The Australian stock market has continued its upward trajectory, defying a backdrop of underwhelming corporate earnings. This bullish sentiment has pushed the market’s price to earnings (PE) ratio to speculative levels reminiscent of the COVID pandemic bubble.
Source: FactSet
Unlike the pandemic-era boom, which was fuelled by a strong earnings recovery, the current market surge is occurring without a similar catalyst. A significant driver of Australian corporate earnings is the health of the Chinese economy, particularly the property sector. Over 20% of the Australian market comprises commodity-related stocks, making it highly sensitive to China's economic performance. Historically, the earnings growth of the ASX200 and Hang Seng Index have been closely correlated and in recent years, both markets have experienced lacklustre earnings growth.
Source: FactSet
While investor sentiment remains buoyant in Australia on subdued earnings, the situation in China is markedly different. The Hang Seng Index is trading at near-record low valuations, with PE multiples approaching those seen during the Global Financial Crisis (GFC) without a corresponding collapse in earnings.
Source: FactSet
A crackdown on Chinese technology companies, speculation of a potential Chinese invasion of Taiwan, the removal of economic statistics when data looks bad, and a slowing economy has made many global investors say China is ‘uninvestable’. Among these concerns, the economic slowdown is the most pervasive as it ultimately drives corporate earnings.
Unlike previous downturns, China’s current economic slowdown has proven resistant to traditional stimulus measures. Since 2022, lower interest rates have not spurred the expected increase in borrowing and investment.
Source: Schroders
Monetary policy currently is broken as cheap interest rates are not stimulating investments. This phenomenon, known as a “balance sheet recession”, has seen consumers and businesses prioritize debt repayment over new investments.
The lack of demand for credit has had a significant impact on China’s property market. Previous property downturns were short-lived and began to recover when mortgage rates began to fall. The current decline in property sales has persisted for over two years.
Source: FactSet
This decline in property demand has also led to falling property prices, creating a negative feedback loop as declining prices discourage potential buyers.
Source: FactSet
The decline in the property market has also rippled through other sectors, such as steel, which is heavily reliant on construction activity.
Source: FactSet
China’s current balance sheet recession differs from those experienced in Japan in the 1990s or the Western world after the Global Financial Crisis. Rather than being driven by speculative boom and bust, China’s downturn has been largely policy-induced. In 2017, President Xi Jin Ping announced a shift in housing policy, emphasizing that houses are for living, not for speculation. This set the tone for future policy measures such as “Three Red Lines”, which forced property developers to reduce debt and helped cleanse the financial system. It also led to the high-profile bankruptcy of Evergrande, once considered China’s largest property developer.
As the economy continues to struggle, Chinese officials are growing increasingly concerned about a potential spiral. With limited success with monetary policy in recent years, the government is now considering fiscal stimulus measures to jump-start the economy. One key area of focus is stabilizing housing prices, marking a significant departure from the previous policy stance. By supporting property prices, the government hopes to create a more favourable environment for investment. While details of the fiscal stimulus package remain scarce, the mere possibility of a policy shift has already had a positive impact on market sentiment in China.
In conclusion, the Australian stock market's continued upward trajectory stands in stark contrast to the challenges faced by the Chinese economy. While Australia benefits from a relatively buoyant market sentiment, China grapples with a policy-induced economic slowdown and a struggling property market. The success or failure of China's fiscal stimulus measures will significantly impact both economies. If China can successfully navigate its economic challenges and stimulate growth, it could provide a much-needed boost to Australian corporate earnings. However, if the stimulus proves ineffective, the Australian market may face a reckoning, as its current valuations appear to be priced for perfection.
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