Migrated – Original Post Date: Nov 23, 2020

Liquidity drives improvements to sentiments in China, while virus drives panic as it spreads globally.

  • The market will gradually turn its focus on the new Biden administration’s policy directions after the election. From now till the end of the year, in the face of deteriorating COVID19 pandemic, the next focus will be an expected new round of fiscal stimulus. Other longer term issues, such as US-China relationships or the return to the TPP talks, may not be a focus until next year.
  • It is crucial to pay close attention to the COVID19 situation in both EU and the US. A new round of social restrictions will become a big blow to the consumption expectations during the Thanksgiving & Christmas holiday season. This will dampen the market’s optimism about a Q4 economic recovery and negatively impact both equities and commodities.
  • Should the COVID19 situation worsens in Europe and the US, which is now more likely, the sustain ability of China’s export growth may face headwinds in Q4.
  • The US election, widening interest rate differentials and, a pickup of Chinese exports and a shift of China’s policy to “internal circulation” are all driving forces of the appreciation of RMB in Q3. If more stimulus are out in EU or the US, we may see further upside in RMB exchange rate. However, if the US domestic political turbulences worsens, the pace of RMB appreciation may slow down in Q4, but we believe devaluation is still unlikely.
  • If Trump concedes, the risk-on trade after election may carry on until late November. But if the power transfer does not go on smoothly, we believe that only gold may benefit relatively.
  • A shares will still be in a range-bound trading. No more stimulus in sight and regulators have expressed their attitudes to contain asset price bubbles and fast leveraging. This means that the short-term market upside is limited.

Hou Zhenhai
Straits Financial (China) Chief Strategist

I. Focus after the US election

The US general election vote may have come to an end, but it may still be some time before the final result is official. Whether Trump and his team can successfully appeal or concede if he fails on ballot recount, may have further impact on the market. Certainly, we believe that the chance of a constitutional crisis is low, and the market will gradually shift its focus to the impact of the new president’s policy changes on the U.S. economy, Covid-19’s response and international relations, especially Sino US relations, after Biden takes office.

The policy focus of the new administration can be observed from the following.

1. Policy reforms which can be realized soon
Since President-elect Biden served as the Vice President to Obama, many of his policy directions have been well-predicted. On domestic policies: return to the Paris Agreement and increase investments in new energy and sustainable industries. Furthermore, as the Democratic Party did not win the majority, the chances of a split or strictly-regulated Internet technology giants which the market were previously concerned about would also be less likely.

On foreign relationship front: to improve relations with EU and other traditional allies, restart negotiations of the negotiation of TPP (Trans-Pacific Partnership Agreement).

These policies are relatively more certain, faced with little obstacles in the congress. Therefore, we can see that beneficiaries of such like new energy industries and IT giants, have risen significantly.

2. Policies that are expected but hard to get through
Biden votes were significantly lower than the polls before the election, meanwhile the Democrats failed to take control of the Senate as expected. Contrary to a “Blue Wave”, the Democratic Party’s leading advantage in the house of Representatives shrunk too. All this means that the market will face a lot of uncertainties in many of the policies that are controversial in the Congress.

Among them, the first is about the scale and time to launch a new round of fiscal stimulus after the election, as well as the Biden’s tax reform (abolish Trump’s tax cut).

3. Issues that hardly can be expected by the market soon
Biden’s attitude on China-US relationships is critical. There is a general expectation that Biden will not continue to pursue protectionist policies such as higher tariffs and restrictions on Huawei or ZTE imposed by Trump. However, with a split Congress, it is also difficult for the Biden government to overturn all of the existing Trump policies. More likely, no further tariff raises will be introduced, but it is worth noting that the democratic government may pay more attention to intellectual property rights protection, the opening of media and Internet markets which may in fact result in more disputes and conflicts of interest with China. Therefore, it is hard to see any dramatic changes in the China-US relationships. More likely, the way of dispute may change from trade negotiations, to more complicated multilateral negotiations such as TPP and Asia Pacific rebalance, pulling together Japan, India and Australia to form a new international coalition to exert pressure on China. In addition, other policies, such as whether the Obama healthcare policies will be restored, and more, remains to be uncertain.

