$China A50 Index - main 2503(CNmain)$ $iShares MSCI China ETF(MCHI)$
The Chinese Yuan has just dropped to its lowest levels since 2008 against the US dollar. This decline began right after Donald Trump won the presidential election on November 6th. Following Trump's victory, the Yuan started weakening rapidly relative to the US dollar. Now that Trump is officially the new US president, investors are bracing for a potential trade war between the US and China. Trump has already announced plans to impose an additional 10% tariff on Chinese goods, which could make them less competitive overnight, especially after decades of companies outsourcing production to China. Trump is attempting to bring business operations back to the United States through the use of tariffs.
This trade war comes at a particularly bad time for China. For the past three years, the Chinese economy has been experiencing consistent weakness. This is evident from the Chinese stock market, which remains down about 55% from its all-time high in 2021. Manufacturing makes up 40% of China's economy, and since China has become the world’s manufacturing hub, Trump's tariffs could severely impact this crucial sector. The trade war is adding pressure to an economy already grappling with domestic challenges. The Chinese credit impulse index, a key indicator of economic health, is at some of its lowest levels since the global financial crisis. Consumer confidence in China is also at its lowest in 30 years, and property prices have been on a consistent decline for three years, suffering their biggest drop in over 20 years.
The US-China trade war is essentially the final straw. Many investors speculate that this could push China’s economy over the edge, potentially leading to a much more severe financial crisis. However, there is still some hope for China. The Chinese government has been turning to the printing presses to stimulate the economy. Authorities have started considering fiscal policy tools, which involve direct government spending to boost economic activity. Unlike monetary policy, which makes borrowing cheaper, fiscal policy injects money directly into the economy through infrastructure projects, subsidies, and other forms of spending. This could help address issues like low consumer spending and weak housing demand.
Recently, China announced a $1.4 trillion stimulus package to boost consumption and stabilize the housing market. Although this initially sparked a rally in Chinese stocks, which surged 50% following the announcement, those gains have almost entirely reversed. This raises the question of whether Chinese authorities are even capable of reversing the downward trend in the economy. To answer that, we need to look beneath the surface of the market’s price movements.
One key indicator to watch is the Shanghai Composite breadth, which measures the percentage of stocks in the Shanghai index that are trading above their 200-day moving average. After the announcement of the fiscal measures, this indicator surged to 90%, signaling that more than 90% of stocks on the Shanghai index were trending higher. While it has since cooled off, such a broad level of participation in rising stocks is rare. Historically, similar surges have often coincided with market bottoms in China, as seen in 2006, 2009, 2014, and 2019.
They all preceded sustained recoveries or consolidation phases, during which the market didn’t revisit its previous lows. When there’s such an extreme level of optimism, it suggests that financial markets believe something significant has shifted in the macroeconomic landscape. In other words, this could indicate that the financial markets believe the fiscal stimulus announcement from Chinese authorities truly has the potential to turn the Chinese economy around.
Of course, this doesn’t guarantee a massive bull run for Chinese equities. For instance, after the breath spikes in 2010 and 2019, the Chinese market entered long periods of consolidation instead of experiencing explosive rallies. However, the key takeaway is that historically, these events have often occurred at the end of prolonged bearish phases. Even a stabilization at these levels could provide a solid foundation for future growth, particularly if backed by improving fundamentals.
Another positive sign is that Chinese companies have significantly improved their profitability over the past year, rising from 4.5% to 5.3%. Businesses are cutting costs, streamlining operations, and finding ways to remain competitive despite the broader economic slowdown. This trend reflects the resilience of many Chinese companies, even as external conditions remain challenging. However, profitability alone is not enough to drive long-term growth—what’s missing is revenue generation. Chinese stock market revenues have been declining steadily since 2015 and continue to do so due to difficult economic conditions in China.
This is where fiscal policy could make a difference. If the Chinese government succeeds in boosting domestic demand, stabilizing the housing market, and encouraging investment, it could spark a much-needed recovery in revenue growth.
The major counterargument to this is that the US-China trade war could negate the effects of China’s stimulus measures, as reduced exports to the US will put additional downward pressure on revenues over the next four years.
From a technical perspective, the Chinese Stock Market ETF (MCHI) is trending upward, with prices forming higher highs and higher lows since 2024. When we overlay the 100, 150, and 200-day moving averages, we see they are all sloping upward, signaling positive momentum. This aligns with the historical patterns we discussed, where breath spikes have often marked significant turning points.
However, this is not without risks. If the government’s fiscal efforts fall short or if external pressures like the US-China trade war intensify, Chinese stocks could face renewed selling pressure. This could lead to the market falling below its key moving averages, with the moving averages starting to curl downward, signaling a change in momentum.
On the other hand, if fiscal measures successfully stimulate the economy, the potential upside is significant. The combination of low valuations, improving profitability, and a more stable economic environment could create a powerful tailwind for Chinese equities, driving prices higher.
Let us know in the comments what you think will happen to the Chinese economy and stock market next.
Disclaimer: I want to make it clear that I am not a financial advisor, and nothing I say is intended to be a recommendation to buy or sell any financial instrument. Additionally, it's important to remember that there are no guarantees or certainties in trading or investing, and you should never invest money that you can't afford to lose.
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