This week marked the meeting between President Joe Biden and Chinese President Xi Jinping.
Given the importance of the relationship between these two superpowers, I wanted to share some commentary from Alpine Macro which recently addressed the macro and market outlook for the U.S. and China.
- U.S. Growth Outlook: Capital markets now price a perfect economic landing. Meanwhile, major economic indicators have been in a holding pattern, but financial conditions are tight. The exhaustion of Covid subsidy-fueled household excess savings has been delayed into 2024 but not avoided.
- U.S. Inflation Outlook: Acyclical (supply-driven) inflation has already normalized back to 2%. Average hourly wage growth peaked a year ago without any rise in the unemployment rate. Now, wage growth is falling in sectors where Covid constraints have given labor a lot of leverage. Demand-driven (cyclical) inflation is the next shoe to drop as tight money slows the economy. Inflation could undershoot expectations next year.
- U.S. Equity Sector Views: Cyclical stocks are peaking, and defensives have cheapened more than expected, given the late stage of the business cycle. Interest rate relief will reinvigorate bond proxy equities next year. Remain overweight energy-geared equities because structural supply constraints put a floor under energy prices over a multi-year horizon, even if cyclical demand comes under near-term pressure from weaker economic growth. The ‘magnificent 7’ mega tech stocks are still mania candidates given strong balance sheets, serial earnings growth traction, and a valuation that is well below historical ‘bubble’ like levels.
- Biden-Xi Meeting Takeaways: The key difference in the U.S./China relationship from a year ago is that China’s economy is now depressed despite the removal of all Covid-related restrictions, which contrasts with a much stronger U.S. economy. Xi faces a confidence crisis, which raised his urgency to reestablish his regime’s legitimacy domestically. Xi was thus eager to be seen engaging with the U.S. business community this week. The structural trend for the U.S./China rivalry is still hostile, however.
- U.S. China Near Term ‘Truce’ – Investment Implications: China had become ‘uninvestable’ for foreigners amid the U.S./China trade war. Chinese firms are now ramping up local equity buyback activity while foreigners have totally deserted Chinese equities. Shorting Chinese stocks had been a very crowded trade. Some short covering is possible now.
- China’s GDP in Perspective: China’s GDP growth is trailing Japan/Korea/Taiwan when each was at a comparable level of development ($13k GDP/capita), a sign that China’s economy is operating well below potential now. Foreign portfolio and FDI capital flight from China signals a confidence crisis from an investor perspective, while consumer and business confidence hasn’t bounced off depressed levels post-Covid. Households are sitting on massive excess savings, and business demand for loans is also weak, which explains why the economy is struggling.
- Chinese GDP Now: GDP will exceed this year’s official 5% growth target, driven by the huge base effect of a comparison to last year’s Covid-constrained economy. There is no evidence of sequential improvement from Q3 to Q4’23, however, so absent some recovery in domestic confidence, the economy will stagnate next year.
- China’s Macro Policy: Both fiscal and monetary policy remain too tight to reflate growth. A major policy pivot would be required to upgrade this outlook, otherwise, the economy will remain in ‘slow burn’ mode. Watch for evidence that the housing sector is bottoming out. Current credit growth doesn’t signal an imminent rebound. Government bond issuance is the major source of total social financing at present, while private sector credit growth is moribund.
- China’s Structural Advantages: In the longer term, the dynamism of China’s economy is key to productivity in the mighty manufacturing sector, as well as the fast pace of innovation in tech, both of which still enjoy a significant global comparative advantage. China is a world leader in EV’s, selling $6.8m in 2023 vs $800k in the U.S.
- China’s Equity Market Outlook: China has wildly underperformed India due to massive Chinese multiple compression. China trades at a 60-70% discount to the U.S. and India. Investors with a long-term horizon should be positive on Chinese stocks, but short term, Chinese policymakers need to do more to boost growth as a catalyst for any relative re-rating of Chinese risk assets.
- Taiwan Is a Red Line for China: China will not invade Taiwan unless it declares independence. Regarding Taiwan’s upcoming election, the ruling DPP party, which Beijing does not recognize, is pro-independence. The main opposition party – KMT – is more China-friendly. Given the KMT’s recent alliance with TPP, the third largest party that is also officially against independence, the incoming government in Taiwan is unlikely to threaten Beijing. The odds of war were low and are now even lower.
Technically, the Chinese stock market has been in a basing pattern since March 2022. Recently, there has been some larger volume days occurring on days the shares closed higher. This is often the sign of accumulation taking place.
The disparity between the improving economic reality in China and equity performance has left investors asking: “When will fundamental improvements finally translate into stock market gains?”
Clearly, the potential for a near-term economic rebound in China driven by consumption, monetary easing, and fiscal support does exist.
Investors with an interest in China should wait for the price to begin advancing from the base on expanding volume.
Until next time…
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