China stocks bounce big, but there’s reason to think the recovery won’t stick

Stocks in Hong Kong and Shanghai rallied strongly today, Tuesday August 7, after The China Daily, citing an unidentified official at the National Development and Reform Commission, reported that the government would roll out more policies to improve investor appetite for stocks. The report contained no details.. The China Business Journal also reported that rail investment would be higher than planned.

The Shanghai Composite index was up 2.74% (and is now up 1.17% over the last month) on a huge bump in shares of property developers. The property index on the Shanghai exchange was up 4.4% today.

This still leaves the Shanghai Composite down 13.5% from its May 22 local high and 22% from its January high. The Shanghai property index is down 31% from the January high.

But there’s reason to doubt the longevity of this recovery. One reason for the decline in Chinese stocks has been a market-wide shift toward bonds. In contrast to the vague sense that the government will do something to support stocks, the government and the People’s Bank have announced very specific measures to support bonds. The latest stimulus package aimed at boosting demand for corporate bonds and ensuring that local government bond issues retain reasonably priced sources of financing. Sovereign bonds have returned 5.4% this year and corporate debt has returned 4.2%.

That said Chinese stocks are cheap. The Shanghai Composite traded at just 13 times reported earnings on Monday, the lowest price-to-earnings ratio in more than three years, according to Bloomberg.

In my opinion, for this bounce to become a rally, though, the market needs more specific government measures to support stocks and some movement toward ending the U.S.-China tariff war. At the moment there’s not a lot of money in cash at asset managers in China so any rally would require a shift out of bonds and into stocks. Under current conditions that’s not a very attractive trade.