Please note the views expressed in this bulletin are those of the author and do not necessarily reflect AMP Capital’s house view.

Theme 1: China steps up easing measures

The cyclical outlook in China depends on the property cycles, the stimulus cycle, and exports (or the global cycle); at the moment it has passing marks on the first two and is underachieving on the latter.

So is it time to worry about China? No. But most investors are already very worried about China. In a recent global fund manager survey ‘China recession risk’ emerged as the biggest tail risk to worry about (over 50% of respondents). In this context, where most investors are deeply concerned, stabilisation is all that’s required in order to surprise to the upside! And that is precisely what I see coming. To my mind there are three key variables to focus on in order to understand the cycle in China; 1. Property prices; 2. Stimulus; 3. Exports. A notable recovery is underway for property prices. This is increasingly important for the consumer sector, particularly as China moves to a more consumption oriented economy. It also highlights the resilience of consumer confidence in the face of stock market volatility, as most Chinese investors have the majority of their assets invested in property and only a small portion in equities. On the stimulus cycle, it is clear that the focus is on the slowdown in growth that we have seen this year and it would not be surprising to see more monetary policy and fiscal stimulus measures (e.g. a further RMB1.2trn quota for to the local government debt swap program has just been announced). On exports, China has faced a double-whammy of poor global demand as well as a notably stronger currency. The move to allow a more freely floating Renminbi could set the stage for some additional weakening of the currency that could reduce the headwinds there. In any case, at the moment we’re looking at two out of the three variables running smoothly. What we need to see is a continuation of the property recovery, more stimulus measures (particularly where these measures include incremental reform steps, mostly on the fiscal front, and that help the right parts of the economy, e.g. the consumer), and the right mix of currency movement and global demand on the export front. Thus, for now the outlook is OK – not booming – but certainly not in hard landing mode.

Theme in pictures


Source: AMP Capital, Bloomberg, Thomson/Reuters Datastream

 

Theme 2: How do things look after the breakdown in Chinese equities?

It’s almost unbelievable but Chinese equities are once again under-valued, under-owned and un-loved, so it is worth understanding and not underestimating.

The short answer is that Chinese stocks are starting to look good on valuation. In addition to this, margin debt has been washed out (falling by 50% since the peak), China ETFs have seen record net outflows, the China ETF VIX traded in the 80’s (extreme fear levels), the People’s Bank of China is becoming more active and more fiscal stimulus is imminent. At the margin you would have to say things are looking better at this point as Chinese equities have once again become under-valued, under-owned, and un-loved. While there are some issues in the short-term, in the longer-term China real GDP growth will probably slow to around 5-6%, inflation will probably range from 2-3% and with a dividend yield on MSCI China at 3%, that adds up to a rough estimation of medium term expected returns of about 10-12%, which is pretty decent, even factoring in some uncertainty. While the structural headwinds (e.g. slowing investment due to the overbuilding of property) and risks (e.g. high debt levels) are well known, the positive medium-term thematics are less well known, e.g. the “One Belt One Road” program will boost infrastructure spend in the short-term and trade in the longer term; “Made in China 2025” will take China up the value chain in exports and industry; and urbanisation/rebalancing/reform will see the consumer take charge as the growth engine of China. So expect ongoing uncertainty and volatility along the way, but a big adjustment in stock prices has taken place making the risk vs reward outlook attractive over the medium-term.

Theme in pictures


Source: AMP Capital, Bloomberg

 

Theme 3: Global trade trends revisited

The shocking slump in global trade probably reached its nadir in H1.

I previously pointed out the absolutely shocking slump in global trade volumes – a key trend which surprised many (myself included). If we think about the reasons or drivers, there were a couple of one-offs in Q1 (US port strikes/cold weather, a later than usual Chinese New Year), but the commodity crash has also been a driver (think: less commodity capex, e.g. less buying of diggers and trucks; as well as the immediate income hits to commodity producers, e.g. Middle East, Africa, et al). The first part of the year has typically been softer post-GFC, but it is much weaker this year. Likewise, global IP and import volumes went negative on a rolling quarterly basis. But is the worst over? Maybe; global IP and import volumes appear to have hit an inflexion point, so in the context of reasonably good domestic growth dynamics in the major developed economies, and if China can manage its cycle (as discussed in Theme 1), then we could be in for improvement going forward, rather than a repeat of 2000 or 2008.

Theme in pictures


Source: AMP Capital, CPB, Thomson/Reuters Datastream

 

Theme 4: Oil prices – is the new low in?

The latest slump in oil prices appears to be demand driven, this highlights the importance of demand and potentially sows the seeds for a rebound in the coming months.

According to some analysts, the latest drop (about 40% from top to bottom) in oil has more to do with demand factors than supply factors, and this is probably a view that would resonate with the trends identified in the previous theme (around the soft global trade and IP outcomes). This is a notable development, as it highlights the role that demand still plays in this market. So while the longer-term slower moving supply cycle is still setting the overall tone, which is for a trend to softer prices, the cycle still matters. Given global liquidity settings and a potential inflexion point in the softening demand situation, we could see a very different environment for oil and commodities over the next 12 months when compared to the previous 12 months. It will pay to keep on top of this theme as it will have important implications across assets, especially – and including – bonds, which have taken their lead from oil in the last 12 months or so.

Theme in pictures

Source: AMP Capital, Bloomberg

 

Theme 5: The curious case of the missing bid in treasuries

Bonds refused to rally during the risk-off episode that we have just been through, this could be a sign that the weight of risks are shifting to higher bond yields.

Usually when the market contracts like it did over the past couple of weeks, people will bid-up treasuries (yield will go down) as they search for a safe haven. This time around however, treasuries have sort of hummed and hawed, seemingly taking the stress in their stride. There are a few decent theories as to why this should be the case: 1. China/EM is seeing capital outflows and is defending the currency, thus having to sell FX reserves (meaning UST liquidation, e.g. China holds over a 3rd of its FX reserves in US treasuries, and EM countries hold over $3 trillion in USTs); 2. Positioning; market had already been fairly long at the long end of the curve; 3. People have been taking a ‘cash is king’ approach and raising cash rather than buying treasuries. In fairness, I think each of these theories has an element of validity. There might also be an element of looking through the short-term noise to an expected benign/positive medium-term economic environment. The idea is that ‘yes we recognise the short-term weakness in the global economy, but further out the domestic dynamics in the US are very strong’ (strong housing market, solid jobs growth, boost to real incomes from cheap oil/imports, higher asset prices, cheap borrowing costs). In addition, global (dis)inflation dynamics have been a big driver of 10-year bond yields over the past year as commodity prices have pushed inflation expectations around. Given the market has seemingly moved to a long bias, maybe the lack of bid in treasuries is a sign that we’re in the midst of a whipsaw that could see bonds sell-off into the rest of the year?

Theme in pictures


Source: AMP Capital, Thomson/Reuters Datastream

 
About the Author

Callum Thomas, MMgt (finance), MMgt (banking), BBS (finance), Investment Strategist

Callum is an Investment Strategist in the strategy team of the Multi Asset Group at AMP Capital. Callum has a passion for global macro investment strategy and constantly strives to generate unique and innovative insights that help inform the strategy team's dynamic asset allocation process. Callum is responsible for researching a range of asset classes and global macroeconomic themes to aid in formulating investment strategies across the Multi-Asset Group. He also keenly collaborates with the global equity and fixed income teams. Callum originally joined AMP Capital in June 2009 as an analyst in the investment business of what was then AXA New Zealand. He previously worked in strategy at the New Zealand Stock Exchange.

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