CICC: What is the impact of the Fed rate cut on the A-share market?

According to the information from the Wise Finance APP, CICC released a research report stating that the Fed's rate cut this time may to some extent benefit the performance of Chinese assets, but the core of the trend stabilization in the Chinese market, especially A-shares, still lies in its own fundamental conditions. The impact of the Fed's rate cut on Hong Kong stocks, which are more sensitive to external liquidity, may be greater than that on A-shares. From the perspective of the A-share market, the key factor for the trend to bottom out is the fundamental shift or marginal improvement. Currently, the valuation of the A-share market is already at an extreme position, and there are historical common characteristics in trading and behavior, showing signs of a bottom. In this context, the Fed's rate cut may help stabilize investors' risk appetite to some extent, but future performance may need to pay more attention to the marginal changes in China's growth-stabilizing policies and whether there is hope for improvement in medium-term fundamental expectations.

Events:

On the afternoon of September 18th local time in the United States, the Fed announced a 50bp cut in the federal funds rate to 4.75%-5.0%, marking the first rate cut in the United States since March 2020.

Key points from CICC are as follows:

Asset pricing logic of the impact of the Fed's rate cut on Chinese assets:

The impact of the Fed's rate cut on the Chinese market can be roughly divided into three levels. 1) The Fed's rate cut often accompanies global fund reallocation, which may to some extent benefit Chinese assets. Historical experience shows that the interest rate cycles in the United States may affect global fund flows. Assuming other conditions remain unchanged, global fund reallocation may provide support for Chinese assets from a fund perspective; 2) The Fed's rate cut may lead to a weaker US dollar, and under the background of a relatively stronger RMB, the impact on A-shares tends to be structural. Without considering relative changes in fundamentals, a weaker US dollar may exert certain pressure on export and overseas companies, but the repayment pressure of companies with US dollar borrowings is also reduced accordingly. From a financial perspective, the impact of exchange gains and losses on different companies needs to be considered; 3) The Fed's rate cut may to some extent help alleviate external constraints on China's monetary policy. Due to the impact of the Sino-US interest rate differential, during the US rate cut cycle, China's policy environment, especially external constraints on monetary policy, are relatively small, especially in a period when China's economic growth expectations are temporarily weak, providing room for further growth-stabilizing policies. Combining the above three aspects, the Fed's rate cut may to some extent benefit the performance of Chinese assets.

However, the reality is often more complex:

Reviewing the performance of Chinese assets, especially the A-share market, during the US rate cut cycles over the past 30 years since 1995, including five rate cut cycles: (1) July 1995 to January 1996, (2) September to November 1998, (3) January 2001 to June 2003, (4) September 2007 to December 2008, (5) July 2019 to March 2020. It is necessary to understand the differential performance of Chinese assets during these stages from two dimensions: 1) The process of globalization. Before China's accession to the WTO in 2002, the impact of the Fed's rate cut on China's economy and market, especially A-shares, may have been relatively limited. The review shows that during the first two rate cut cycles, the performance of A-shares was more influenced by domestic factors, with the correlation coefficient between the Chinese and US stock markets being -0.19 and -0.7, and the impact on styles and industries was not significant; (3)(4)(5) During these stages, the correlation between the US policy cycle and stock market performance in China has significantly increased, with coefficients above +0.7 2) Economic environment or event factors are superimposed, and the impact of other factors at certain stages may even exceed the US interest rate cuts, making the overall impact on global assets even reverse. For example, in 2007, the more important background of the US interest rate cuts was the evolution of the US subprime mortgage crisis into a global financial crisis, and both the Chinese and American stock markets showed a period of suppression followed by recovery during this period. From 2019 to 2020, the market environment was characterized by policy responses to the epidemic, and both the Chinese and American markets experienced twists and turns before rebounding.

How is the impact of this Fed rate cut on the Chinese market different from the past? The biggest difference in the timing of this Fed rate cut compared to previous ones lies in the new changes in the global macro paradigm.

In recent years, there has been a significant shift in the global macro paradigm, and the world economic landscape has entered an era of "great differentiation," with the linkage of the macro cycles between China and some major overseas economies weakening, continuously differentiating in terms of growth, inflation, interest rates, and private sector leverage. The endogenous forces generated by this differentiation are the asynchrony of the financial cycles between China and Western countries, leading to a mirror image of internal supply-demand imbalances between China and the United States, where China's demand is insufficient and the United States' supply is insufficient. This shift in the macro paradigm has profound structural implications for the Chinese economy. Against this backdrop, the impact of this Fed rate cut on the financial environment in China may be relatively milder compared to previous stages.

In summary, this Fed rate cut may to some extent benefit the performance of Chinese assets, but the core of the trend stabilization in the Chinese market, especially A-shares, still lies in its own fundamental conditions.

The impact of the Fed rate cut on the more externally liquid Hong Kong stocks may be greater than on A-shares. From the perspective of the A-share market, the key factor for the trend to bottom out is the fundamental shift or marginal improvement. The current valuation of the A-share market is already at an extreme level, and there are also common historical features of a bias towards the bottom in terms of trading and behavior. In this context, the Fed rate cut to some extent may help stabilize investors' risk appetite, but future performance may need to pay more attention to changes in the marginal intensity of China's growth-stabilizing policies and whether there is hope for improvement in medium-term fundamental expectations.

With the Fed rate cut initiated, pay attention to three types of assets that may affect A-share performance.

In light of the marginal changes brought about by this Fed rate cut, it is recommended to focus on the performance of the following assets in the near term: 1) Foreign-favored stocks. The Fed rate cut may continue to drive global fund reallocation, which may have a marginal impact on the flow of foreign funds into A-shares. Focus on foreign-favored targets in A-shares, especially leading companies in sectors such as new energy, food and beverage, household appliances, automobiles, electronics, and machinery equipment; 2) Companies that may benefit from RMB appreciation. If the rate cut leads to a weaker US dollar, the RMB is expected to appreciate relative to the dollar, reducing repayment pressure for companies with high dollar borrowings, making them more likely to benefit. Focus on companies in sectors such as non-ferrous metals, especially gold, electronics, agriculture, forestry, animal husbandry, fishery, retail, and trade, where companies that may generate exchange gains from RMB appreciation are also worth watching; 3) Targets with high policy sensitivity or phase-specific opportunities. If the Fed rate cut eases external policy constraints and growth-stabilizing policies are further strengthened, sectors that may benefit are also worth temporary attention, such as finance, real estate chains, some consumption sectors, etc. Subsequent observations are needed on the direction and intensity of China's policy responses Risk Warning:

Changes in the US election situation, changes in overseas trade policies, geopolitical risks, China's stable growth policies, and related reform efforts