Behind surging markets are solid fundamentals

In the past, when the economy performed well, the stock markets fell. The current market has again surprised investors, however, by surging in recent months despite strong economic numbers.

In fact, the markets climbed above 2,650 during intra-day trading on Friday, after hitting the low of 1,991 in May.

Against the backdrop of weakening economic fundamentals, the surprising performance of the stock market has made many wonder why, and if the bullish market will continue.

There have been many explanations for the exceptional rise, but economic fundamentals are what count.

Months of economic weakening have driven China's GDP growth to as low as 7.3 percent in the third quarter year-on-year, the lowest since the global financial crisis. As a sign of the continued weakening, China's industrial production rose 7.7 percent year-on-year in October and its retail sales rose 11.5 percent compared to a year ago, both fell below market expectations.

The stock market has taken the bad news on the chin. The weakening may have been pre-reflected in the mediocre performance of the stock market in recent years. According to Goldman Sachs, stock markets in the Asia-Pacific region, including China, have failed to register major gains in the past four years thanks to a cooling economy.

In China's case, its benchmark Shanghai Composite Index has been fluctuating largely within a band of 2,000 and 3,000 for four years as investors are uncertain about where the economy was heading.

Starting this year, the weakening of China's economic fundamentals has become quite entrenched. More importantly, the policymakers have made their stance clear: There will be no major stimulus like the ones launched after the eruption of the global financial crisis. Instead, the country will stick to its reform, restructuring and rebalancing agenda to achieve a more sustainable growth.

In May, President Xi Jinping defined China's new economic changes for the first time as the "new normal". It means China will tolerate lower growth rates while accelerating reforms and economic restructuring. Premier Li Keqiang also repeatedly clarified that it does not matter if the real growth rate turns out to be moderately lower than pre-set targets.

The new stance brings hope to investors that the economy may gradually bottom out, although no one is sure where the bottom is.

In other words, the "new normal" stance has settled the markets and brought home to investors that the country's reform and restructuring drive will unleash greater potentials of the world's second-largest economy and lead to improved corporate performance and more sustainable growth of the broader economy in the future.

Some have readily attributed the stock market rally to the boosting effect of favorable policies, such as the interest rate cut last week, the first such move since 2012.

Such a cut, together with market expectations that more steps are in the pipeline, has provided a strong boost to the index. If the markets remain divided to the country's fundamental policy stance, however, such a gain would be short-lived and could dive again if there are no new policy boosts in the coming months.

Now that policymakers have largely agreed that China will stick to its reform and restructuring policies and be more tolerant towards the "new normal" state, investors may take a long view and continue to buy. This scenario could possibly push the Shanghai index to the level of around 3,000 in the coming months, although temporary corrections cannot be ruled out.