Lesser Focus on the A-Share Market’s Short-Term Ups and Downs

Summary

• US employment data weakened significantly. While the unemployment rate  did not rise substantially, non-farm payrolls (NFP) fell sharply, and the number of people leaving the labor market increased significantly. The application of AI has significantly contributed to  job reductions in some US industries. This suggests that if the US economy or stock market weakens, the unemployment rate may rise further. This also suggests that the Fed will certainly resume rate cuts in September. However, financial markets have mostly priced in these cuts, and the market may shift its focus to concerns about downward economic pressure. Therefore, these cuts will have little impact on the prices of risky assets such as US stocks.

• The rally in A-shares accelerated. The recent rapid increase in A-share margin trading and the significant shift of deposits into non-bank financial institutions may have raised regulatory concerns. From the perspective of liquidity and household asset allocation, A-shares still have significant room to rise, still policymakers may implement hedging measures to curb the rapid rise in the stock market and leverage levels.

• However, we also believe that, at the current index level, the risk of a significant decline in A-shares is low. This is primarily due to the continued downward pressure on domestic economic fundamentals, including consumption, investment, and property. Therefore, it does not support a rapid shift towards tightening macroeconomic policies. Policymakers may prefer a slow but long-term bull market in A-shares, allowing the stock market's wealth effect to trickle down and boost real economic demand. A rapid and leveraged boom-bust market will ultimately inflict greater harm on  ordinary consumers and dampen consumption.

• We shift our short-term outlook of US stocks to neutral. However, we remain optimistic about the upside potential of US treasury bonds and gold. We maintain a positive stance toward China A-shares. However, suppose  A-shares continue to rise rapidly, it will be accompanied by a further increase in leveraged margin trading. In that case, investors should consider that short-term policymakers may step in to curb excessive market speculative inflows, potentially leading to short-term market volatility. Therefore, investors are advised to avoid frequent buying and selling. If A-shares can slow the pace of leverage and price increases, the market outlook will be more optimistic.

• Gold remains our preferred commodity. Other domestic industrial commodities are likely to fluctuate closely in line with stock-market trends. The overall economic fundamentals of the US and China are not conducive to a significant increase in industrial commodity prices. Therefore, the short-term market will still focus on commodities driven by domestic money that follows market sentiment and "anti-involution" policies.

Previous Views:

We continue to be optimistic about the global stock markets. The core factors driving the rise of stock markets around the world are still liquidity and policy expectations, rather than economic fundamentals. The intensity of fiscal easing by the Chinese government in the first half was the largest in the world, which boosted recent market sentiment and accelerated fund inflow  into the stock market. Commodity trends will  diverge. The first wave of rising commodity prices driven by expectations of the "anti-involution" policy is mainly affected by short-term speculative funds and market sentiment.

Views in September:

I. The US Job Market Situation Will Push the Fed to Cut Interest Rates Again

Recently, the Non-farm payroll (NFP) employment data in the US has weakened significantly. From April to August, the cumulative increase in NFP over four months was only 107K, meaning  the average monthly rise in NFP dropped to less than 27K, marking the weakest NFP performance since the end of the pandemic. However, from a broader perspective of the US employment data, the weakening of the US job market actually became apparent starting Q4 of last year. As shown in Figure 1, since Q4 last year, U.S. unemployment has not risen significantly and employment has held steady. Still  the number of working-age people leaving the job market has increased notably. Looking at the situation this year, although the increase in the number of unemployed people has still been slow since April, the number of people dropping out of the job market has increased rapidly. By August, the net increase of those people this year has reached 1.28 million, while the number of unemployed people had risen by only 540K during the same period.

At this point, we need to understand a concept. The total number of working-age people in the US is currently about 274 million. Among them, around 170 million people are participating in the job market, while the remaining 100 million are non-employed individuals who are not part of the job market. In other words, although they are jobless, they are not classified as unemployed. Instead, these are individuals who choose not to work, such as full-time housewives. Multiple factors contribute to shifts in the number of individuals who give up looking for work. First, the economic situation. Suppose some middle or higher-income workers lose their jobs, they may not quickly accept job opportunities with much lower incomes than their previous jobs and instead choose to withdraw from the job market temporarily. Second, stock market trends also play a role. During periods of rapid stock market growth, many individuals particularly those nearing retirement, may consider quitting their job and relying on investment income to cover  living expenses, thus dropping out of the job market.

Therefore, we believe that since Q4 last year, the employment situation in the US has declined. Particularly due to the widespread use of AI, a significant number of jobs for people in middle-and high-income industries have been replaced by AI, contributing to higher unemployment. The most typical example is the professional and business services sector (Figure 2). Since the second half of 2024, the cumulative number of jobs in this sector has decreased by 120K. Job reductions in other sectors, such as IT, have also been driven by AI. On the other hand, the acceleration of the rise in the US stock market has led to an increase in household investment income, prompting more people to withdraw voluntarily from the job market.

