The People’s Bank of China (PBOC) is going to buy Chinese stocks.
That’s the latest proposal to stimulate China’s economy and revive its markets.
But the PBOC is not supposed to buy stocks.
It adjusts interest rates and tells banks how much credit they can issue.
The central bank rarely intervenes in the stock market unless China and the PBOC have exhausted conventional measures.
For example, the PBOC recently announced two more rate cuts.
The first was on January 15, and the second one will take effect on January 25.
These cuts should release another $116 billion worth of liquidity into the economy.
Despite the bank’s ongoing efforts, credit isn’t growing as hoped.
The borrowing rate in China has slowed for 15 months straight.
This is China.
When it needs to do something, it always does!
Buying stocks is one of the few tactics left.
One other country resorted to this tactic.
History shows it may not help the economy, but it could help traders make money.
A Lesson From Japan
It’s rare, but not unheard of, for a central bank to buy shares.
The Bank of Japan (BOJ) bought stocks during two periods in the 2000s.
The Japanese economy did not grow for two decades prior.
Interest rates were already at rock bottom, and the BOJ was desperate to lure investors back into the stock market.
So, in 2013, it began an ETF-purchase (exchange-traded fund) program.
It didn’t help the economy, but it helped investors.
The Japanese gross domestic product (GDP) growth shrank.
Five years later, the BOJ is still purchasing ETFs — in an attempt to escape a multi-decade slump.
However, just five months after BOJ announced the program, Japan’s Nikkei 225 Stock Index surged 60%.
China would love to replicate the effect on the stock market.
Running out of Options
In 2009, China unveiled a $586 billion stimulus package.
But those days and ways are gone.
Debt has increased too fast — hindering the potential for economic growth.
China’s government debt-to-GDP has nearly doubled since 2008.
Fast forward 10 years, and China cannot afford to pump billions of dollars into projects that could stimulate the economy.
Add in the shadow banking system, and the country looks more like the debt-driven economies in the Western world.
When debt is larger than economic growth, it puts the financial system at risk.
If it doesn’t function properly, the economy implodes.
The U.S. subprime mortgage debt debacle, for example, produced a global credit crisis.
China’s shadow banking system is its $10 trillion market for nontraditional lending and borrowing. And it’s grown fragile.
Last summer, Chinese police shut down Beijing’s financial district after many peer-to-peer lending companies closed shop.
The chaos in shadow banking liquidated 600 Chinese mutual funds. That’s more than the previous 12 years combined.
China’s Shanghai Stock Exchange Composite Index lost 25% last year.
All the while, the Chinese yuan fell 5.4% in 2018.
The yuan’s plunge has been a thorn in China’s side .
When investors expect yuan-denominated investments to lose value, they pull capital out of the country.
A stock-buying program from the PBOC would help bring investors back.
ETFs Could Help Grow the Economy
To be clear, it is not new for China to intervene in its stock market.
In 2015, the State Administration of Foreign Exchange bought stocks in China’s A-shares market.
It was part of a coordinated effort to halt a 34% decline in the stock market that year.
If the PBOC purchases shares, it will do it to shore up investor confidence.
And it will tell us the result will be a wealth effect that improves the economy.
In theory, the “wealth effect” occurs when investors profit from a rising market.
They feel confident spending more within the economy.
According to Bloomberg: “More than 90% of China’s stock market is owned by domestic investors.”
Maybe richer Chinese investors will spend more money.
It’s not that simple, but it is a welcomed gesture with good timing and a chance for investors to make some money.
Nothing is certain yet.
But you should be prepared before the PBOC implements a plan to buy stocks.
Such a plan would improve global sentiment.
Chinese stocks will be big winners if the PBOC steps in … just as Japanese stocks were after the BOJ stepped in.
If you want to buy Chinese stocks, one of the simplest ways is with the iShares China Large Cap ETF (NYSE: FXI).
The ETF tracks an index of 50 Chinese large-cap stocks trading in the Hong Kong Hang Seng Index.
FXI is due to rebound after last year’s losses.
If the PBOC doesn’t buy stocks, it could climb 20%. If it does, the ETF will skyrocket even higher.
Good investing,
John Ross
Senior Analyst, Banyan Hill Publishing