On October 14th, the three major A-share stock indices in China rose by more than 2%, reflecting a generally positive market response to the Ministry of Finance's press conference held on the 12th. Many international investment banks believe that although details of fiscal stimulus are lacking, the signal of a policy shift is already very clear.

Goldman Sachs has recently revised its forecast for China's GDP upwards. Given that China's latest round of stimulus clearly indicates that policymakers have changed their cyclical policy management to focus more on the economy, the institution's macro team has also revised its forecasts for China's real GDP in 2024 and 2025 — raising the 2024 real GDP forecast from 4.7% to 4.9%, and the 2025 real GDP growth forecast from 4.3% to 4.7%.

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At the same time, debt swaps have also attracted attention from both domestic and international markets. Goldman Sachs expects that policymakers will approve an expansion of the local government debt swap program to 5 trillion yuan at the next session of the Standing Committee of the National People's Congress, while Morgan Stanley expects it to be 6 trillion yuan. Both institutions separately anticipate an additional 1 to 2 trillion yuan in ultra-long-term government bonds.

The scale of debt swaps is under scrutiny. On the 12th, at a press conference held by the State Council's Information Office, the Minister of Finance, Lan Fu'an, stated that a one-time increase in the debt limit on a larger scale is planned to swap the existing implicit debt of local governments, and to intensify efforts to support local governments in resolving debt risks. The market considers this policy to be the most significant measure to support debt resolution in recent years.

"Regarding last Saturday's press conference, our macro team believes that it is generally in line with expectations, with positive factors including clear forward guidance on fiscal expansion for many years to come, a larger scale of local government debt resolution, and more central government debt financing," said Goldman Sachs.

"After communicating with many institutions yesterday, although the press conference did not announce additional fiscal stimulus, debt resolution is increasingly being paid attention to, and at least it can release the consumption power of this chain, including civil servants and enterprises that have been owed payments," said an overseas insurance asset management investment research person to the reporter.

Goldman Sachs expects that policymakers will approve an additional 1 to 2 trillion yuan in ultra-long-term government bonds at the next session of the Standing Committee of the National People's Congress, expand the local government debt swap program to a scale of 5 trillion yuan, and plan for higher government bond issuance in 2025 and beyond by setting a higher official deficit target and a larger ultra-long-term central government bond quota. As a result, China's GDP forecast has been revised upwards.

Morgan Stanley also expressed a positive view on the following two points — the press conference on Saturday confirmed that the local government debt swap will be the largest in recent years, and it is expected that this plan will reach more than 6 trillion yuan in the next few years, which will alleviate the tightening effect on local governments and thus help enterprises that face tax recovery and fines due to tight local government funds; in addition, this is the first time that government bonds have been used to repurchase housing inventory, and the Ministry of Finance reiterated the government's position on stabilizing housing prices. This echoes the key message of the Political Bureau meeting on September 26th, further strengthening the possibility of accelerating the digestion of excess housing inventory, which is crucial for reflation.

Although the Ministry of Finance did not mention specific figures, research by CITIC Futures' fixed income team shows that the Ministry of Finance has historically led three large-scale debt resolution actions, including: the first round (2015-2018) with a total of about 12.2 trillion yuan in debt swaps to replace existing government debt; the second round (2019) with the issuance of 157.9 billion yuan in debt swaps to replace implicit debt; and the third round (December 2020 to June 2022) with a cumulative issuance of 1.13 trillion yuan in special refinancing bonds.Minsheng Securities stated that the approach to debt replacement seems to have returned to the period between 2015 and 2018. In addition to continuing to allocate a certain scale of bonds in the annual increase of special debt limits to support the resolution of existing government investment project debts, it is proposed to increase the debt limit by a large scale at one time to replace local existing implicit debts, and to increase efforts to support local governments in resolving debt risks. The scale of implicit debt has been reduced by 50% compared to 2018, and it is estimated that the remaining 50% will not be resolved all at once, but will continue, with the overall scale estimated to exceed one trillion yuan.

In the short term, sentiment and capital flows may stabilize.

On September 24th, a joint press conference held by the central bank and other departments has propelled a bull market in Chinese stocks. By the end of the National Day holiday, the MSCI China Index and the CSI 300 Index have rebounded by 36% and 27% respectively since their September lows, shocking the international market. This is one of the strongest and most concentrated rebounds since the launch of the two indices in 1993 and 2005, respectively. However, after the holiday, the market plummeted significantly, with the Shanghai Composite Index falling to around 3200 points, and the potential market impact of this Ministry of Finance press conference is also closely watched.

