Brokerages Spot Right-Side Opportunities

Reflecting on the past, it is highly likely that 2024 will mark an unprecedented turning point in the Chinese securities industry. The recent surge in the brokerage sector over the last month, while impressive, scarcely captures the industry’s true potential and expectations.

Historically, a resurgence in the brokerage sector has often been driven by anticipations surrounding supportive policies for the capital markets and the securities industry. These reversals typically occur during times when the market is relatively undervalued. The continued momentum of these trends relies on a positive feedback loop where policy impacts market performance, which in turn enhances company earnings.

Looking back at historical precedents, events like the collective appearance of the heads of the three major financial sectors on September 24, and the pivotal policymaking meeting on September 26, can be seen as the inception of a new wave of market revival. With policy measures driving the change, the outlook for the Chinese stock market has significantly improved. A-share trading volumes surged back into the trillions, shattering records on September 30 and October 8, hitting astonishing peaks of 2.6 trillion and 3.4 trillion Yuan.

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As direct beneficiaries of the increased market activity, brokerages have seen immediate improvements in their performance. Reports indicate that over 70% of the 43 listed brokerages in the country recorded net profit growth in the third quarter of this year. For instance, CITIC Securities reported a third-quarter net profit of 6.229 billion Yuan, reflecting a year-on-year increase of 21.94%. Huatai Securities topped this with a staggering net profit of 7.211 billion Yuan, marking a growth of 137.98%.

Alternatively, mid-tier brokerages displayed even greater elasticity, with Northeast Securities showing an astounding tenfold increase in profits, while Guohai Securities and First Capital Securities reported nearly twentyfold profit surges.

The cycle of policies positively influencing market performance, which subsequently drives improved earnings for brokerages, has evidently firmed up. As long as the market continues to flourish, brokerages will be poised to reap the benefits of this growth cycle.

During a recent briefing, the Central Bank announced the introduction of a special re-lending facility aimed at supporting share buybacks by publicly listed companies and encouraging major shareholders to increase their stock purchases. The initial allocation for this initiative stands at 300 billion Yuan. Additionally, the central bank will facilitate a swap program for securities, fund, and insurance companies. Eligible firms can leverage their holdings, such as stock ETFs, as collateral to obtain liquidity from the central bank, with the first round of swap operations set at 500 billion Yuan.

The Central Bank’s president, Pan Gongsheng, hinted at the possibility of further injections, suggesting an optimistic scenario where an additional 2.4 trillion Yuan could flow into the market. Currently, these funds remain untapped, implying that their eventual entry could serve as a new thrust for market growth.

An interesting development was observed after the monetary policy announcement on September 24, which led the market to speculate that fiscal policy enhancements would only follow after considering the impacts of the new financial rules. However, contrary to expectations, a mere two days later, the Politburo meeting laid out more explicit fiscal policy demands and expectations. Plans to mitigate debt are already underway, and the upcoming Central Economic Work Conference in December is anticipated to unveil significant measures.

The implementation of fiscal policies is likely to fundamentally enhance the profitability metrics across the entire market, serving as a true engine of the rally.

From a broader perspective, the current landscape of the securities industry is rife with unprecedented historical opportunities.

Recalling past strategies, China’s economic growth has historically thrived on rapid industrialization and urbanization, powered largely by infrastructure and real estate projects. The duo of resident savings and bank credit has long been viewed as the optimal allocation method under government control. However, as China transitions to an era of innovation-led growth, characterized by a need to overcome critical barriers, the focus shifts to fostering new productive capacities. This shift calls for companies to engage in risks through trial and error, making direct financing through capital markets preferable to traditional bank-led indirect financing.

On the investment front, from 2020 to January 2024, household deposits surged by 58.24 trillion Yuan, with 82% of this being in fixed-term deposits. This total exceeds the combined savings observed in the decade from 2009 to 2019. As the property sector wanes, the Chinese stock market has reached a critical juncture as a viable reservoir for monetary investment, especially considering that the proportion of financial assets held by ordinary Chinese households is significantly lower compared to developed nations. This trend underscores an imminent and strong shift towards equities and other asset classes, making it almost inevitable.

With both financing dynamics at play and investment strategies demanding a robust capital market, it is apparent why there is a concerted push at the highest government levels to cultivate a flourishing stock market. This ambition aligns with aspirations to establish a financial powerhouse, predicated on a well-supported and vibrant securities industry.

Drawing from global experiences, total assets within the U.S. securities industry range from 15% to 30% of GDP, while China’s ratio languishes between 3% and 6%. This discrepancy starkly contrasts the standing of China as the world’s second-largest economy.

Accordingly, in March 2024, the China Securities Regulatory Commission emphasized the need to expedite the establishment of premier investment banks and institutions, supporting leading brokerage firms in enhancing their competitiveness through innovation, consolidation, and acquisitions. Following this directive, establishments like Zheshang Securities, Guolian Securities, and Guotai Junan have outlined plans for mergers and acquisitions.

Historically, mergers and restructuring have proven to be the most effective strategies for financial firms aspiring for rapid growth. The synergistic efficiencies realized through scaling up can significantly elevate involved firms within short timeframes. The Chinese securities sector has experienced four notable merger waves from 1995-2022, and the current climate is witnessing a renewed wave.

A striking fact remains: whether driven by bullish market conditions or the burgeoning strength of brokerages themselves, a reevaluation of brokers is inevitable—a trend observed throughout history.

It’s noteworthy that, over the past two decades, every significant performance uptick in the A-share market has consistently been paralleled by exceptional returns from the brokerage sector.

For instance, during the massive rally from early 2006 to late 2007, the main index surged by 464%, while the brokerage index soared over 1100%. In another example, from January to July 2009, the broader index climbed by 95%, with brokerages hitting a high of 111% during the same period.

Such patterns persist through various market cycles, revealing that Chinese brokerages are poised for remarkable growth amid the lifting tide of a dynamic capital market.

Today, the urgency for a robust capital market in China has never been greater, signaling that the potential for brokerages has similarly reached unprecedented heights—as reflected in the current narrative. Even after a significant price rise by the end of September, the brokerage sector continues to hover at low valuation levels, with price-to-book ratios around 30% of their norm since 2014. This indicates substantial upward potential for both valuations and earnings performance.

For investors, the current moment may still present an optimal entry point on the right-hand side of market trends.