The above three factors have different influences on market transaction. We believe that the first has been taken into account for. Therefore, there has been a significant increase in the relevant beneficiary sectors and its equities. However, on the other hand, these sectors might face headwinds in the event of an unexpected turn on election results where Trump gets his appeal accepted or managed to show actual evidences of electoral fraud, though chances might be low.

Those listed in point 2 is likely to be the core driver affecting the market trend from now to 20th January next year when the new president is sworn in. Although it will be hard to certify, but with the sharp worsening of COVID-19 in the US and Europe, the market really needs more certainty right after the election, such as when and how big the next round fiscal stimulus will be.

The policies listed in point 3 are much harder to predict, but it may have a far-reaching impact on the future market, including stocks, forex and commodities.

II. New wave of COVID-19 infections impacting the holiday season spending

Since late autumn, the COVID-19 pandemic situations in Europe and USA have been deteriorating sharply. The “2nd wave” of infections in Europe is worrying with number of new infections per day in major EU countries surpassing more than 10 times the previous peaks set in the first wave (Figure 1). In the current situation, UK, France, Italy and other major countries have announced new lockdown measures in large cities, including closing offices, limiting social activities and curfews. At the same time, Eastern European countries with relatively mild outbreaks in the first wave, such as the Czech Republic, Poland and Romania, also experienced large-scale outbreaks this time (Figure 2). As a result, a new round of halt in productions and consumptions is almost inevitable.

Source: Bloomberg, CEIC, Wind

Source: Bloomberg, CEIC, Wind

Similarly, the average daily new infections in the US has reached a new high at more than 100k cases a day. At the same time, the average daily death toll also rose to the warning levels of 1000 cases a day (Figure 3). Although, due to the opposition of the GOP, we think that the US is unlikely to adopt a national lockdown as the EU countries. However, as the pandemic continues to worsen, it is very likely that some states will introduce regional social restriction measures in large cities, especially those in the Democratic states, such as California. As we enter the holiday seasons of Thanksgiving and Christmas, if Europe and the US adopt a full-scale lockdown during this period, it will have a huge impact on consumer spending and outdoor social activities. Based on past data, we know that year-end holiday season consumption accounts for more than 30% of the whole year’s figures in Europe and the US. Therefore, a new lockdown throughout the period will have a more adverse effect on consumption than in the first wave of pandemic.

Source: Bloomberg, CEIC, Wind

Therefore, from this point of view, it is quite uncertain in Q4 whether a rebound could continue.

III. China’s economic uncertainty in the Q4

China’s economy recovered in Q3 with its cumulative growth rate for the first 3 quarters rebounded to 0.74%, first positive cumulative growth this year. Although fixed asset investments made the largest contribution, a strong rebound of exports in Q3 came as a surprise surpassing expectations, while domestic consumption wasn’t as well as expected. From Figure 4 we can see the contribution of net exports to China’s GDP growth in the first three quarters as being positive. However the cumulative domestic consumption was still a negative contributor of 2.4 percentage points to GDP. So foreign demand was a more prominent contributor in Q3.

Source: Bloomberg, CEIC, Wind

This data very much differ from the market expectations, as China was the first country that managed to control the pandemic with its economic activities back to normal when other major countries were still plagued and fighting the pandemic, so domestic consumptions should have done better.

A popular market interpretation on the rising China’s exports is that most manufacturing & exporting countries shut down productions due to COVID19, resulting in large amount of orders being transferred to China. However, the data below shows a different story. The percentage of imports from China over the total US imports actually fell slightly in Q3. (Figure 5).

Source: Bloomberg, CEIC, Wind

But those of the other trading partners of the US, such as Germany, Japan, Vietnam and India, rose slightly in Q3. Therefore, at least from the US import data, this does not show a pattern that global productions shifted to China in Q3.

