Haitong: Can we usher in a "liquidity bull market" in 25 years?

Core conclusion: Historically, the improvement of macro liquidity in China has mostly been synchronized with the turning points in the A-share market, but there have also been temporary deviations, the key factor being whether risk appetite (fundamental expectations) can rebound. The correlation between micro fund changes in the stock market and market trends is higher, and the fluctuations in the market since September 24th have been due to a significant increase in retail and other incremental funds entering the market followed by a cooling-off period. Looking ahead to 2025, policy efforts are expected to drive an improvement in fundamental expectations, the situation with funds entering the A-share market may further improve compared to 2024, and the net increase in funds for the whole year may reach 2 trillion yuan. 1. The indirect impact of macro liquidity on A-shares Looking ahead to next year, China's macro liquidity is expected to further ease. From the tone of monetary policy, the Central Economic Work Conference in 2024 explicitly stated that in 2025, "a moderately loose monetary policy" will be implemented, "timely lowering of required reserve ratios and interest rates to maintain adequate liquidity," signaling a potential further shift towards loose monetary policy. Currently, China's monetary policy still has room for further efforts, for example, in December 2024, Wang Xin, head of the research bureau of the People's Bank of China, mentioned that "the average reserve requirement ratio in China is 6.6% at the liquidity level, and there is room for further cuts." In addition, although nominal interest rates in China have fallen significantly over the past two years, as of November 2024, the yield on the 10-year government bonds has decreased by about 90 basis points to 2.0% from the beginning of 2023, but the real interest rate (difference between the 10-year government bond yield and CPI) has increased by about 100 basis points to 1.8%. Compared to the United States (real interest rate of 1.5% in November 2024), Japan (-1.8%), and Germany (-0.1%), there is still some room for further decline in China's real interest rates. In addition, the growth rate of China's money supply has been decreasing in recent years, with both M2 year-on-year growth rate and remaining liquidity growth rate (difference between M2 year-on-year growth rate and social financing growth rate) significantly declining from the peak in early 2023. Furthermore, in conjunction with China's expansionary fiscal policy in 2025, the pace of monetary policy is expected to be coordinated accordingly. The recent Central Economic Work Conference also emphasized the need for "more proactive fiscal policy," explicitly stating "raising the fiscal deficit rate" and "increasing issuance of ultra-long-term special national bonds" as key focuses, which indicates a significantly stronger positive tone for fiscal policy. On October 9, 2024, according to the People's Bank of China, the People's Bank of China and the Ministry of Finance have established a joint working group, indicating a closer coordination between China's monetary and fiscal policies. Looking ahead to 2025, as the pressure on government debt supply increases, the central bank may adjust market liquidity through monetary policy tools. Therefore, overall, China's macro liquidity in 2025 is expected to further expand. Historically, the improvement in macro liquidity and the turning points in the stock market have been relatively close, but the impact is indirect. When it comes to the A-share market, does a more accommodative macro liquidity environment inevitably correspond to a more positive market trend? Looking back at the history of A-shares, the turning points in liquidity improvement and market valuation have often been highly synchronized, largely because liquidity is usually a leading indicator of economic fundamentals, and stock market valuation reflects investor economic expectations, therefore, the turning points of the two are often close. However, there have also been deviations between macro liquidity and valuation trends in A-shares history. Looking at the price indicators of macro liquidity, historically during periods of declining nominal interest rates in China, A-share valuations have often declined, such as in 2011-12, 2018, and 2022-2024; similarly, during periods of declining real interest rates in 2010-2011, 2018, and 2021-2022, A-share valuations continued to decline. Likewise, looking at quantity indicators, historically, during periods of increasing money supply, A-share valuations have also experienced a decline. For example, using M2 year-on-year growth rate to measure speed in 2012, 2015, and 2022, and using the residual liquidity indicator (difference between M2 year-on-year growth rate and social financing growth rate) to measure speed in 2011-12, 2015, 2017-18, 2021-22, etc., it is evident that the historical relationship between macro liquidity and A-shares is not absolute. The deviation between macro liquidity and stock market trends may be due to the fact that market risk appetite has