of a law to promote private enterprises," "promoting income growth for middle and low-income groups," and "urgently improving the maternity support policy system" mentioned in the Political Bureau meeting are yet to be implemented. Thirdly, micro expectations are still on the rise, with data such as large certificate of deposit transfers reflecting an increasing enthusiasm for market entry.

Fifthly, for the next two quarters, there are several key points to note: Firstly, the real estate sales data in mid to late October. This year, the "May 17 real estate new policy" and the sales pulse brought about by the relaxation of real estate policies in Beijing at the end of June have to some extent triggered adjustments in equities and interest rates. The intensity of this round of real estate policies will be much greater, and the policy effects may be more significant, but tracking and verification are needed.

Secondly, the Standing Committee of the National People's Congress in late October. On October 24, 2023, the Sixth Session of the Fourteenth National People's Congress Standing Committee raised the deficit ratio from 3% to around 3.8%, clearly stating that the central government will issue 1 trillion yuan in national bonds in the fourth quarter of the year. The current market expectations for broad fiscal policy are relatively concentrated, making this period a observation window.

Thirdly, credit in October and November. The comprehensive policy announced on September 24 includes not only marginal easing of monetary policy but also marginal adjustments in financial policy, which will be crucial in determining changes in subsequent new credit amounts.

Fourthly, the year-end deployment for next year's economic growth, which will guide expectations for the medium-term compound growth rate. If next year's actual GDP target continues to be around "5%" as this year, mainstream expectations for next year's growth rate may be underestimated. To maintain a growth rate of around 5%, further restorative drivers need to be formed in end-demand areas, such as household consumption, affordable housing or some infrastructure sectors, and the manufacturing sector.

Sixthly, taking the 2019 bull market as an example, this round of market rise shows some similarities to the initial driving factors back then. In the April 2019 article "The Five Major Macro Backgrounds and Evolution Trends of the Bull Market," we summarized the five drivers that initiated the bull market at that time: the peak of the Fed's tightening cycle, emerging market assets entering a "comfort zone"; forward-moving fiscal spending driving infrastructure initiation, stabilizing growth and tax cuts leading to improved corporate expectations; loose monetary environment, credit conditions restoration; confirmation of capital market strategic positioning; progress in China-US economic and trade negotiations.

However, whether this round of rise can continue until the end of 2021 is related to the continuation of many fundamental factors, including post-pandemic global liquidity easing, China's manufacturing sector taking over global production capacity gaps, a brief round of compensatory consumption, and an industrial investment cycle dominated by dual carbon and new energy vehicles. Whether this round can form a similar fundamental "continuation" is crucial.

Seventhly, uncertainties are also worth early attention. Firstly, the low nominal growth in the third quarter (especially in August and September) will bring certain short-term pressure on corporate profits for the quarter, as the PPI is still low year-on-year, making it difficult for corporate profits to improve synchronously The uncertainty lies in the fact that the rise in equity assets in the early stage is driven by risk preference, showing a general upward trend. In addition, the market's understanding of fiscal space and debt-to-GDP ratio may not be sufficient, and this still needs further clarification in the future.

The second uncertainty is that this round of market consensus is strong, which may lead to some assets being irrationally valued to a certain extent, and it cannot be ruled out that it may trigger policy vigilance and market expectation correction.

The third uncertainty is that the coexistence of "numerator" and "denominator" in overseas markets represents a relatively fragile balance. If its economic data continues to be stronger in the future, the space for precautionary interest rate cuts will be released more quickly. If the economic data is weaker than expected, it will also have an impact on global trade and commodity pricing expectations. We understand that ultimately, the market still needs to find new structural themes after a round of broad-based pricing corrections.

Main Text

In late September 2024, the stock market saw a concentrated rebound. Comparing the changes between September 23rd and September 30th, the Shanghai Composite Index, the CSI 300 Index, the STAR 50 Index, and the ChiNext Index rose by 21.4%, 25.1%, 35.7%, and 42.1% respectively. During the National Day holiday, the Hang Seng Index and the Nasdaq China Dragon Index continued to rise.

