Key Points:
- Overseas markets’ short-term expectations of the Fed’s easing may have reached a short-term inflection point. There may be misunderstandings in the market’s interpretation of the so-called “dovish” speech by Fed Chairman Powell after the February FOMC meeting. The US yoy CPI is more likely to fall back to around 3% in the middle of the year, but the Fed has not changed its 2% inflation target, so it is unlikely to cut rates as soon as the market expects.
- The recent stronger-than-expected US nonfarm and service industry PMI data show that the US economy is still relatively stable, and the trend of tight job market has not been fundamentally changed. Therefore, we believe that the current round of rebound in US technology stocks based on easing expectations may be coming to an end.
- We remain optimistic about the A-share market in Q1. We believe that although the current market has risen, it still does not fully reflect the reopen economic recovery and room of re-rating after domestic pandemic. After the impact of some short-term uncertain events, we are still optimistic about the possibility of a further rebound in A shares.
- In the previous rise of A shares, the main inflows mostly came from foreign investors, while domestic inflows remained conservative and cautious. Further recovery of domestic investor sentiment requires more facts of economic recovery and realization of expected stimulus policies. But on the whole, we still believe that the recovery of economy and corporate financing demand is relatively certain. But under the background that property sales and housing prices are likely to continue to be sluggish, more favorable and policy stimulus can be expected in the future. However, judging from the current sentiment of domestic investors and previous fund inflows, there is still a room for marginal improvement.
- The most likely short-term risk for the domestic stock market is still the geopolitical risk in China-US relations. But we believe that the possibility of a sharp diplomatic deterioration in the short term is still low. This is because: China will focus on economic recovery this year, while a large part of the diplomatic and military resources of US will be on Russia-Ukraine war.
- We continue to be optimistic about the A-share market in Q1. If the market experiences a correction of more than 5% due to short-term risk events, we think it is a good opportunity to buy on dips. Hong Kong stocks may be relatively weaker than A-shares. We do not recommend investors to short US stocks either, because the overall decline in US inflation and the relative stability of the economy do not support a sharp decline in US stocks.
Hou Zhenhai
Straits Financial (China) Chief Strategist
I. Overseas markets may have too high short-term expectations for the Fed’s easing.
We believe that overseas markets’ short-term expectations for the Fed’s easing are too high and may have reached a short-term inflection point. First of all, the market’s expectation is based on the judgment that US inflation will fall in 2023. We don’t think there is a big problem with this. The level of inflation in the US, i.e. the yoy CPI, has a high probability to reach about 3% at the end of 2Q2023. However, this decline is largely due to the yoy base effect. But from the sequential inflation, especially the core inflation that is more related to wage growth, we think, unless the US economy suffers a severe recession, that a high probability is CPI will still run above the 2% level of the Fed’s target inflation. Secondly, Fed Chairman Powell’s speech after the February 1 FOMC meeting was interpreted by the market as “dovish”, but we believe that there may be errors in this market interpretation. Because the Fed neither indicated that it would change its 2% inflation target, nor did it hint that it would turn loose, but only stated that it might consider stopping interest rate hikes “after further raising interest rates twice in the future”. But it needs to be clear that the Fed’s stop raising interest rates does not mean a turn to easing, especially when the interest rate level may have increased to more than 5% soon, which is also the highest interest rate level since 2007. If the Fed chooses to maintain this high interest rate level, even if it does not hike rates further, the overall interest rate level will still have a restrictive effect on the US economy. Finally, the market previously had high expectations for the Fed to cut interest rates in 2H2023, but with the influence of the nonfarm employment data and service industry PMI data in January that were significantly better than expectation, the market’s expectations for interest rate cuts in the 2H have slowed down significantly. At the end of January, the federal funds rate futures showed that the market expects the Fed to cut interest rates to 4.58% by the end of this year. On February 7, this expected interest rate level has risen to 4.83%, a new record high (Figure 1).