Similarly, if we compare Chinese Q3 export growth with other countries, including developed economy like Japan, as well as developing countries like India and Vietnam, it portrays a similar pattern. (Figure 6)

Source: Bloomberg, CEIC, Wind

From the data above, we believe the strong recovery of China’s exports in Q3 was not due to a global supply chain shift to China, but mainly due to a recovery of overseas demand and replenishment of low inventory levels. This means that the sustainability of China’s export growth in Q4 will largely depend on the global demand. As the major overseas consumption markets in Europe and the US may be affected by the pandemic again, Chinese export growth in may face headwinds in Q4.

IV.  RMB FX outlook

The RMB appreciated significantly in Q3. We believe that the main factors driving this appreciation includes:

1. US general election
As the US election heats up, China likely became a topic in the contest between candidates from both parties. Therefore, an appreciation of RMB before the US general election may help to deviate the focus of disputes away from China before the election.

2. Large scale fiscal and monetary stimulus in EU and the US
The zero-interest-rate policies in EU and the US has led to a very high treasury yield spread compared to China, which promotes the foreign capital flowing into China’s capital markets increasing demand for RMB in the forex market. In addition, the recovery of consumption in EU and the US helped by large scales of fiscal stimulus also promoted an increase of China exports and trade surplus, which drove a RMB appreciation.

3. China’s “internal circulation”policy
China’s long-term economic plan in the next 10-15 years will focus more on “internal circulation”, aiming at improving domestic technologies, consumption capacities and industrial structures. It means the need for maintaining export competitiveness through RMB exchange rate will gradually decrease. Chinese government may use this opportunity to push the internationalization of the RMB, allowing for a greater exchange rate volatility as well as a gradual relaxation of forex capital control. This also helps with short-term appreciation of the RMB.

On a short term view of the next few months, there are several factors that may affect the trend of RMB exchange rate.

First, whether the US general election can go through smoothly. If Biden’s election can be confirmed quickly or trump admits that he has lost the election, the RMB may open up room for further appreciation.

Second, if the US Congress can restart the discussion and pass a new round of fiscal stimulus as soon as possible, it will be relatively conducive to the further appreciation of RMB.

On the contrary, if there are further turbulences in the US general election, if it turns into a prolonged recount, lawsuits or even riots, and meanwhile a new stimulus package can’t get through in the congress early enough in the face of worsening pandemic, these all indicate that the uncertainties of China’s external environment will increase. In that case, we believe the pace of rapid appreciation will slow down in Q4, but a depreciation of RMB is much less likely.

Market Outlooks

If Trump concedes or loses on his appeal, the global market’s risk-on trade after the election is expected to continue towards the end of November. After which, the market should fall back to economic fundamentals, more so based on the scale of the new round of fiscal stimulus in both EU and the US, as well as the pandemic situation. The market will likely wait until December to decide whether there are any real fundamental risks.

If the election faces prolonged lawsuits and investigations, or even large-scale riots in the US, it may paralyze the government’s function, causing the worst case scenario for the risk assets, especially for stocks and industrial commodities such as crude oil, while gold might benefit.

The deterioration of COVID-19 pandemic and an uncertain political environment may also have a negative impact on the US dollar.

Chinese domestic A shares are still in a range bound trading as we believe. China policy maker will pay more attention to the country’s long-term stability and its economic transformation, which means that there will be no more stimulus policies in the foreseeable future. On the other hand, regulators will further emphasize their policy attitudes to contain a financial bubble and fast-leveraging. This could be good for the A shares to form a long term “slow bull” market, but it also means that the short term upside of the stock index is quite limited.

About the Author

1998 – 2004, Chief Representative Assistant of GKN Group in China.

2006, obtained MBA degree from Wisconsin School of Business at University of Wisconsin–Madison.

2006 – 2007, served at the Wisconsin Foundation.

August 2007 – July 2013, served at China International Capital Corporation (CICC) as the leader of the overseas strategy team and A-share strategy team. He is also the main report writer and contributor. Mr. Hou and his team received many honors including the top team for the New Fortune Sell-side Strategy Research in 2008, and the top team for the Asia Money China Strategy Research in Hong Kong in 2009 and 2012, etc.

September 2013 – December 2019, served at Discovering Group and was responsible for the Group’s macro strategy research. During the period, the company has accumulated absolute returns that far exceed the market level.

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