However, it is worth noting that these short-term unemployed individuals could potentially re-enter the workforce under certain conditions, such as a further decline in household savings rates or a decline in household wealth following  a stock market downturn. Therefore, while the rapid increase in the number of people quitting the labor market won't immediately manifest itself in a rise in the unemployment rate now, it could contribute to a sharper rise  during future economic or stock market downturns. Furthermore, the job-replacing effect of AI cannot be ignored. While AI can improve labor productivity, its adoption can also significantly reduce employment. This is particularly relevant in the US, where the business services sector accounts for a large proportion of jobs.

In the short term, those displaced by AI will struggle to find alternative jobs with similar salaries. Therefore, in addition to reducing employment, wage growth could also slow. Of course, over the long term, new technologies can generate new avenues for consumption and services, thereby increasing overall employment, but this often takes a long time to achieve,  spanning several years or even decades. Therefore, based solely on short-term labor  market conditions, the rapid adoption of AI in the US will weaken the country's job market.

These factors also significantly increase the likelihood  that the Fed will resume interest rate cuts in September. However, we must also point out the following: First, the market has already fully anticipated the Fed's September rate cut, and even expectations for the overall rate cut in the second half of this year have risen above 50 bps. Therefore, the Fed's rate cut is already largely priced into the financial market. Second, suppose the US economy and job market continue to weaken significantly, even if the Fed resumes or even increases its rate cuts. In this case, it may not substantially boost risky assets like stocks. 

This is because once the Fed's rate cut expectations are priced in, the market will instead focus more on US economic fundamentals and corporate earnings. For risky assets such as US stocks, the optimal scenario remains a "soft landing,” meaning steadily declining inflation without the risk of  recession. Therefore, a moderate Fed rate cut is optimal for the stock market. If the Fed were to drastically cut rates rapidly due to downward economic pressure, it would  negatively affect  stocks and industrial commodities in the short term. However, this scenario would be more favorable for gold and Treasury bonds.

II. As the leveraged bull market in A-shares accelerates, short-term policy risks rise

In our previous reports, we have consistently expressed optimism about the rise of A-shares and Hong Kong stocks. The core reason for this optimism is the Chinese government’s aggressive fiscal expansion this year. As of the end of August, the net increase in government bonds reached CNY 10.28 trillion, far exceeding the CNY 5.98 trillion issued  in the first eight months of last year, representing an RMB 4.3 trillion increase. As a result, monetary indicators such as total social financing, M1 and M2 have also rebounded significantly this year (Figure 3). Looking at the overall social financing structure, the accelerated pace of government bond issuance, along with fiscal expansion and local government debt reduction measures, constitutes the dominant driver of this round of domestic monetary expansion. This is because other sectors, particularly households and small and medium-sized enterprises, are still undergoing significant deleveraging.

Therefore, it is undeniable that the fundamental basis of this A-share bull market is the liquidity easing brought about by fiscal expansion. As a result,  A-shares will inevitably exhibit the typical characteristics of a liquidity-driven, leveraged bull market. However, from a fundamental perspective, whether in terms of  corporate earnings or economic data, investors are unlikely to find, and do not need  solid support for this bull market.

From the perspective of policymakers, while the stock market's rise can undoubtedly contribute to household  wealth growth, they also do not want to see this liquidity-driven bull market morph into an even faster leveraged bull market. Since mid-July, A-shares have gradually shifted from a liquidity-driven market to a more rapid leveraged bull market, with the most notable indicator of this shift being the rapid increase in on-exchange margin trading account balances. From CNY1.86 trillion  on July 10th, A-share margin trading balances soared to a peak of CNY2.28 trillion  in less than 40 trading days, an increase of over 20%.

This level has already surpassed the A-share market peak in 2015, and the rate of increase is essentially the same as during the leveraged bull market in the first half of 2015 (Figure 4). Of course, after 10 years of growth, China's current total money supply and household deposits are more than 2.5 times their levels a decade ago (Note: China's current M2 total is CNY330 trillion, compared to CNY137 trillion  in 2015; China's current residents' deposits are CNY160 trillion compared to CNY54 trillion  in 2015). Therefore, unless the government takes measures to prevent this rapid leverage bull market from further advancing, the A-share leveraged bull market still has considerable  room for further growth.

Deposit data indicate that a shift in Chinese household savings from banks to non-bank financial institutions has begun to emerge. By the end of July, deposits held by non-bank financial institutions had increased by CNY4.69 trillion, including a net rise of CNY2.1 trillion in July alone. We expect this rapid growth to continue in August. At the peak of the leveraged bull market in 2015, deposits in non-bank financial institutions rose by CNY6 trillion, followed by a sharp decline during the subsequent stock market downturn (Figure 5). While this rapid increase in non-bank financial institution deposits does not necessarily equate to household investment in the stock market, since it also includes inflows into other non-bank institutions such as trusts and funds, its rapid short-term fluctuations are closely correlated with fluctuations in the A-share market.

