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China established a diplomatic relationship with the US in 1979. Since then, their economy has grown at an incredible pace, averaging around 9% per annum from 1980. That was until the pandemic hit in 2020 and devastated the economy, taking down the stock market with it. There was a short rebound in 2022 due to stimulus packages, tax cuts, and an aggressive monetary policy to prop up demand, but by 2023, the economy began to lose steam again.

Sporadic COVID-19 outbreaks and the government’s strict Zero-Covid policy led to localized lockdowns, causing disruptions in supply chains, reducing the number of jobs, and increasing youth unemployment — i.e., the perfect storm to tumble the stock market.

As if this wasn’t enough, the real estate sector, a vital pillar of China's economy, saw retail sales dry up due to the pandemic. Unable to secure financing, builders began to default on loans and construction stalled. As a result, consumer spending in China remained subdued, investor confidence dropped, and concerns about economic stagnation took center stage.

But over the last month, something unexpected happened. Despite these headwinds, China’s stock market staged one of its strongest rallies in nearly a decade. What was the catalyst behind this reversal? An economic stimulus package designed to reset the economy and restore investor confidence.

So, in this week’s newsletter, let's understand what prompted the stimulus strategy and its potential impact on the global financial markets.

China’s Economic Growth and the Problems It Now Faces

For the last three decades, China’s economy has been on an unstoppable growth trajectory. This economic boom was fueled by diplomatic ties established with the United States in 1979, which opened the door to international investment. Fast forward to 2001, China became a member of the World Trade Organization and it positioned itself as a global production powerhouse. Low-cost manufacturing became a key driver of growth, lifting 400 million people out of poverty and expanding its economy to more than 11 times its size in 2001.

However, the rapid rise came with significant trade-offs. Allegations of unfair trade practices and manipulating currency values have tarnished China’s reputation among global trading partners.

These policies, combined with internal economic missteps, have contributed to three major challenges the nation faces today.

China’s Triple Threat

• The Real Estate Crisis

One of China’s biggest hurdles is fixing its real estate sector. Real estate became the primary means of wealth accumulation for Chinese citizens, leading to a property bubble of massive proportions. At one point, 70% of the country’s wealth was tied up in real estate, compared to only 30% in the United States. This boom resulted in a staggering 700% increase in property prices from 2001 to 2017, fueled by a demand that far outstripped supply.

However, as growth slowed, developers struggled to raise funds, leading to unfinished construction projects and frustrated buyers. This crisis reached its peak when Evergrande, one of China’s largest property developers, filed for bankruptcy in mid-2023, owing over $300 billion to investors. This sparked a domino of bankruptcies across the sector, affecting more than 230 developers and sending shockwaves throughout the economy. In response, China has begun lowering interest rates and loosening property regulations to help revive the market. But the question remains, whether this is a temporary fix or a more serious warning sign of long-term instability.

• Youth Unemployment

China’s higher education expansion, which began in 1998, was designed to boost the economy by producing a more skilled workforce. The goal was to create a knowledge-based economy and meet the demand for educated workers to grow the Chinese economy. However, this growth in graduates far outpaced the demand in the job market. In a way, this made higher education more like mass education, resulting in a significant mismatch. Currently, youth unemployment (ages 16-24) stands at a staggering 18.8%, driven by a surplus of degree holders and insufficient job creation.

In fact, unemployment has gotten so bad that it has led to a rise in lottery ticket sales as young people increasingly see gambling as a way out of financial hardship. Additionally, many employers are hesitant to hire new graduates, fearing the cost of severance if layoffs are needed. In some cases, severance can include 30 days’ notice plus two months’ salary, making it risky to hire in an uncertain economy. Youth unemployment has become so severe that the government paused its publication of unemployment data in 2023, and only resumed it after they changed their methodology.

• Deflation

All this unemployment has led to deflation, which is the general decrease in price levels. While lower prices may sound appealing, they often signal weak demand, which can further slow economic growth. As prices drop, consumers hold off on spending, expecting prices to fall even more. This lack of demand leads to reduced production, layoffs, and even lower spending — a vicious cycle that can further weaken the economy.

Despite household income growth outpacing spending, Chinese citizens remain cautious due to lingering economic uncertainty from COVID-19 lockdowns, real estate instability, and banking sector concerns. The result is a failure to meet China’s targeted 5% GDP growth rate.

China’s Stimulus Bazooka

In response to these economic challenges, China is implementing a series of aggressive measures collectively dubbed the Bazooka Stimulus. This stimulus package aims to inject liquidity, encourage borrowing, and restore confidence in the market. Here’s how it breaks down:

1. Banking Reforms: The People's Bank of China has proposed injecting approximately $112 billion into the stock market by reducing interest rates, lowering mortgage rates, and freeing up $140 billion through lowered bank reserve requirements. This aims to encourage more lending and investment activity.
2. Sovereign Bonds: Beijing is rumored to be planning a release of $284 billion in sovereign bonds later this year to pay down local government debt and strengthen the social safety net.
3. Additional Stimulus: There are discussions about launching a broader stimulus package worth up to $1.4 trillion to prevent further economic deterioration.

While these measures have sparked a 20% rally in the stock market, it’s important to note that much of this optimism is based on anticipated future stimulus rather than the results of policies already in effect.

Is the Stimulus Sustainable?

Even though they did cut interest rates and reduce mortgage down payments, it’s arguable whether this is a long-term solution or a quick fix designed to get the wheel rolling, until they have to step in again eventually. A significant portion of the recent surge is based on expectations of further stimulus rather than tangible economic improvements. For instance, lowering bank reserve requirements may provide short-term liquidity, but it could also increase risks if there is a sudden demand for withdrawals.

While the rally could continue in the near term, fundamental challenges like youth unemployment, real estate instability, and weak consumer demand are likely to persist. Investors should watch closely for additional policy changes and assess whether China’s long-term strategy can effectively balance growth with financial stability.

What’s Next?

China’s latest economic reset showcases the nation’s willingness to allocate significant resources to solve its economic problems. However, whether this approach delivers sustained growth or simply delays deeper issues is yet to be seen. Investors should remain cautious and consider whether the current rally represents a genuine turnaround or just a short-term reaction to aggressive stimulus.​

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That's it for this week. I hope you enjoyed this article. Let me know your thoughts by responding to this email - I read every single comment :)

Stay safe, stay invested and I will see you next week – Graham Stephan.

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