Chart that tells a story: Here's why China's market has bounced back in 2019

The turnaround can been seen as the result of a number of shifts in both policy and investor sentiment.

The Chinese market has got off to a roaring start this year. As the chart below shows, the Shenzen Composite index has a year-to-date return of 33.6%, making it the best performing index in the world. Meanwhile, the second most successful index is its rival, the Shanghai Composite, up 24.1% this year. 

The returns dwarf all other major markets in the world. For example, the tech-heavy NASDAQ index, in third place has returned 13%, followed by Canada's TSX Composite with 12.2%. 

China's solid performance in 2019 so far follows its abysmal performance in 2018. The country's major indices both floated within bear market territory for much of the year. 

Source: Bloomberg

China's strong performance largely comes on the back of a poor 2018. Principally, the turnaround can been seen as the result of a number of shifts in both policy and investor sentiment.  

First of all, during 2018 China's government took active measures to restrict credit and reduce debt within the country's economy. This was seen as harmful to the economy and consequently Chinese shares took a hit. 

However, if 2018 was all about deleveraging, 2019 is now all about a return to growth in China. As Mark Williams, manager of the Liontrust Asia Income fund, notes:

"Premier Li (recently) announced VAT cuts, the restrictive tone on property announcements appears to be easing and infrastructure projects continue to be supported."

There is now a growing perception that Chinese authorities will do whatever it takes to support growth. According to Charles Su, managing director at CIB Research, the Communist Party, above all, fears social disorder that could challenge its rule. A significantly slowing economy, therefore, is to be avoided at all costs. 

That presents potential longer-term risks, with much needed structural reforms being delayed. As George Magnus, economist at the China Centre at Oxford University  has noted, China's economy is becoming less and less efficient and major changes are needed to avoid falling into the dreaded "middle income" trap. For now, however, many investors appear happy to be bullish in the short term.

Next, Chinese shares were rocked by US president Donald Trump's decision to begin a trade war with China in 2018. However, following last year's tit-for-tat escalation of tariffs, investors are now largely optimistic about the resolution of the dispute – or at least little further escalation anytime soon. 

As Williams notes: "Trade tensions already seemed to be ebbing away at the start of the year due to the agreement of a 90 day suspension of a tariff rise from 10% to 25% on Chinese imports. Sentiment surrounding the 'Trade War' has only improved as both parties have made conciliatory noises, with the Trump's new tariff deadline of 1 March again pushed further down the road 'until further notice'."

Finally, Chinese shares have been buoyed by the US Federal Reserve's decision to put monetary policy tightening on hold. 

The Fed's interest rate hikes in 2018 saw the dollar appreciate by 10% in trade weighted terms. That put pressure of Asian and emerging market economies with large amounts of dollar-denominated corporate debt, helping dampen sentiment on China. 

Now, due to fears about the US own economy and markets, the Fed has announced it will be "patient" when it comes to policy, forecasting two rate hikes this year and putting its quantitative tightening (reducing the balance sheet it built up during quantitative easing) on pause. "All of this suggests that further strong dollar gains of the type seen in 2018 are fairly unlikely," says Williams. 

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.