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One of the biggest headlines in markets this week was what transpired with the Chinese equity market. We’ve seen stimulus after stimulus over the past couple of years on behalf of both the People’s Bank of China and the Chinese government, so what makes this round so special?

The spoiler is that there isn’t anything special about this new round of stimulus. On the contrary, I think it has a lot more to do with the Fed’s policy decisions as of late.

But as I’m about to show you, the trend of China’s underperformance against U.S. stocks has been going on for years. The trillion-dollar question now is whether we’ve reached a key inflection point…

Capital Flows Never Lie
 

In markets, it’s critical to separate narrative from reality, lest you get burned. For years, we’ve been lectured about how China was going to become the global economic superpower, and to be clear, the country's economic transformation was nothing short of spectacular.

However, when we look at where the money has been flowing, it would seem that “Mr. Market” had other opinions over the past several years. Check out this ratio chart between Chinese stocks and U.S. stocks going back to the end of 2004.

This ratio has been dropping ever since October 2007. This means that over the past 17 years or so, U.S. stops have outperformed Chinese stocks - both to the upside and downside.

The last meaningful period where Chinese stocks didn’t underwhelm against U.S. stocks was 2016-2018, but as you can see Chinese stocks have hardly ever been cheaper relative to U.S. stocks.

I think the Fed’s latest move towards easing has been a major gift for Chinese markets. Basically, with rates going down, the incentive to invest in the U.S. market over the Chinese market isn’t as large as it once was.

That being said, the Chinese market has a lot more to prove before we can consider this a sustainable trend, but this doesn’t mean we can’t start speculating on the long side. In fact, we got long Tencent Holdings (TCEHY) and Qifu (QFIN) just this last week, simply because the risk-reward setup was so compelling.

This could be one of the biggest macro developments unfolding right now. I’ll be sure to keep you posted on my thoughts.

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