"Previously, the market was worried that fiscal stimulus would not meet expectations, leading to a continued market decline, especially as further fiscal measures may not be gradually introduced until 2025. However, this press conference seems not to have disappointed the market," said the aforementioned foreign asset manager to the reporter.

Morgan Stanley's Chief Equity Strategist for China, Wang Ying, said that in the short term, sentiment and capital flows may stabilize, while the impact on fundamentals remains to be observed. The reason is that the institution believes that the Ministry of Finance's commitment to "adequate" fiscal deficit expansion will help stabilize market sentiment. Although there are no specific details, the signal of policy shift is already very clear, so it is not believed that the inflow of passive and active funds will return to the level before September 24th.

"However, with less than three months left until the end of the year, further fiscal measures may not be gradually introduced until 2025. The potential trough of corporate profit growth is still unclear at present. Therefore, we believe that investors should still focus on profit expectations and quality in their existing allocations in order to choose the right investment timing," she said.

Before this round of adjustments, the valuation of the MSCI China Index quickly recovered from 9 times to 12 times at the time of the "epidemic restart trade," which has fully recovered to the average of the past five years and even slightly exceeded it. However, profits have not improved, so further rebounds must rely on further support from fiscal policy, especially the improvement of the economic fundamentals and deflationary situation, the stabilization of the real estate market in terms of volume and price, and the transmission to the recovery of corporate profits.

However, all parties believe that this also indicates that when valuations fall again, the market will present trading opportunities, and range trading may become the main mode.

Hedge funds take partial profits but still have the momentum to inflow.

Recently, the capital flows of global hedge funds and long-term investment institutions have also attracted attention.Goldman Sachs mentioned that, from a position perspective, global mutual funds increased their allocation to Chinese stocks in September. By the end of September, it stood at 6.1% (the 8th percentile over the past 10 years), compared to 5% at the end of August. Moreover, due to the market rebound, the underweighting of China has expanded.

The institution predicts that if global active mutual funds raise their allocation to Chinese stocks to the standard weight, the inflow of funds will approach $50 billion.

According to the reporter's understanding, some hedge funds and overseas public funds mainly trade in Chinese concept stocks listed in the United States (ADR). Information from Goldman Sachs' trading desk shows that, looking at the capital flow over the past three weeks, on September 24, the day the stimulus policy was announced, the trading volume of the ADR market was 38 million shares, and the demand for the third quarter was net buying. The capital flow is huge. Since September 25, Chinese ETFs have attracted about $11 billion in capital inflows, with Chinese-related ETFs (FXI and ASHR) attracting the largest inflows. Considering that U.S. investors previously held an ultra-low position in China, it is reasonable for them to follow this rebound, especially with the participation of hedge funds and long-term investors.

However, starting last week, hedge funds and long-term investment institutions turned to net selling. "Last week, Chinese ADRs fell by 5%, and we began to see hedge funds taking profits on short-term positions (not large in scale or not urgent in operation), which have risen by 20% to 30% in the past few weeks, and are currently waiting for the next positive catalyst," the aforementioned institution said.

At present, the stocks with the highest buying tendency held by investors include: Pinduoduo (PDD), Ctrip (TCOM); while the stocks with the highest selling tendency are: Alibaba (BABA), Huazhu (HTHT), Full Truck Alliance (YMM), Bilibili (BILI); the targets for two-way trading include: Beike (BEKE), Miniso (MNSO). The most discussed issue among investors is that if China's subsequent stimulus measures are implemented, the biggest beneficiaries are those consumer goods and industrial enterprises with a large exposure to China, such as Alibaba, Nike (NKE), Las Vegas Sands (LVS), Freeport-McMoRan Copper & Gold (FCX), CSX, Alcoa (Alcoa).

Looking at the capital flow of A-shares, by the end of last week's trading, "long-term investors have a buying intention in the financial and consumer sectors, followed by more buying in the healthcare and daily necessities sectors, while the consumer and information technology sectors have seen some selling. Hedge fund clients, due to the market showing signs of weakness, rushed to take profits, especially net selling Hong Kong stocks, and later still bought A-shares. The daily necessities, healthcare, and financial sectors received buying, while the public utilities and communication services sectors were sold," Goldman Sachs said.