In early December, we stated that "We are bearish on Chinese A-shares until the “national team” starts to buy". Beijing now seems determined to mobilise state funds into a sizable equity stabilisation fund to prop up the domestic equity market. 

This 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. 

Chinese policymakers are on the verge of mobilising Rmb2.3trn, reported Bloomberg, made up of Rmb2trn sourced from offshore accounts of state-owned enterprises (SoEs). Traditionally, the "national team"comprises state-backed funds, such as Central Huijin Investment, the National Social Security Fund, the State Administration of Foreign Exchange and China Securities Finance Corp. This group is expected to provide an additional Rmb300bn.  

Bringing offshore SoE funds, likely mostly in dollars, onshore through the Hong Kong connect schemes not only swells the stabilisation fund to a consequential size but is also likely to support the yuan. 

Enodo estimates that the "national team" bought about Rmb1.6trn of stocks during the 2015 stock market crash, which has been its largest intervention. 

An Rmb2.3trn injection into A-shares is likely to send a powerful signal to domestic investors, likely acting as a catalyst to entice households out of low-yielding interest-bearing deposits into buying stocks. This, in turn, may lead to a self-fulfilling cycle of greed as more investors are drawn into the market. Chinese investors tend to be short-termist and find it difficult to resist a rising market. 

The positive feedback loop of market enthusiasm could also be helped by drawing in foreign funds. Foreign investors' underexposure is so extreme that even a mere 5 percentage point switch out of India, Brazil, and Mexico would mean a lot for the CSI 300. 

Historically, the largest chunk of a bull market or a simple rebound develops, everywhere in the world, while commentators and the media are still either sceptical or outright bearish. For American investors, holding Chinese equities is no longer politically correct. 

But a generalised underweight position in Chinese stocks is becoming dangerous.

Deflation is bad for stocks, as we have argued, but it is not the case that the entire corporate sector suffers because of falling prices. Where dividends are either safe or perceived as safe, very low bond yields do help. The the same happened in the US market when the S&P 500 Dividend Aristocrats and the Dividend Growers trashed the benchmark for years as the bond market bubble developed.

Beijing continues to encourage SoEs to pay out dividends and buy back shares, and for investors with a local benchmark, a basket of safe dividend-payers has allowed significant outperformance. With earnings season about to start, market fears have grown that China’s listed companies will announce disappointing earnings in coming weeks. 

But anything that doesn’t disappoint, with high dividend potential, should be given a thought, especially among SoEs.

Has the time arrived when investors should rotate out of dividends and into sectors that better respond to the chances of a ‘reflation’ package? We seriously doubt it. True, fiscal and monetary policy interventions could catch investors with their pants down, but whether they are going to work (or how long they will take to work) is another story. Beating deflation out of the system is easier said than done. 

As expected, the PBoC said today that it would cut the reserve requirement ratio (RRR) for banks within two weeks and hinted at more support measures to come. The RRR – which determines the amount of cash banks have to keep in reserve – will be lowered by 0.5 percentage points on Feb. 5 to provide Rmb1trn in long-term liquidity to the market. 

Our analysis suggests that the RRR cut is aimed at helping banks deal with mounting credit losses and is unlikely to translate into a substantial boost of broad money growth. 

But it certainly helps boost market confidence, especially alongside Premier Li Qiang’s clear call to action at Monday's State Council, where he emphasized the urgency of implementing robust measures to stabilize both the market and investor confidence.

Conclusion

China's authorities are gearing up to bolster the equity market with a Rmb2.3trn stabilisation fund. We judge this has the potential to unleash pent-up domestic liquidity and create a self-fulfilling cycle of market enthusiasm.

Given China's serious deflation problem, this is unlikely to lead to a sustained bull market. But an equity upturn could run a few quarters, especially if it leads to foreign investors reassessing their severely underweight China position.

Lowering underweight positions in Chinese stocks, with a focus on safe-dividend payers, especially among SoEs, seems a good idea at this stage.