not significantly recovered. As mentioned earlier, historically, there have been instances in China where A-share valuations have declined during periods of improved macro liquidity. We believe that this may be mainly due to a certain lag between the turning points in macro liquidity and economic fundamentals. If the recovery of fundamentals takes a longer time after liquidity improves, and overall market risk appetite remains low during that period, it is easier to see a deviation between macro liquidity and stock market valuations. Combining the analysis above, we believe that macro liquidity measures the degree of overall liquidity in the macro system, and how much of that liquidity can flow into the equity market depends largely on the level of risk appetite. Considering risk appetite, we use the risk premium (1/all A-share PE - 10-year government bond yield) to measure the risk appetite of the financial market, and the ratio of the total market value of A-shares to the total Chinese household RMB deposits to measure the overall risk appetite of Chinese residents. When macro liquidity is ample and financial markets or Chinese residents have a low risk appetite, there may be a deviation between macro liquidity and A-share valuations, as seen in 2012, the second half of 2015 to the beginning of 2016, 2018, and 2022-2023. 2. Micro liquidity directly impacts the A-share market Compared to macro liquidity, micro liquidity is a more significant factor influencing A-shares. As mentioned earlier, we believe that loose macro liquidity alone cannot be the sole driver of a bull market for A-shares. In fact, micro liquidity at the stock market level directly measures the adequacy of funds entering the stock market, and therefore, is more relevant to market trends. Specifically, we summarize and estimate various types of micro funds from the bottom up in terms of inflows and outflows to the stock market. Looking further into: The funds flowing into the stock market mainly come from five sources: retail funds (calculated using customer trading settlement fund balances), leverage funds (only accounting for on-exchange margin balances), domestic institutional funds (including funds, insurance, social security, etc., with public fund capital estimated using fund shares, net asset value, and A-share positions, while private funds, asset management, and insurance funds are estimated by changes in stock market values representing fund inflows and outflows), overseas funds (including Shanghai-Hong Kong Stock Connect data from 24/08After the age of 16, we will adopt our estimated cash inflows, dividends, and repurchases (calculated excluding the perspective of large shareholders and secondary investors).to 2. The main destinations of funds flowing out of the stock market are: equity financing (where the scale of cash subscriptions in rights issues is considered, excluding the proportion subscribed by major shareholders), net reduction of industrial capital holdings (calculated by self-estimating the details of secondary market transactions of company shareholders), and trading taxes and fees (financing costs, stamp duties, and other trading fees). Drawing from history, there is a clear positive correlation between the fluctuation of A-shares and the scale of incremental funds entering the market. In our analysis in "Stock Market Fund Supply and Demand Imbalance - 2022 A-share Outlook Series 6-20211231", we found that in the short term, the inflow and outflow of funds in the stock market are more related to the market's bull and bear cycles. During bull and bear markets, funds flow in and out significantly, while in a volatile market, the inflow and outflow of funds balance out. For example, from 2013 to 2015, the overall market experienced a bull run with the Wind All A Index rising by 122.6%, and micro-funds entering the market accumulated to around 6.2 trillion yuan; from 2016 to 2017, the market was mostly choppy, corresponding to a tight balance of micro-funds; in 2018, the market experienced a weak decline with the Wind All A Index falling by 28.3%, and micro-funds exiting the market amounted to around 1.4 trillion yuan, showing a close relationship between the direction of micro-funds and the market environment. Reflecting on the past 24 years: before September 24th, market sentiment was weak and long-term funds were the main incremental source, leading to a volatile market during that period. Furthermore, we reviewed the relationship between the micro-fund flow and market trends in 2024. Before September 24th, long-term funds represented by China Investment Corporation continued to invest passively in broad-based ETFs, becoming the most significant incremental fund in various funds in the A-share market. Specifically, the source of incremental funds from ETF expansion this year was mainly driven by China Investment Corporation, with estimated accumulation of nearly 800 billion yuan in net purchases of A-share ETFs in the first three quarters of 2024. In addition, although the overall equity allocation of commercial insurance funds has increased modestly since the beginning of the year, there has been a significant growth