Here’s why BCA says China’s "anti-involution" policies may not end deflation

China continues to face significant deflationary pressures, with consumer prices contracting 0.3% and producer prices 2.3% in September. Beijing has responded with an "anti-involution" campaign aimed at curbing aggressive price cutting among domestic firms. However, BCA Research analysts are skeptical these policies will resolve the issue, predicting persistent deflation due to authorities' reluctance to curtail capacity, which would lead to layoffs and continued overproduction. Consequently, they advise investors against chasing Chinese share prices higher, recommending a neutral weighting in Chinese stocks given the lack of broad economic recovery and poor corporate profitability.

Analysis

China is currently grappling with persistent deflationary pressures, with consumer prices contracting 0.3% and producer prices 2.3% year-over-year in September. In response, Beijing has launched an "anti-involution" campaign, aiming to curb aggressive price cutting and consolidate industries to address oversupply and intense competition among domestic firms. This initiative seeks to stem the decline in prices and stabilize the economy.

However, analysts at BCA Research express significant skepticism regarding the efficacy of these policies, predicting that they will not resolve deflation within the next year. Their assessment is based on the expectation that Chinese authorities will be reluctant to implement substantial capacity cuts due to concerns about potential layoffs, which would perpetuate overproduction.

Consequently, this continued imbalance between supply and demand is anticipated to drive cascading price drops as companies strive to protect market share, thereby negatively impacting domestic corporate profits. The analysts further underscore the absence of a broad economic recovery in China and generally poor profitability among most companies, with the exception of a few technology firms.

Key Decisions for Investors

• Investors should exercise caution regarding Chinese equities given the persistent deflationary environment and analyst skepticism about the effectiveness of current government policies.
• It is prudent to maintain a neutral weighting in Chinese stocks across Hong Kong, U.S., and mainland A-share markets, aligning with BCA Research's recommendation.
• Avoid chasing higher Chinese share prices, as the underlying lack of broad economic recovery and poor corporate profitability do not currently support sustained upward momentum.