China’s equity market needs a significant boost to maintain its upward trend amid weakening broad money growth and weak earnings performance. 

A lot is riding on the new policies targeting capital markets, which the China Securities Regulatory Commission (CSRC) is set to announce at the Lujiazui Forum starting tomorrow.

Nothing less than announcing the proposed equity stabilization fund or significantly increasing the equity allocation of long-term funds will inject the necessary positive momentum.

At the start of the year, we argued that mobilising state funds into a sizable equity stabilisation fund is the only policy lever that can potentially boost domestic investor confidence, bring back foreign money and unleash a self-fulfilling cycle of greed in the market. 

In the event, the A-share market started to recover on the back of a mild increase in “national team” buying and rising foreign inflows.

But domestic investor confidence remains low and the authorities’ window of opportunity to bolster equities and propel a liquidity-driven rally is rapidly closing.

Since Wu Qing assumed leadership of the CSRC in February, the regulator's focus has been on professionalizing China’s equity market, ensuring strict oversight, and prioritizing investor protection. Wu’s reputation as the "Brokers Butcher" for his stringent enforcement of rules during his tenure at the CSRC’s Risk Disposal Office may overshadow the fundamental transformation he aims to achieve. Beijing's goal is for China’s equity market to become the preferred vehicle for storing and growing household wealth.

While addressing market inefficiencies to make it attractive for long-term investment is crucial, it may not be enough to lure domestic investors back into equities.

China is currently facing serious debt-deflation and increasing foreign protectionist backlash. During the pandemic, annual broad money growth averaged over 10%, which should align with a real GDP growth target of 5% and 3% inflation. 

However, demand for holding money balances surged, pulling the economy into deflation.

Annual broad money growth peaked at 13% at the start of 2023 and has since slowed to 7.1% in May. On a three-month annualised basis, a better guide to recent trends, Enodo M3 growth plunged to 4.5%, the lowest rate since October 2014. 

The demand for holding money balances continued to increase in this period.

The tightening of monetary conditions is set to pull the rug from underneath the current equity market revival unless decisive policy action is taken.

Beijing is understandably reluctant to openly prop up the equity market with a large injection of state funds due to the criticism it faced for its knee-jerk intervention during the 2016 equity market debacle. But in combination with its concerted efforts to improve the quality of listed firms, incentivise increased dividend distribution, curb excessive high-frequency trading and root out fraud and insider trading, injecting a sizable amount of state funds would be just the spark needed to unleash greed.

If regulators focus solely on the structural market improvements and broad money growth continues to decline, the equity market’s positive run is set to peter out over the next couple of months.

Conclusion

Structural reforms and improvements to market integrity are crucial for the long-term health and development of China's equity market. But immediate and bold policy actions are necessary to sustain its current momentum.

Injecting substantial state funds, alongside existing efforts to enhance market quality, could reignite domestic investor confidence and further attract foreign capital. Without such measures, the combination of weakening broad money growth and persistent debt-deflation will lead to a decline in market performance.

The upcoming capital market announcements at the Lujiazui Forum will be critical in determining the trajectory of China's equity market for the rest of this year and beyond.