in the balance of insurance funds, with an increase of about 18% from the end of last year to the third quarter of 2024. Therefore, the direct incremental impact of insurance funds entering the market is also considerable, estimated to be over 300 billion yuan in the first three quarters, while we estimate that the net purchases of ETFs by insurance funds in the first half of 2024 exceeded 55 billion yuan. In comparison, the sentiment of other investment entities is relatively weaker, with foreign capital and leverage funds showing net outflows and active public funds facing overall net redemptions, as detailed in "Which funds have been leading the style switch since September 24th? - 20241007". Therefore, the A-share market before September 24th in 2024 faced overall ups and downs, with the Wind All A index falling by 14% during that period. Since September 24th: Incremental leaders may be individual investors, while other funds have been fluctuating, leading to significant market volatility. Since the market volume surged after September 24th, incremental funds, mainly represented by individual retail and leverage funds, have flooded into the market. On one hand, from the perspective of individual funds, the estimated total amount of funds transferred between individual bank and brokerage accounts from September 24th to October 11th is around 170 billion yuan, showing a similar speed of market entry as in early 2015. Moreover, analyzing the turnover of stocks listed on the Dragon and Tiger List, since the middle of October, the trading volume of retail investors and individual investors is about four times that of institutional investors, significantly higher than during previous clear uptrends. On the other hand, in terms of leverage funds, the net inflow of margin trading funds since September 24th has exceeded 500 billion yuan, surpassing the peak of the bull market in 2021. However, since the middle of October, the enthusiasm of margin trading has begun to slow down, with the size of margin trading funds entering the market continuously shrinking after the middle of November. Institutions have experienced significant fund fluctuations, with more inflows in the early stages of the market after September 24th, but a shift towards outflows since the middle of October. Looking at foreign funds, based on our high-frequency tracking of Mainland-Hong Kong Stock Connect funds, the net inflow of northbound funds was estimated to be over 80 billion yuan in a single week on September 27th, setting a new record high. However, it has gradually turned into a trend of net outflows since then, with an estimated cumulative net outflow of 33.2 billion yuan from October 18th to December 27th. As for private equity funds, in November 2024, the long position ratio of private equity stock funds was 55.0%, a slight decrease compared to 55.6% in September 2024. Considering that small-cap stocks, in which private equity funds held a considerable amount, had a significant increase during October and November, there may be a noticeable trend of actively reducing positions among private equity funds. In terms of passive stock funds, the expansion of broad-based ETFs has slowed significantly since mid-October, with the main source of incremental funds coming from the CSI 500 Index ETFs. As of December 27th, the net purchases of CSI 500 ETFs since October 15th exceeded 230 billion yuan, while the cumulative net redemption of other ETFs exceeded 200 billion yuan. 3. Micro-funds expected to see net inflow of 2 trillion yuan next year Looking ahead to 2025, there may be an improvement in A-share micro liquidity, with an expected incremental fund of 2 trillion yuan. As mentioned earlier, the outlook for China's macro liquidity next year may further loosen, but whether it can significantly boost the A-share market upwards depends on the influx of micro-funds into the market and the improvement of market expectations about fundamentals. In our analysis in "How can a loose fiscal policy drive corporate profits? - 25-year strategic outlook series 1-20241127", we have discussed that currently A-shares are at the bottom of the production capacity and inventory cycle, and under different strengths of fiscal policies, the non-financial parent net profit growth in 2025 is expected to be around 20% and 10%, respectively. Therefore, looking into 2025, with the improvement of macro liquidity and the restoration of fundamental expectations driving the recovery in risk appetite, the influx of micro-funds into the market may further improve compared to 2024, with an expected total incremental fund reaching 2 trillion yuan. Estimated key fund inflow projects: Passive funds and insurance funds may still be the main forces entering the market in 2025. First, looking at funds related to individual investors entering the market, from the perspective of bank and brokerage account transfers and margin trading funds, the inflow of such funds is highly correlated with market trends and trading sentiment, following the overall rise in the central pivot of the market in 2025, there may still be a certain amount of increment, with an estimated scale of 300 billion