In 2015, CNY6 trillion represented 11% of total household deposits at that time. Converted to China's current total household deposits, this equates to CNY17 trillion. Therefore, as of now, it is projected that non-bank financial deposits inflows this year may already exceed CNY6 trillion , but there is still significant room for growth compared to the 2015 level. Can we conclude that A-shares still have considerable room to rise? Based on the current household asset allocation structure and funding levels, the A-share leveraged bull market still has significant potential. However, drawing a complete analogy between the 2015 leveraged bull market and the current situation is misleading. First, the overall economic environment and corporate profitability were better in 2015 compared with current conditions. 

More importantly, having experienced the rapid leveraged bull market in A-shares in 2015, followed by the stock market crash and the adverse consequences caused by the leveraged collapse, it is reasonable to assume that Chinese policymakers are unlikely to want to see a repeat of the 2015 boom-bust leveraged market. "You cannot step into the same river twice." Precisely because of the lessons learned from 2015, we believe the likelihood of the current A-share market replicating the leveraged bull market of a decade ago is extremely small.

A crucial prerequisite for avoiding the risk of a crash caused by the leveraged bull market is to prevent the kind of rapid increases in leverage and stock prices seen previously. Therefore, the rapid increase of more than 20% in A-share margin leverage within just over a month has likely triggered warning signals from policymakers. Therefore, policymakers may consider tightening requirements, raising thresholds for stock market leverage and money inflows, or taking other measures to cool down the market if necessary. In summary, the current A-share leveraged bull market still has significant room for growth, based solely on household asset allocation and deposit shifts. Still, policymakers are likely to begin implementing hedging measures to prevent an excessively rapid increase in stock market leverage.

This dynamic, where the inherent upward momentum of liquidity continues to offset policy slowdown, is likely to dominate the A-share market over the next one to two months. Under such circumstances, short-term volatility in the A-share market is expected to intensify significantly, and rapid short-term or even intraday price fluctuations will become more frequent. Therefore, investors should avoid chasing intraday stock price fluctuations, as a slow bull market is the best investment situation. When the index experiences rapid fluctuations with significant volatility, it is necessary to reduce the frequency of day-trading, and even to operate in the opposite direction of the market's short-term sentiment, meaning that the difficulty of short-term trading will increase significantly.

III. We believe that, at the current level, the risk of a significant decline in A-shares is low

However, we remain generally optimistic about the Chinese stock market. We believe that while volatility risk is increasing, the current level does not indicate a significant decline. This is primarily because current domestic economic fundamentals do not support an imminent tightening of macroeconomic policies.

Recently released economic data indicate that investment, consumption, and property in China are still facing downward pressure and slowing growth. For example, the growth rate of retail sales of consumer goods slowed rapidly from 6.4% in May to 3.7% in July (Figure 6). Furthermore, given that the base effect of consumer subsidies introduced since last September diminishes, year on year consumption growth may face further downward pressure in Q4.

Similarly, the Chinese housing sector continues to experience a downward trend in new construction starts, property sales, housing prices, and land sales. The relative weakness of the overall economy means that a near-term shift in domestic loosening macroeconomic policies is unlikely. Policymakers are unlikely to anticipate a significant stock market decline and will therefore refrain from imposing hard restrictions on A-shares. Consequently, we remain optimistic about A-shares overall. However, policymakers clearly hope to translate the wealth effect from the stock market prices into actual growth in the real economy, consumption, investment, and the property market. Their preferred model is a return to the previous "slow and long-term bull" trend. At the same time, they recognize that rapid, and leveraged bull markets will ultimately only cause greater harm to ordinary consumers and dampen consumption. Therefore, from the perspective of policymakers, a period of short-term volatility and consolidation in A-shares, slowing the rate of increase in leverage and the stock price index, is a better outcome.

From an investor’s perspective, a continued acceleration in A-share gains, accompanied by a further rapid increase in leverage, would signal a dangerous policy risk. Conversely, a mild consolidation in A-shares, with a slowdown in the rate of growth in leverage, would be more favorable for future market trends.

IV. Market strategy

The Fed's resumption of rate cuts in September is almost inevitable, but this factor has already been fully priced into the US stock market. Therefore, the short-term upward momentum in the US stock market has slowed, and we shift our short-term outlook to neutral. However, we remain optimistic about the upside potential of US Treasury bonds and gold. While there is some potential for a short-term decline in the US dollar index, we do not expect the overall impact to be significant.

The risk of a significant decline in A-shares is low at the current level. However, if A-shares continue to rise rapidly, accompanied by a further increase in leveraged margin trading. Investors should consider that policymakers may step in during the short term to curb excessive market speculative inflows, potentially leading to market volatility. Therefore, investors are advised to avoid frequent buying and selling. However, the overall liquidity environment remains favorable for A-shares. Thus, if A-shares can slow the pace of leverage and price increases, the market outlook is more optimistic.

Gold remains the most favorable commodity. Other domestic industrial commodities are likely to fluctuate in close alignment with stock market trends. The overall economic fundamentals of the US and China are not conducive to a significant increase in industrial commodity prices. Therefore, the short-term market will still focus on commodities driven by domestic money that follows market sentiment and "anti-involution" policies.