Under such circumstances, we believe that the current round of rebound in US stocks may be coming to an end. In particular, those technology stocks that have rebounded more strongly due to the impact of the Fed’s easing expectations may weaken again in the near future. However, the “good news” is that the US economic data remains relatively stable, so investors are less worried about the decline in earnings and a severe economic recession, so the performance of those relatively undervalued large-cap blue chips will likely outperform again.
But at the same time, we do not recommend investors to short US stocks now. Because in the current environment in Q1 when the US economy has not yet experienced a recession and inflation has fallen, although it does not meet the conditions for the Fed to turn loose, it will generally not cause too many negative shocks on market sentiment and liquidity. The probability of a sharp drop in US stocks is also very low. Investors can continue to pay attention to the upcoming US inflation data to be published next week. We believe that as long as U.S. inflation continues to fall, the probability of US stocks falling sharply or even hitting new lows in the near future will be extremely small.
II. China’s domestic stock market still has room to rebound
We mentioned in our previous reports and online meetings: With the end of Covid19 lockdown in China and the reopen of its economy, we are optimistic that A shares will rebound and rise in the 1Q2023. We have seen that A shares did rise in January, but there has been a slight pullback recently. At present, we remain optimistic about the A-share market in Q1. We believe that although the current market has risen, it still does not fully reflect the reopen economic recovery and room of re-rating after domestic pandemic. After the impact of some short-term uncertain events, we are still optimistic about the possibility of a further rebound in A shares.
First of all, we believe that the overall tone of the domestic economic policy bias to maintain accommodative and promote economic recovery will not change throughout the first half of the year. On the one hand, this may be reflected in the continued rapid growth of domestic M2 and overall social financing in Q1. On the financing structure, the speed of corporate and government financing will accelerate the fastest. For example, it can be seen from Figure 2 that the net financing amount of non-financial corporate bonds (excluding local government funding vehicle bonds) was impacted by the spreading Covid cases and experienced a sharp negative increase of RMB405 billion in December 2022, which directly caused social financing to be significantly lower than expected. But against the backdrop of peaking of Covid in early January, the net financing amount of corporate bonds reached RMB789.5 billion in January. Even after deducting the negative growth in December, the increase has exceeded the level of the same period in January since 2019. Considering that Covid in early January still has a big impact and all of this year’s Spring Festival holidays are in January, we believe this level shows that the overall corporate financing demand has recovered relatively quickly. Of course, this may also be inseparable from the policy efforts that governments at all levels are promoting to solve financing difficulties for enterprises. Therefore, although we believe that the recovery of household loans may lag behind, on the whole, we believe that the overall social financing and credit demand in Q1 may still show significant improvement driven by the recovery of government and corporate financing demand.
Source: Bloomberg, CEIC, Wind
Secondly, in the context of the overall economic recovery, especially the slow recovery of household credit and domestic property market, the government may consider to enlarge economic stimulus in the future. We believe that under the background of China’s declining birth rate and high residents’ debt ratio, it is very difficult for household sector to restart property sales and house price increases by themselves. Although this will pose great difficulties for China to promote economic recovery, on the other hand, it also reduces many concerns about stimulus policies caused by concerns about rising housing prices. Therefore, after the “Two Sessions (the annual sessions of NPC and CPPCC)” this year, in some areas other than properties, such as household consumption and non-property investment, policies may have more room to push forward. Although the current judgment on these policies are still vague expectations in the market, we believe that investors can still expect that there is still room for A shares to be further boosted and rise. The reason is that we believe that the current rebound and overall valuation of A-shares have not reflected these possible positive policies or economic improvements. In fact, domestic investors have been very cautious since January. On the one hand, this can be roughly judged from the fact that domestic stock funds’ net inflows are still relatively sluggish, and on the other hand, it can be roughly judged from the fact that outstanding domestic stock margin account volume has continued to fall before the Spring Festival (Figure 3). Although it bottomed after the Spring Festival, its level is still at a low level since 2021. This shows that although the sentiment of domestic investors has generally improved after the peak of Covid infection, they are relatively conservative and cautious.
