The New Height of A-shares "Outperforming" the Market

As the Shanghai Composite Index broke through last year's high of 3674 at today's opening, how should we view the subsequent consensus building and liquidity gathering in the market? We believe that this round of A-shares at a new height also has new realms, especially reflected in the following three "outperforming" aspects:

First, it has outperformed history in terms of "cost-effectiveness," increasingly exuding the "composure and confidence" of mature markets during the rise: This is concentrated in low volatility and low drawdown. The sharp rises and falls of the past have diminished, leading to better sector rotation, profit-making effects, and more confidence in "buying the dip" under controllable volatility.

Second, it stands out in the "race" with the economy, as the July Politburo meeting clearly positioned: the economy needs to "recover and improve," and the capital market needs to "stabilize and improve." As of the second quarter, the stock market's year-on-year growth rate has outperformed economic growth for four consecutive quarters, marking the first time since the second half of 2021.

The third aspect is our expectation to "outperform" the U.S. stock market. Reflecting on the numerous pressures faced domestically and internationally this year, if the current "slow bull" market of A-shares since April can continue, it will also be a practice of the July Politburo meeting's call to "enhance the attractiveness of the domestic capital market."

In our report "Stock Market Outperforms GDP: Analytical Framework and International Comparison," we introduced a two-dimensional framework of real GDP and inflation. During periods of "increasing volume and decreasing prices" or "increasing volume and prices," the probability of stock market rises is greater, making it easier to outperform GDP growth. For the domestic stock market to sustain its momentum, there are typically two paths: one is to follow the "slow bull" route of new technology with "increasing volume and decreasing prices"; the other is to accelerate out of the inflationary weakness period and move towards economic recovery and style switching. Specifically:

We constructed a simple framework that decomposes nominal GDP into real GDP and the GDP deflator, corresponding to the actual output in the economy and inflation factors, respectively. Theoretically, different combinations of the two correspond to different economic scenarios (see the report "Stock Market Outperforms GDP: Analytical Framework and International Comparison"). We found that:

When actual economic growth is on the rise, and the GDP deflator is declining or remaining at low levels, the probability of the stock market outperforming is greater, and the duration is longer. A typical example is the stage of significant development in information technology in the United States during the 1990s, which set the record for the longest consecutive outperformance of the stock market in U.S. history. Another example is Japan's Koizumi reforms in the early 21st century, which promoted privatization on the supply side, advanced technology and intellectual property, and concentrated on handling non-performing assets on the financial side. Although inflation was not strong, the economy stabilized and rebounded through channels such as going abroad, and the stock market continued to outperform the economy

However, when the economy is in a phase of weak supply and demand or stagflation-like conditions, the difficulty for the stock market to outperform the economy significantly increases. This can be seen from the experiences of Europe and Japan.

Of course, the Chinese market has certain peculiarities. In its relatively short history, there have been instances where the stock market has surged during periods of economic slowdown and weak inflation. Typical examples are from 1999 to 2001 (hereinafter referred to as 1999) and from 2014 to 2015 (hereinafter referred to as 2015).

One of the biggest macro differences between the two is that the former gradually emerged from a period of weak inflation—starting in 2000, the GDP deflator turned positive, allowing the stock market to switch and continue; while the latter faced further economic downward pressure—economic growth fell below 7% in the fourth quarter of 2015, and the deflator turned negative, leading to a final stock market decline. As a current reference, the former may be a positive case, while the latter provides certain lessons.

The performance of industry sectors varies under different macro environments. In 1999, when the overall economy was still experiencing negative year-on-year CPI, a typical example was the "519" market, where the financial services sector performed the best, followed by concentrated industries in "technology stocks," including information equipment, information services, and electronics. By 2000, as the economy stabilized and rebounded, the best-performing sectors were building materials, oil and petrochemicals, agriculture, forestry, animal husbandry, fishery, leisure services, and non-ferrous metals. In contrast, 2015 saw a broad market rally, with leading sectors including computers, media, as well as traditional industries like construction decoration and non-bank financials.

Returning to the present, there are two possible scenarios for the future market trend:

One is a technology innovation route where actual GDP rebounds and inflation remains low. Riding the wave of AI and new productive forces, it emulates the United States in the 1990s and Japan in the early 21st century, following a supply-side and slow bull technology route.

The second scenario is the cyclical recovery route where both actual GDP and inflation rise simultaneously. Macroeconomic policies are being strengthened, and within a year, inflationary pressures are expected to ease significantly, with sectors gradually shifting from growth to cyclical value.

In the first half of this year, the Chinese economy actually showed signs of "increased volume and decreased prices"—despite weak inflation, economic growth stabilized in the first half of the year. Based on the current policy tendencies and pace, the first scenario may align more closely with policy preferences and the future direction of industrial development.

Authors of this article: Shao Xiang, Wu Shuo, Tao Chuan, Source: Chuan Yue Global Macro, Original title: "The New Height of A-shares 'Outperforming' the Market (Minsheng Macro Tao Chuan, Shao Xiang)"

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