The People's Bank of China (PBOC) on Monday reiterated its pledge to avoid "flood-style" liquidity. The headline seemed at odds with a massive stimulus injection in the first quarter, with January seeing close to 1.1 trillion yuan injected in just a week prior to the Lunar New Year holidays.
February and March saw boosts as well, perhaps not of the same magnitude, but needless to say China came in to support its domestic market aggressively in the first quarter due to the horrendous performance seen in fourth quarter. It is then almost amusing to read these statements when Chinese officials never admitted to the injection or the reason behind it in the first place.
Taking a step back from the bigger picture, China's strategy has been to de-lever the economy of the excess stimulus seen over the past decade and especially since 2016 (the last emerging market slump). Chinese officials are trying to let the economy grow at a mean of around 6.25% to 6.5% in terms of annual GDP and they either take their foot off the pedal or put it back on depending on the economy's direction. The trade war with President Trump was a curveball thrown at them last year. It all changed in the fourth quarter as China had to step in immediately to support its economy.
The Chinese stock market (FXI) has recovered most of the losses of the second half of 2018, with small-caps up 35% in the first quarter; their goal was achieved. But first-quarter credit growth of 10.7% was way above the PBOC's goal to keep growth in line with nominal GDP. That statement could indicate they are now done with stimulus and are free to leave the markets to their natural causes... or not.
China's lending activity picked up in March, with domestic loans being way above consensus. The three-month moving average for total bank loans is back at 0.6 trillion yuan year over year.
Chinese exports also have recovered from the seasonal slump in 2019. All this "extra" liquidity has found its way into the system, boosting asset prices and jump-starting the economy. Chinese 10-year bond yields also are increasing. They hit 3.4% here on Tuesday morning, the highest level since December. As yields keep rising, they at some point will put a break on the rally in Chinese equities.
First-quarter earnings season has slowly started with the market expecting a 4% decline year over year. However, China's small-cap stocks are expected to show a 29% drop year over year. Considering that the ChiNext has rallied 35% over this time, investors may have weaker stomachs once they see the actual numbers on screen.
Sell-side analysts expect a pickup in the second quarter across the board as the worst of Trade Wars is expected to be past them. However, reality and. expectations can be two different things. Stocks generally seem to be holding in around tighter ranges day on day as they seem tired; is it a sign of a short-term top?
Trading activity has slowed even as stocks have reached all-time highs. There does seem to be a two-way pull as institutions (hedge funds) have not been involved in this rally and insiders have been selling while retail investors have been bullish and fully invested in the market.
Who is right? Only time will tell.
The market once again has gotten complacent with volatility (VIX) trading back at 12. Risk-reward does not look as tempting now as it did back in January, when nobody wanted to touch the market and doomsday scenarios were pitched across the board.
Investing is all about risk versus reward. There are more contrarian bearish indicators than bullish ones, if one is willing to observe rather than just chase performance. Even if one is not in the recession camp, valuation at these levels do not look compelling enough given the broader risks still at hand and a lack of earnings growth with price targets close to where stocks are trading today.