According to WIND (as follows), on September 30th, the Shanghai Composite Index, the CSI 300 Index, the STAR 50 Index, and the ChiNext Index rose by 21.4%, 25.1%, 35.7%, and 42.1% respectively compared to September 23rd; the Nasdaq China Dragon Index and the Hang Seng Index rose by 22.8% and 15.8% respectively.

On October 4th, the Nasdaq China Dragon Index rose by 11.4% compared to September 30th; on October 7th, the Hang Seng Index rose by 9.3% compared to September 30th.

We understand that there are four direct driving factors for the rapid revaluation of the stock market in this round: (1) In late September, a series of macroeconomic policies were introduced, targeting the three key macro aspects of consumption, real estate, and credit, reversing short-term growth expectations;

(2) The Political Bureau meeting emphasized the serious implementation of "distinguishing among different entities" and "supporting those who take responsibility and backing those who do practical work". This means that after a round of concentrated risk prevention in local debt resolution, the flexibility and subjective initiative of local governments in solving economic problems are expected to expand again, which will also have an impact on medium-term growth expectations;

(3) Stabilizing the capital market is considered one of the important means for stabilizing growth in this round, showing the policy's emphasis on its resource allocation and expectation guidance functions, which is conducive to the premium of risk assets; the wealth effect brought by the upward trend in the capital market also helps to boost consumer spending;

(4) The combination of overseas "rate cuts + no recession" has emerged, and historical experience shows that this combination is beneficial to emerging markets.

The Political Bureau meeting on September 26th pointed out "reducing the interest rates on existing housing loans", "promoting the stabilization of the real estate market", "reducing the reserve requirement ratio, and implementing a substantial interest rate cut", targeting the three key macro aspects of consumption, real estate, and credit. Since September 24th, a package of policies has been directed towards these key areas On September 26, the Political Bureau meeting required all regions and departments to conscientiously implement the decisions and deployments of the Party Central Committee, take action, unite as one, fully stimulate the enthusiasm, initiative, and creativity of the whole society to promote high-quality development, and push the economy to continue to recover and improve. Party members and cadres should bravely shoulder responsibilities, dare to innovate, enhance their capabilities and achieve results in overcoming difficulties. It is necessary to set a good example in selecting and appointing personnel, conscientiously implement the "three distinctions," and support those who take responsibility and support those who work. It is necessary to support economically strong provinces in taking on major responsibilities and better play their role in driving and supporting.

The Political Bureau meeting on September 26 pointed out the need to make efforts to boost the capital market, vigorously guide long-term funds into the market, and remove obstacles for social security, insurance, wealth management, and other funds to enter the market. It is necessary to support the mergers and acquisitions of listed companies, steadily promote the reform of public funds, and study and introduce policy measures to protect small and medium-sized investors.

The overseas macro environment is also a key point. In the report "Seven Understandings of the Macro Environment" on September 22, we pointed out that historically, the combination of "interest rate cuts + no recession" overseas is relatively favorable for the pricing of domestic assets.

Changes in valuation assumptions are another important background. From the equity split reform in 2005 to 2019, the average compound annual growth rate of nominal GDP was 12.8%, while the average compound annual return of the Wind A-share Index during the same period was 12.2%, roughly equivalent. The average compound annual growth rate of nominal GDP from 2020 to 2024 is 5.8% (with a 4.1% expected growth rate in nominal GDP in 2024), while the average compound annual growth rate of the Wind A-share Index during the same period (as of September 30, 2024) is only 2.7%.

One of the reasons we understand is that the nominal GDP growth rate is expected to fluctuate downward from 2022 to 2024, leading to equity asset pricing to some extent incorporating a linear extrapolation of the medium to long-term nominal growth rate.

If there is a change in the expected nominal growth rate, valuations should readjust. Looking back, the pressure on the nominal growth rate over the past three years is mainly due to adjustments in the real estate market (2022-2024), cautious local government finances under a new round of deleveraging (2023-2024), and the contraction of residents' balance sheets squeezing consumption (2024); from this perspective, the trigger for the expected reversal in this round is precisely the adjustment of real estate policies (reducing down payment ratios, relaxing home purchase restrictions), the potential release of residents' balance sheets (adjustment of existing home loan rates), and the expectation of active fiscal expansion.

