Why Chinese Stocks Are Jumping on Tuesday

Chinese stocks leapt out of the gate Tuesday morning, with shares of Pizza Hut and KFC operator Yum China Holdings (NYSE: YUMC) rising 6.1% through 10 a.m. ET. Electric car manufacturer Li Auto (NASDAQ: LI) had gained 7.3% and casino powerhouse Melco Resorts & Entertainment (NASDAQ: MLCO) had gained 7.2%.

What's the common thread behind all of these moves? As Reuters reports today, China's central bank has just unveiled its "biggest stimulus since the pandemic."

What's happening in China right now

China's economy is sinking right now, and at serious risk of missing the government's target for growing GDP by 5% in 2024. Weak consumer demand is weighing on the economy and creating "deflationary pressures." To counteract this trend, the government is pumping money into the economy and cutting interest rates to encourage spending. The logic is that if interest rates fall, consumers will owe less money on their mortgages, and have more disposable income, even as the lower cost of taking out credit card loans makes it easier to shop.

As such, consumer-facing companies like Yum China (restaurants), Li Auto (cars), and Melco Resorts (gambling) should, in theory, be immediate beneficiaries of the government's plans.

Specific stimulus measures include lowering interest rates on several forms of loans by 20 to 30 basis points, and cutting rates on mortgage loans by 50 basis points. The People's Bank of China (PBOC) also reportedly is cutting the minimum down payment on Chinese mortgages to 15% to encourage more homebuying. And in what appears to be a first for the government, China is introducing two new programs -- worth 800 billion yuan ($114 billion) in total -- aimed at making it cheaper for institutional investors to buy Chinese stocks, and for companies to buy back their own stocks.

That right there seems a direct stimulus to the Chinese stock market, and helps to explain the outsize effect on Chinese stock prices today.

Is it time to buy Chinese stocks?

Now here's the bad news: It might not work.

Analyzing the stimulus measures announced by PBOC, economists polled by Reuters and The Wall Street Journal today warned that the measures announced "won't be enough to pull China's economy out of a low-growth rut marked by falling prices, a festering real-estate crisis and spiraling tensions over trade."

Of particular concern to investors in consumer-facing stocks like Yum China, Li Auto, and Melco is the fact that, as WSJ points out, "borrowing costs are already low, yet credit data suggests households and businesses aren't that interested in borrowing." Cutting the cost of credit card debt by 0.2 percentage points or so, therefore, probably isn't going to give that big a boost to consumer spending -- especially not with "consumer confidence ... near record low levels."

Additionally, I'd point out that about half the measures proposed (lowering mortgage rates and down payment requirements), as well as eased financing for stock purchases, don't seem aimed at easing consumer worries or boosting consumer spending at all, or at least, not more than tangentially. Investors piling into Yum, Li, and Melco stocks today on the theory that just because China wants to boost consumer spending, it will succeed in boosting consumer spending, I fear, may be overreacting.

True, I could be wrong, and it's not like these Chinese stocks are all that expensive today. The most expensive, Melco and Yum, cost a mere 14 times forward earnings, while Li stock looks positively cheap at a projected 10 times 2024 earnings right now. If China somehow succeeds in goosing its growth rate higher -- hope against hope -- investors today could be rewarded as the economy revives.

I just don't think it'll happen. Not if these are the best answers China's government can come up with to fix its economy.

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Rich Smith has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.