Frequent Risk Events Highlight CN50's Comparative Advantage

In the short term, under the pressure of multiple risk factors, we've observed a divergence in the performance of the CN50 and HK50 indices. The CN50, which should have benefited from policy support, fell by 0.75% yesterday, dropping below 12,200 points. In contrast, the HK50 rose by 1.7%, recovering the losses of the previous two days.

On a broader time frame, the CN50 has been on an upward trajectory since July 9, while the HK50 has struggled to reverse its downward trend.

This leads us to ponder: What are the underlying reasons for the divergent trends in these two indices? Which index holds stronger upward potential or comparative advantage? And what future risk events should we be watching that could influence the performance of Chinese assets?

Three Trading Contexts in the Chinese Market

To understand the recent divergence between the CN50 and HK50, we need to consider the broader trading context for Chinese assets.

1. Central Banks Entering Easing Cycles and US Election Risks:

Looking at the external interest rate environment, central banks in Switzerland, Sweden, the eurozone, and Canada have successively cut rates. With U.S. inflation cooling steadily, the market fully expects the Fed to start cutting rates in September. The accommodative stance of developed market central banks provides China with greater policy flexibility.

On the geopolitical front, President Biden’s sudden announcement of his withdrawal from the race last Sunday has altered the dynamics, making Kamala Harris the likely Democratic nominee. This shift has directly impacted Trump’s odds, reducing his predicted winning probability from nearly 70% to 60%.

However, Trump's advocacy for imposing a 60% tariff on Chinese goods and restrictive export policies continues to cast a shadow over Chinese market sentiment. In contrast, Harris is expected to maintain Biden’s approach of engaging in trade with China while implementing the "small yard, high fence" strategy to limit Chinese technological advancements.

In summary, as the US presidential election intensifies, any developments will likely amplify volatility in Chinese assets.

2. Domestic Economic Slowdown and the Ongoing “Two-Speed” Recovery Model

China's GDP growth for the second quarter slowed to 4.7% year-over-year, down from 5.3% in the first quarter. Retail sales growth also fell sharply in June, dropping to 2% from 3.7% previously, and the house prices index declined by 4.5%. While strong performance in exports and industrial production continues to drive economic growth, consumption and property remain persistent weaknesses.

With the right policy measures in place, achieving a 5% growth target through the “two-speed” recovery model seems attainable. We can anticipate new economic stimulus efforts in the third quarter or later in the year, which should enhance market liquidity and boost sentiment. However, given the shift in focus from "rapid growth" to "high-quality growth," the likelihood of substantial large-scale stimulus is relatively low.

3. No Major Reforms from the Third Plenum; New Monetary Policy Framework and Rate Cuts to Stimulate the Economy

The Third Plenum was focused on setting out China's economic trajectory for the next 5 to 10 years, but it didn’t introduce any major policy reforms. Interestingly, the top leadership reiterated this year's development targets, signaling heightened urgency after the second-quarter GDP came in below expectations. This reinforces the points made earlier.

At the same time, the decision document provided an extensive outline of mid- to long-term strategies. Key aspects relevant to the market include: 1) Developing new productive forces and technological innovation to strengthen China's advantage in the new energy sector and counteract US technological restrictions; 2) Advancing fiscal and tax reforms to allow local governments to retain more tax revenue, broaden the tax base, and improve local financial conditions, including shifting value-added tax collection from the production stage to the retail stage.

However, the document offered limited details on the pressing issues of property and domestic demand. Without concrete implementation plans, the market had little immediate reaction.

The rate cuts on July 22, while aimed at boosting the economy, also align with the new monetary policy framework proposed by PBoC Governor Pan Gongsheng at the Lujiazui Forum. The reduction in the LPR, in tandem with the 7-day reverse repo rate cut, suggests a gradual shift toward using short-term policy rates as a reference. This developing interest rate transmission mechanism will aid in more precise rate adjustments, and a stable rate environment should support trading in Chinese assets.

For traders, this presents a landscape where both risks and opportunities coexist.

CN50 Has a Short-Term Comparative Advantage

Amidst frequent risk events and high market volatility, the differing performance of CN50 and HK50 can be largely attributed to the unique characteristics of each market.

The CN50 index is made up of the 50 largest and most liquid A-shares listed on the Chinese mainland. Essentially, the CN50 benefits from a "CCP Put," the same way that Wall Street is underpinned by the 'Fed Put'. In other words, investors are safe in the knowledge that if things were to turn sour, authorities, in both cases, would step in with policy support, thus providing additional confidence to sit further out on the risk curve, and raising the bar for any significant downside to be seen.

On the other hand, the HK50 index includes companies listed in Hong Kong, encompassing major Chinese and international firms. This index is more sensitive to external market influences and has higher liquidity, reacting more swiftly to global market conditions and geopolitical developments.

As noted earlier, I anticipate that authorities will likely enhance policy stimulus in the third quarter, and with expected increases in exchange rate volatility and geopolitical risks, CN50 is better positioned to reflect domestic policy benefits while mitigating the impact of external events.

Key Focus Areas and Potential Risks

In light of recent developments in China and the evolving risk landscape, several key areas warrant our ongoing attention.

First, the policy uncertainty. The Third Plenary Session outlined some long-term policy directions but didn’t offer specific plans or timelines. This lack of detail, especially regarding the proposed tax reforms versus the goal of boosting domestic demand, leaves a gap in short-term clarity. Clearer action plans would help direct market movements and improve sentiment.

Second, the primary goal of the recent interest rate cuts is to stimulate property and consumer demand, but the key to success is restoring market confidence. Simply easing policy may not resolve underlying issues. If economic outlooks remain gloomy, increased stimulus might only make consumer behavior more cautious.

Third, the upcoming Politburo meeting at the end of July is worth watching closely. With roughly two-thirds of this year's government bond quota still untapped, any measures to accelerate budget execution could invigorate Chinese assets. Additionally, any constructive proposals to address high local debt, sluggish real estate, and weak domestic demand could significantly boost the performance of Chinese equities, particularly high-quality dividend stocks.

For broader reform actions, the year-end Central Economic Work Conference and next year’s National People’s Congress will be crucial. Monitoring these events, especially any legislative measures, will provide insights into the future direction of China’s economic policies.