In the report "Waiting for the Demand Side" on June 30, 2024, we pointed out that the insufficient nominal growth rate in this round is a major issue, with year-on-year nominal GDP growth rates of 4.8% and 4.6% in 2022 and 2023, respectively, and 4.1% in the first half of 2024. Nominal GDP determines asset pricing.

For this round of nominal GDP, one of the influencing factors is the adjustment of the real estate market, with year-on-year real estate investment declines of -10.0%, -9.6%, and -10.2% in 2022, 2023, and the first eight months of 2024, respectively The second factor affecting the situation is the prudence of local finances under the background of a new round of debt reduction. Narrow infrastructure investment in 2022-2024 (the first 8 months of 2024) is 9.4%, 5.9%, and 4.4% respectively.

The third factor is the partial contraction of the residents' balance sheet, which squeezes current consumption to a certain extent. In "Waiting for the Demand Side," we point out that urban consumption is expected to be weaker than rural consumption, which may include the effect of adjusting housing prices on the residents' balance sheet, imposing certain constraints on actual consumption.

From this perspective, the current policy adjustment hits the nail on the head, as it is conducive to the improvement of the nominal growth center.

Currently, there are still obvious favorable factors for the market: First, both the PPI (representing nominal growth and corporate profit cycle) and M1 (representing micro-activity and narrow money supply cycle) are at empirical bottom areas. This means that if the macroeconomic situation is forming positively, there is considerable room for improvement in the fundamentals;

Second, the policy space is still unfalsifiable. The Political Bureau meeting pointed out the need to "increase the counter-cyclical adjustment of fiscal and monetary policies." The fourth quarter involves setting economic targets and policy directions for 2025, and there is still room for imagination in fiscal policy. Measures mentioned in the Political Bureau meeting such as "introducing a law to promote private enterprises," "promoting income growth for middle and low-income groups," and "urgently improving the maternity support policy system" are yet to be implemented;

Third, micro expectations are still heating up, with data such as large certificate of deposit transfers reflecting an increasing enthusiasm for entering the market.

We expect the year-on-year PPI in September to be -2.6% (see "Macro Trading Themes Since September"), and there is a high probability that the low point of PPI in August and September will be the final low point for the second half of the year. This corresponds to the improvement potential for corporate profits in the fourth quarter and the first half of next year. M1 in August had a year-on-year decrease of -7.3%, and we expect that this may represent the bottom of the current M1 cycle. This corresponds to the improvement potential for micro-activity in the fourth quarter and the first half of next year.

In the previous report "Counter-cyclical Policies Expected to Continue to Take Over," we also elaborated on this logic: the comprehensive incremental policies released on September 24th strengthened the signal of counter-cyclical measures, and the Political Bureau meeting on September 26th further confirmed the start of a stable growth cycle. The "policy bottom" is basically confirmed.

If the series of policies introduced in this round can have an impact on key areas such as credit and real estate, the third quarter may be the trough of the nominal GDP growth rate in this short cycle. This means that the profit growth rate of enterprises in the third quarter may be relatively low, but there may be a turning point in the fourth quarter. Paying attention to this macro cycle position is indicative for equity and interest rate pricing For the next two quarters, there are several key points to watch:

1. Mid to late October real estate sales data. This year, the "May 17 Real Estate New Policy" and the sales pulse brought about by the relaxation of Beijing's real estate policies at the end of June have to some extent triggered adjustments in equity and interest rates. The current round of real estate policies is much stronger, and the policy effects may be more significant, but they need to be tracked and verified.

2. Late October National People's Congress Standing Committee. On October 24, 2023, the Sixth Session of the Fourteenth National People's Congress Standing Committee will raise the deficit ratio from 3% to around 3.8%, clearly stating that 1 trillion yuan of national bonds will be issued in the fourth quarter of the year. The current market expectations for broad fiscal policy are relatively concentrated, making this period a observation window.

3. Credit in October and November. The comprehensive policy announced on September 24 includes not only marginal easing of monetary policy but also marginal adjustments in financial policy. Whether it can bring about changes in subsequent new credit amounts is crucial. Also, the deployment at the end of the year for next year's economic growth will guide expectations for the medium-term compound growth rate. If next year's actual GDP target continues to be around "5%", mainstream expectations for next year's growth rate may be underestimated.