yuan for bank and brokerage account transfers and 200 billion yuan for margin trading funds in 2025. Regarding public funds, compared with the development of public funds in the United States, the overall size of public funds in China in 2023 was 27.6 trillion yuan, accounting for only 22% of the nominal GDP, which indicates that there is still room for growth, and the tremendous potential for public funds to drive the market in the future.In recent years, the United States has approached 100% level with plenty of room for further development. We expect that the incremental funds from public offerings will reach 700 billion yuan in the next 25 years. In addition, the central financial office and the China Securities Regulatory Commission issued a joint document on September 26 to guide long-term funds into the market, addressing obstacles for social security, insurance, wealth management, and other funds to enter the market, further boosting the capital market. In the future, long-term funds are expected to accelerate their entry into the A-share market through ETFs, and A-share ETF funds are expected to play an important role in public offerings next year.Looking at other institutional investors, from the perspective of insurance funds, in recent years, benefiting from the stable growth of insurance premiums, the accumulated growth of premiums from January to October 2024 has reached 12.4%. Insurance funds have become one of the main sources of incremental funds for A-shares. Looking into the future, starting from 2023, the Ministry of Finance requires listed insurance companies to implement new financial instrument standards. The fair value changes of equity assets under the FVOCI category are not included in the income statement but are included in other comprehensive income, which can help reduce the fluctuations in insurance company profit and loss statements. There is still a large space for equity asset allocation for insurance funds in 2025, with an estimated total inflow of 450 billion yuan. From the perspective of foreign capital, taking a longer-term view, northbound funds have shown a stable trend of increasing holdings in A-shares. However, in recent years, the long-term trend of foreign capital inflow into A-shares has slowed down, possibly due to economic uncertainties and pressure on core assets with fundamental advantages. With the expected improvement in the fundamentals of the Chinese economy, foreign capital may continue to have a net inflow in 2025, with an estimated incremental inflow of 150 billion yuan. Finally, in recent years, supported by policies, the scale of dividends for A-shares and the number of individual stocks implementing dividends have continued to increase. Especially in April 2024, the new "Guojiu Regulations" further strengthened the regulation of cash dividends for listed companies. Policies such as incentives for high-quality dividend companies have guided the implementation of dividends in 2024 to a total of approximately 2.4 trillion yuan for about 4000 individual stocks, both reaching historical highs. Looking into the future, in December 2024, China Securities Depository and Clearing Corporation announced that it will halve the dividend handling fee for Shanghai and Shenzhen A-share listed companies starting from 2025, indicating that there may still be room for growth in A-share dividends. It is estimated that the amount of dividends entering the market in 2025 (calculated only for secondary investors) will reach 750 billion yuan. Key calculations for funds outflow projects: By 2025, the financing scale of A-shares may marginally rebound, and transaction costs may increase. Since September 2023, with the gradual tightening of regulatory measures on financing activities, the scale of A-share IPOs and refinancing has continued to decrease. However, based on historical experience, periods of suspension of A-share IPOs often end when the market environment improves. Additionally, the scale of industrial capital reduction is closely related to the A-share market. Therefore, looking ahead to 2025, with the improvement in expectations for fundamentals leading to a rise in risk appetite, combined with the continuous improvement in capital market regulations, the A-share investment and financing environment may continue to recover, with a marginal shift towards an active financing environment. It is estimated that in 2025, the IPO scale will be 100 billion yuan, the refinancing scale will be 200 billion yuan, and the industrial capital reduction will be 300 billion yuan. In addition, in terms of stock market-related taxes and fees, the forecast scale of trading taxes and fees is based on the predicted market turnover in 2025, and the financing costs are derived from leveraged funds, with the prediction of leveraged funds referenced earlier. We expect that the market trading enthusiasm will increase in 2025, with a marginal increase in turnover, and the total scale of transaction stamp duty and financing costs in 2025 is estimated to be around 450 billion yuan. This article is reprinted from the WeChat public account "Haitong Research Strategy"; GMTEight Editor: Wang Qiu Jia.