Brokerage Stocks: At a Turning Point?

On November 26, the stock of brokerage firms once again surged, with Jinlong shares reaching their daily limit. Other prominent companies, including Everbright Securities, Huashang Securities, CITIC Jianan Investment, First Capital Securities, Nanjing Securities, China Galaxy Securities, Pacific Securities, and CITIC Securities followed suit. This notable activity underscores a potential inflection point for the Chinese securities industry as we enter 2024, which could mark a historic milestone in its evolution.

While the brokerage sector has shown impressive gains over the past month, many believe that this is just the beginning, and the true potential of the industry has yet to be realized. Historically, the drivers behind the reversal of the brokerage sector have been rooted in optimism surrounding supportive government policies and a comprehensive suite of economic strategies. Such turnarounds typically occur when the overall market is relatively low, and sustained growth in the sector relies on a positive feedback loop between policy, market performance, and corporate earnings.

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A critical moment occurred on September 24 when leaders from three major financial divisions made a public appearance, followed by top-level government meetings on September 26. These events hinted at the onset of a new wave of optimism for the market. The shift in policy resulted in a significant turnaround in expectations for the Chinese stock market, as evidenced by the A-shares' trading volume soaring back into the trillions, reaching historic highs of 2.6 trillion and 3.4 trillion yuan on September 30 and October 8, respectively.

As a direct beneficiary of increased market activity, brokerage firms have seen a marked improvement in their financial performances. Data indicates that among 43 publicly listed brokerages, over 30 reported net profit growth in the third quarter of this year. Notably, CITIC Securities reported a net profit of 6.229 billion yuan, reflecting a year-on-year increase of 21.94%. Similarly, Huatai Securities recorded a staggering growth of 137.98% year-on-year, with a net profit of 7.211 billion yuan.

Interestingly, smaller brokerages demonstrated even greater resilience and growth. Northeast Securities saw its net profit swell more than tenfold, while Guohai Securities and First Capital Securities enjoyed nearly twentyfold increases in their net earnings.

This progression from policy to market performance to earnings suggests a fortified transactional logic, indicating that as long as the market remains buoyant, brokers will inevitably thrive—a highly probable outcome. At a recent press conference, the People's Bank of China (PBOC) announced initiatives like a special refinancing tool designed to support listed companies in stock buybacks and incentivize major shareholders to increase their stakes, with an initial budget of 300 billion yuan. The central bank is also creating arrangements for securities, fund, and insurance companies to secure liquidity backed by their holdings of stocks and exchange-traded funds (ETFs), with a starting operation scale of 500 billion yuan. If the outcomes of these measures prove favorable, there could be even more financing on the way, amounting to a potential total of 2.4 trillion yuan.

Additionally, following the announcement of new monetary policies, markets expected subsequent fiscal measures only after assessing the effects of these recent initiatives. However, events unfolded more rapidly than anticipated, with fiscal strategizing being discussed at the Politburo meeting just days later. The current debt resolution plan is already in motion, and significant developments are anticipated at the upcoming Central Economic Work Conference in December, which is the highest-level annual economic council.

The implementation of these fiscal policies is projected to fundamentally elevate profit margins across the market, serving as the true engine for upcoming market rallies.

From a broader perspective, the securities industry is presented with unprecedented historical opportunities. In the context of financing, China's previous focus on rapid industrialization and urbanization hinged heavily on infrastructure and real estate to spur economic growth. Under the previous regime, resources were optimally allocated through household savings and bank lending, largely steered by the government. Now, China has entered an era where technological innovation is the key driver of growth, demanding breakthroughs in various sectors and necessitating that firms engage in continual experimentation and risk-taking. This shift signals a transition from an indirectly financed model, primarily through commercial banks, to one centered around direct financing via capital markets.

On the investment front, from 2020 to January 2024, household savings reportedly surged by 58.24 trillion yuan, with a staggering 82% designated as fixed deposits. This four-year increase in savings is comparable to the total accumulated between 2009 and 2019. In the post-real estate era, the stock market appears poised to become the new reservoir for currency. Current statistics reveal that Chinese households have a disproportionately low percentage of financial assets compared to developed nations, underscoring an urgent need to allocate more towards equities. In October, household savings decreased by 570 billion yuan in a single month, while deposits in non-banking institutions like securities firms saw an inflow of 1.08 trillion yuan, indicating that the shift of deposits has begun.

Both ends of the financing equation are calling for a robust capital market, which explains why top leadership is making concerted efforts to bolster the stock market. Furthermore, unprecedented plans have been laid out to transform China into a financial powerhouse, necessitating a securities industry that matches this ambition.

When we turn our gaze to international precedents, the total assets in the U.S. securities industry account for 15%-30% of GDP, whereas China's share stands at a mere 3%-6%. This discrepancy is stark and demands rectification given China's status as the world's second-largest economy.

Consequently, in March 2024, the China Securities Regulatory Commission (CSRC) emphasized the urgency of accelerating the construction of top-tier investment banks and institutions. They are set to support leading brokerage firms in improving their strength through business innovation, conglomeration, and mergers & acquisitions. Following this, several firms like Zheshang Securities, Guolian Securities, Guoxin Securities, Guotai Junan, and Haitong Securities have announced plans for related acquisitions or mergers.

The history of mergers and acquisitions in the financial sector demonstrates its efficacy in propelling companies towards rapid expansion. The synergistic and scaling effects enable firms to ascend rapidly within the sector. This will be the fifth wave of consolidations within China's securities realm, following notable prior waves between 1995-2022, 2004-2006, 2008-2010, and 2012-2020.

Unquestionably, whether stemming from a bullish market or brokers solidifying their market positions, a reevaluation of firms will ultimately ensue, a pattern that has consistently held true in past events.

Another noteworthy observation pertains to the surplus returns that the brokerage sector has generated during previous significant market rallies in the last two decades. In every case without exception, brokerages have outperformed.

To exemplify: from early 2006 to November 2007, the market surged by 464%, while brokerage indices skyrocketed by over 1100%; from January to July 2009, the market increased by 95%, with brokerage yields peaking at 111%; in early 2012 to June of the same year, the market's best was 15%, while brokerages achieved 46%; and in later periods, similar trends followed with brokerages consistently outperforming the market indices.

The necessity for a strong capital market and securities industry in China has never been as pressing as it is today, which in turn invites unprecedented aspirations for brokerage firms themselves. This perspective points toward a future brimming with potential for brokers, possibly greater than at any time prior.

Even after notable increases since late September, the brokerage sector remains undervalued compared to historical standards, as its price-to-book ratio is presently around the 30th percentile since 2014. Both valuation and performance metrics still have room for growth. For investors, the current climate may still represent an appealing opportunity.