Why stock markets can't rely on US or China policymakers to rescue them

If you are a global equity investor, should you be more concerned about President Xi Jinping or his US counterpart Joe Biden?

As recently as last summer, it would have seemed absurd even to pose such a question. The sweeping regulatory controls underpinning the “common prosperity” campaign launched by Xi spooked foreign investors to such an extent that some asset managers said Chinese stocks had become “uninvestable”.

In the United States, by contrast, Biden’s strong belief in “acting big” when it came to public spending cheered equity investors who saw America’s economy, turbocharged by massive monetary and fiscal stimulus, as best placed to recover from the Covid-19 pandemic with few lasting scars.

The benchmark S&P 500 index rose 27 per cent in 2021 compared with a 5 per cent decline for the CSI 300 index of large Shanghai- and Shenzen-listed shares. Yet, towards the end of last year, market perceptions began to shift significantly.

In China, a change in tone on the part of Beijing – particularly the frequent use of the word “stability” when setting the policy direction for the coming years – and a series of measures to help shore up the economy raised expectations of a policy-induced rally in stocks.

In the US, on the other hand, Biden’s struggles with his approval rating have convinced his administration and the Democratic Party that the country’s high inflation rate – a big concern among middle-income Americans – needs to be brought down quickly. This has emboldened an increasingly hawkish Federal Reserve to begin raising rates.

The political pressure on the Fed to rein in inflation contributed to this month’s sharp sell-off in stocks, with the S&P 500 on course for its worst January on record. In the space of just a few months, Biden and Fed chair Jerome Powell – who played down the threat posed by the surge in consumer prices for much of 2021 – have turned into inflation hawks.

Chinese equities, which are trading at discounts versus their global peers, look like a buying opportunity all of a sudden. That is provided Beijing follows through with more forceful measures to ease the liquidity crisis in the all-important property sector.

While several major financial institutions have turned bullish on Chinese stocks in recent months, others predict a much sharper Fed-driven sell-off in US shares. Global equity investors’ underlying concern is the growing reluctance of policymakers in both countries to shore up markets during periods of intense selling pressure.

Central banks have been the main prop for asset prices since the 2008 financial crisis. Their unwillingness to come to the rescue whenever markets tumble stems from a combination of shifting political and economic priorities in Beijing and Washington and, crucially, mounting concerns about financial stability.

In China, the campaign to curb financial risks and efforts to address the nation’s acute housing affordability crisis have increased the government’s tolerance of slower growth and market volatility in the interest of promoting longer-term stability and reducing inequalities.

While investors are struggling to determine what Beijing’s pain threshold is, the new policy and regulatory agenda – particularly the clampdown on leverage and speculation in the real estate sector – has left markets without a reliable backstop.

Although it is a risky course of action given the financial contagion in the property industry, the government wants to reduce moral hazard as much as possible without triggering a systemic threat to China’s economy and markets.

This is creating huge uncertainty for investors. It also explains why Chinese high-yield property bonds still lost 16 per cent in the first three weeks of this year despite expectations of further easing measures, according to JPMorgan data.

While Xi faces a delicate balancing act in pursuing his deleveraging campaign while maintaining confidence in China’s economy, Biden faces an even bigger challenge in taking a tough stance on inflation without endangering America’s recovery.

By supporting the Fed’s shift towards tighter policy at a time when his administration is struggling to pass key economic legislation and faces criticism over its handling of the Omicron outbreak, Biden is betting that the economy and markets can cope with higher rates in the face of slowing growth.

While this is the right decision, given the severity of the threat posed by high inflation, investors have yet to come to terms with a more hawkish Fed. Still, following the central bank’s policy meeting on Wednesday, Powell made it clear the sell-off in equities would not deter the Fed from raising rates as soon as March.

For the first time since the 2008 financial crash, stock markets can no longer rely on support from policymakers when sentiment deteriorates sharply. The inflation shock in the US and the crackdown on leverage and speculation in China make for a more perilous market landscape.

When it comes to policy support from Beijing and Washington, investors can be forgiven for feeling they are being left to fend for themselves.

Nicholas Spiro is a partner at Lauressa Advisory