Source: Bloomberg, CEIC, Wind
In contrast, overseas investors are much more optimistic about China’s economy and China’s stock market. For example, we have seen that the northbound inflow of A shares continues to increase and continues to set new record highs (Figure 4). We believe that the reason why domestic and foreign investors have such big differences in their views on China’s economy and stock market in the near future, first it is because domestic investors were still under the shock of Covid infection, as many investors themselves were infected during December and January, and that physical agonies must have caused negative psychological repercussions. On the other hand, overseas investors have already experienced similar reopen and the infection shock of opening-up, and also know that after the first impact diminished, the economy and corporate performance would experience a wave of fast recovery due to “Reopening”. The Reopen transaction has now been completed in Europe, America and even other Asian markets, and China is the only market where the transaction can still be carried out. Therefore, it is not difficult to understand why foreign investors are optimistic about the Chinese market in the short term and more concentrate on buying.
Source: Bloomberg, CEIC, Wind
Of course, we do not think that the inflow of foreign capital will continue forever. In fact, the peak of the first wave of inflow of foreign capital may be coming to an end. But we don’t think these foreign capitals will flow out of the Chinese market soon, including the Hong Kong stock market. Because the reopen of the Chinese economy and some favorable stimulus policies that may be introduced in “Two sessions” in March have not been confirmed by the market, but they have not been denied either. In the absence of more and better investment targets in the world and the overall rise of A shares is very limited, continuing to hold A shares is likely to still be the choice of most foreign funds. Of course, if it can be confirmed that the Chinese economy has begun to recover or further stimulus policies are introduced, it cannot be ruled out that the second round of foreign investment inflows may also be brought by the end of Q1.
Analyzing the fundamentals of A-shares and Hong Kong stocks in the next quarter from an economic and policy perspective, I think investors can still be modestly optimistic. But some short-term negatives may make some turbulences in the market from time to time. In our view, the most important possible short-term risk is still the geopolitical risks in US-China relations.
For example, the recent “Chinese balloon” drama and the planned visit to Taiwan by US House of Representatives speaker McCarthy may all bring uncertainty risks to short-term China-US relations. However, from a rational point of view, we believe that the possibility of a sharp deterioration in China-US relations in the short term is still low. This is because: first of all, the Russia-Ukraine war is not over, and it may even intensify in the near future under the background that the Russian army may launch a new “spring offensive”. Therefore, as the Russia-Ukraine war continues to draw a lot of international concerns and US diplomatic & military resources, maintaining relatively stable China-US relations is also in the US’s own interests at this point of time. Secondly, China-US relations will also be a topic of gambling between Republicans and Demographics. Therefore, although the Republicans may hope to gain from it, Biden administration and the Democratic-led Senate may not want China-US confrontation to be a top headline issue in the US public media right now. Thirdly, although the US is committed to gradually decouple from China in terms of technology and trade, this decoupling cannot be done quickly, as a quick decoupling will also harm the economic interests of the US at least for the time being. Finally, from China’s perspective, the most important task this year is still to restore the domestic economy as soon as possible. Therefore, maintaining a relatively stable international environment is also an important guarantee factor to help the economy recover after the pandemic. It is not in line with China’s current self-interest. Therefore, based on the above points, we believe that although China-US relations will become unfavorable factors that disturb short-term market sentiment due to certain events from time to time, we do not think that it will become a major substantive driver before the end of the Russia-Ukraine war.
We continue to be optimistic about the A-share market in Q1. If the market experiences a correction of more than 5% due to short-term risk events, we think it is a good opportunity to buy on dips. We still judge that the current round of A-share market is expected to reach the 3400-3500 level on Shanghai Composite Index. Hong Kong stocks may be relatively weaker than A-shares in the short term due to the larger rebound in the past, but overall, we are still not bearish on Hong Kong stocks. In the US stock market, we generally believe that the rebound based on the Fed’s easing expectations is coming to an end, and the market may fall back to some extent. However, we do not recommend investors to short US stocks, because the overall decline in US inflation and the relative stability of the economy do not support a sharp decline in US stocks.
Our judgment on the trend of commodity prices remains neutral, and some varieties that have rebounded greatly in the previous period are more likely to go through a correction.
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.