Author: Asia Investment Strategy Team
Following the tragic events in Israel, our thoughts remain not on the market impact, but with those affected. Nonetheless, we continue to face a number of questions over how the situation might unfold and what, if any, implications will be felt politically, economically, and in markets. First and foremost, we continue to stress diversification and balance across portfolios. As fractures continue to emerge across the global system and market risk stemming from geopolitics seemingly on the rise, diversification and reduced concentration are increasingly important for investor portfolios. Beyond this important and overarching principle, the next obvious area to watch is oil prices. Brent crude oil jumped earlier in the week but gave much of the move back by midweek. In the context of the recent -11% sell off since September 27th, the move higher seems fairly muted, and this is undoubtedly because neither Israel or Palestine produce any oil. At this point supplies are not impacted and the price reaction is reflective of traders attempting to price a premium on the potential for disruption ahead.
The short-term implication for oil is reduced downside risks, absent a global recession, while the potential for a move higher again towards $100 has now increased. We still do not believe this will happen as the effect of a higher dollar and a higher oil price is creating strained gasoline and diesel prices, which are particularly challenging for Emerging Market consumers. Demand is dropping for both these fuels and in the United States gasoline consumption dropped below seasonal averages in recent months.
Iranian production remains a big wild card. Iranian production has increased under a more permissive sanctions regime (see below chart). If the conflict widens or Iran were to be more directly implemented in supporting the attack, it could result in tighter sanctions implementation by the Biden administration or a larger risk premium to price in the potential of a broader disruption.
How golden was China’s Golden Week?
In China, the October Golden Week holiday numbers paint the picture of a slightly more confident consumer – particularly compared with earlier in the year. That said, the uptick is more visible in small ticket items and services, and still hint at budget constraints. Over the course of the eight day long holiday, 826 million trips were made, and domestic tourism spending totaled RMB 753 billion. On an adjusted basis, this translates to RMB 94bn in spending each day. This is up 1.5% from the 2019 level (the last comparable year before the rolling pandemic restrictions), and up more significantly versus 2022 (due to pandemic distortion). Relative to some more optimistic projections earlier (including from official sources), this outturn was a little underwhelming. But from a different perspective, the resilience is in fact quite notable, and highlights the growing importance of services in the overall consumption mix.
Looking ahead, as the economy cyclically bottoms out, consumption, and particularly services, have some room to improve further in the coming months. Another question in the consumption story is the likely trajectory of large ticket goods spending. Historically, selected big ticket items – such as white goods, furniture and home decoration – are loosely correlated with the housing market cycle. Given the de-leveraging pressures in the housing market, it’s hard to see spending in these areas coming back in a significant way, and in fact they may face more downside in the coming months as more home completion projects end. Nevertheless, other items like electronics, cars and jewelry look more resilient. Both auto and electronics gadget sales are up by about 7% so far this year, which is a decent – and sustainable – pace of growth. Putting all these together, we see underlying resilience in the consumption story that should likely support steady growth, but not a meaningful acceleration. While saving rates remain very elevated, and can be a potential help to consumption down the line, this accumulation reflects precautionary motives rather than extra income, so will likely require a better growth prospect in order to be unlocked.
In past cycles it has often been investment growth that ends up bailing out the economy. In this cycle, the investment response has been handicapped so far – and for various reasons. Property investment is down another 10% so far this year, as developers’ liquidity problems worsened. With no investment-driven demand, the overall housing market faces the prospect of over-supply. This creates persistent de-leveraging pressure, and is putting downward pressure on prices as well as sentiment. Infrastructure investment is up 8% year-to-date, but has meaningfully slowed in recent months. The Chinese policymakers’ focus has shifted to defusing local government debt problems in the next few months. The process has so far been smoother than feared, but will likely still take time, and means that major spending and infrastructure projects are now being suspended.
Meanwhile, there has been a slow drip feed of (mostly monetary) policy easing on various fronts. The People’s Bank of China (PBoC) lowered the reserve requirement ratio by 25bps for most banks. Regulators also lowered the minimum mortgage rate for second homes by 40bps, and the rate on existing mortgages by a more incremental degree. By and large, these measures are not aggressive, and still hint at a gradualist approach. The response from homebuyers was tepid. For a short while, there were some signs of better demand in select cities, but the uptick appears to have been short-lived. Beyond the recent measures, there is scope to ease more, but an incremental approach should likely help with stabilization around current levels, rather than a meaningful recovery.
A key question is whether policymakers will continue to stick to their extremely conservative approach in 2024, or whether a full year of observation and the prospect of a potentially drawn-out deleveraging process will prompt them to take a more proactive policy stance. In particular, fiscal policy discussions were mostly held up by debt restructuring talks. There is nonetheless a possibility that the focus shifts to more expansion next year. In recent days there appears to have been more discussions around issuing additional public debt to fund infrastructure projects. This is an encouraging sign, but details remain scarce. For example, one question would be if it represents new pending or a shift in how stimulus is funded, putting more of the burden on the central government and less on local governments. Nonetheless, this is an area we will be closely watching as a more supportive fiscal policy stance is key to offsetting the headwinds to the economy (namely deflation in the housing market and uncertainty on the export front), and realizing better growth in 2024.
Regarding equities, we continue to focus on names that are oversold and could benefit from the gradual consumption recovery. Select outbound- travel-related sectors (including Macau Gaming and Online Travel Agencies) have delivered robust growth during the Golden Week Holidays and showed resilience amid macro uncertainties. These stocks have largely corrected along with the across-the-board sell-off in the China equity market but could deliver better-than-market results. Meanwhile, beaten-down blue-chip names in the Internet and Sportswear sectors are other areas providing investment opportunities.
Lastly, from a currency perspective, we remain a bearish bias on CNH as fundamentals still point to some further weakness: 1) carry disadvantage against most major currencies could widen as PBOC delivers more rate cuts; 2) macro headwinds with tail risks of a messy unwind of developer liquidity crunch; 3) balance of payments challenges due to export slowdown and capital outflows. That said, we don’t see a free fall from here either as it remains a heavily managed currency. Intervention efforts from the PBOC has ramped up in recent months with stronger fixings every day since late June and continuous funding squeezes in offshore market. While we think these measures are temporary in nature, which aim at stabilizing the currency instead of reversing the weakness, they put a cap on how high USDCNH can go over the short term. For investors, given the positive carry, we still think it makes sense to hedge long CNH exposure. In addition, a weak CNH also opens the door for using it as a funding currency to leverage attractive borrowing costs and take advantage of opportunities elsewhere.
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