At the same time, to maintain a growth rate of around 5%, there needs to be further restorative drivers in end-demand areas, such as residential consumption, affordable housing or some infrastructure sectors, and the manufacturing sector.

The effect of real estate policies is an observation point. Looking at real estate sales in 30 cities, the impact periods of the previous two rounds of real estate policies were relatively short: the second to fourth weeks of May saw one pulse, and the fourth week of June to the first week of July saw another pulse. This round of policies is more intense, including unifying the minimum down payment ratio for housing loans to 15%, increasing the support ratio for refinancing of affordable housing from 60% to 100%, supporting banks in issuing loans to help enterprises acquire existing land from real estate companies, and relaxing home purchase restrictions in first-tier cities. The policy effects are likely to be greater.

New credit is another observation point. In the article "Counter-cyclical Policies Expected to Continue to Relay", we pointed out that the comprehensive policy announced on September 24 includes not only marginal easing of monetary policy but also marginal adjustments in financial policy. On the evening of September 24, the China Banking and Insurance Regulatory Commission issued a notice on continuing loans and improving financial services for small and micro enterprises. This adjustment in monetary supply combined with financial policy adjustments is expected to bring changes in the amount of new loans in the future.

Taking the 2019 bull market as an example, from the initial driving factors, the current market rally has some similarities to that time. In the April 2019 article "Five Major Macro Backgrounds and Evolution Trends of the Current Bull Market", we summarized the five drivers that opened the bull market at that time: the peak of the Federal Reserve's tightening cycle, emerging market assets entering a "comfort zone"; fiscal spending shifting forward to promote infrastructure initiation, stabilize growth, and tax cuts leading to improved corporate expectations; loose monetary environment, credit conditions improving; confirmation of capital market strategic positioning; progress in China-US economic and trade negotiations. However, whether the previous round of gains can continue until the end of 2021 is related to many fundamental factors, including post-pandemic global liquidity easing, China's manufacturing sector taking over the global production gap, a brief compensatory consumption phase, and an industrial investment cycle dominated by dual carbon and new energy vehicles. The key to this round is whether a similar fundamental "continuation" can be formed.

Looking back at the stock market from 2019 to 2021, taking the Wind A-share Index as an example, the first round of steep rise was from the beginning of the year to mid-April; followed by a correction phase (late April to early June); and then an overall low-to-medium slope upward trend (early June to the beginning of 2020).

Starting from the second quarter of 2020, the Wind A-share Index continued its oscillating upward trend. We understand that the first phase was characterized by loose policies and liquidity (second and third quarters of 2020); the second phase saw a significant expansion in exports, coupled with a round of "compensatory" consumption for about two quarters, driving nominal GDP expansion (fourth quarter of 2020 to 2021); and the third phase is the second half of 2021, with the expectation of the "dual carbon" industrial chain heating up as a series of policies are introduced.

Global liquidity easing is also one of the conditions that enabled the developments in 2020-2021. Looking at the 10-year U.S. Treasury yield, the lowest period relative to others was during these two years.

Uncertainties are also worth paying attention to in advance. Firstly, the relatively low nominal growth in the third quarter (especially in August and September) will bring certain short-term pressure on corporate profits for the quarter, as the PPI is still low year-on-year, making it difficult for corporate profits to improve synchronously. The previous rise in equity assets was driven by risk appetite and had a general upward trend; in addition, the market's understanding of fiscal space and debt relationship may not be sufficient, which still needs further clarification in the future;

The second uncertainty is that this round of market consensus is strong, which may lead to some assets being irrationally valued to a certain extent, and it is not ruled out that it may trigger policy vigilance and market expectation correction;

The third uncertainty is that the coexistence of "numerator" and "denominator" in overseas markets represents a relatively fragile balance. If their economic data continues to be stronger in the future, the space for preemptive rate cuts will be released more quickly; if the economic data is weaker than expected, it will affect global trade and commodity pricing expectations. We understand that ultimately, the market still needs to find new structural themes after a broad-based pricing correction.

Author: Guo Lei (S1220515070001), Source: Guo Lei Macro Tea House, Original Title: "【GF Macro Guo Lei】The Macro Background and Trend Analysis of the Rapid Revaluation of the Current Stock Market"