Monday Digest

Posted 30 September 2024

Global growth tailwinds

For once, markets were preoccupied with non-US news last week – after China’s double shot of economic stimulus boosted Chinese (and European) stocks. Our verdict is that they will be impactful – just not quite the ‘bazooka’ levels of 2015-16. Markets seemed to ignore the second clause, with strong gains for stocks exposed to Chinese demand, including European luxury goods maker LVMH. The longer term implication is that Beijing’s loosening of financial conditions plugs what was a significant drain on global liquidity – benefitting markets all over. Slightly less positive was Shigeru Ishiba’s appointment as Japanese Prime Minister. He’s seen as a candidate of the old guard that might dampen Japan’s positive corporate reforms.

Interestingly, oil prices fell – the opposite of what you would expect in an environment of rebounding Chinese demand, however, this is a supply- not demand-side story: Libya’s fractured government approved a new central bank head, which should release the country’s huge supply potential. At the same time, Saudi Arabia will reportedly increase production to regain market share (as we thought and wrote it might). Lower oil prices should ultimately be pro-growth, supporting consumers and non-energy businesses.

Energy disinflation is especially important if China recovers from its malaise. Chinese disinflation was a key part of the ‘soft landing’ narrative (central banks cutting interest rates without a recession) that has underpinned market upside for most of this year. Without it, central banks will need another source of disinflation, and lower energy prices fit the bill. The current outlook is that a rebounding China should at least counterbalance a slowing US – but US growth might improve too, looking at recent data. The world’s two largest economies expanding at the same time would mean strong global growth, but it is too early to say for sure.  We will know more next week, when important US jobs data comes out. US news will then dominate markets again.

Will Chinese stimulus lead to long-term profit?

China unveiled significant policy stimulus last week, in a dramatic change from the week before. The People’s Bank of China (PBoC) will inject Rmb800 billion into its financial system, cut several policy rates and support house-buying. Shortly after that announcement, the politburo said it will pursue fiscal expansion to support consumption and “the driving role of government in investment”. Chinese stocks surged 15% through the week in response. This shift came a week after the PBoC declined to cut loan prime rates – a stasis which made global onlookers (ourselves included) conclude that Beijing had a strong hawkish bias. Chinese policy can be frustratingly unpredictable.

Last week’s PBoC announcement was reportedly put together just two days in advance, after high-ups became concerned about overproduction and deflation. The catalyst seemed to be officials in a major coastal province warning that they might miss the 5% GDP growth target. That shows how seriously the government takes GDP figures – even though the weakness was already clear from consumption and profit numbers (a weakness covered up by industrial production). Industrial profits are 17.8% down year-on-year, meanwhile.

The stimulus packages show Beijing’s intent – which is why stocks rallied so strongly. But it isn’t the ‘bazooka’ stimulus we saw in 2015-16. The deeper question is whether Chinese companies will be able – or permitted – to make long-term profits. President Xi has cracked down on excess profit-making many times over the years, and fears of intervention have stymied private sector activity. It’s notable that mortgage rates on second homes have been lowered, given Xi’s previous clampdowns on property speculation. The current signs are that profit-making will be encouraged, but the sudden change feeds into the ‘whack-a-mole’ policy approach we have come to expect from Beijing. The problem is what we said at the start: Chinese policy is frustratingly unpredictable.

Global liquidity is improving

Western central banks have started easing monetary policy. Interest rates have been cut in the US, UK and Europe, and markets expect more to come. Market expectations for Federal Reserve rate cuts are probably too optimistic, but the easing trend is clear and should boost global liquidity. Interestingly, broad global liquidity has been improving since 2022 – according to our friends at CrossBorderCapital. Their research suggests global liquidity fluctuates in long cycles, and this one has a way to run yet. That should support markets.

Fed easing is the lynchpin of this story. While we think the US economy is too strong to vindicate markets’ steep rate cut predictions, the Fed clearly has a dovish bias – and we should interpret its 2% inflation target more like a minimum. Asian central banks are also part of the story: the Bank of Japan and the People’s Bank of China have been detracting from global liquidity for a while, but those liquidity drains will probably be plugged. The BoJ basically capitulated to markets after Japan’s summer crash, promising not to raise rates in times of stress. The PBoC, meanwhile, has just announced significant stimulus measures.

Greater money supply means greater demand for risk assets. It should eventually boost global growth and risk appetite too, but the benefits aren’t evenly spread. Long-term bonds could actually underperform on a relative basis¸ since the ‘term premium’ (the extra returns demanded for long-versus-short lending) goes up when investors want to buy riskier assets instead. More liquidity can also be accompanied by pockets of volatility, like we saw in the summer sell-offs. The main takeaway from August’s sell-off, though, was encouraging. Volatility was extremely short-lived, because there is plenty of money around. That should continue to be the case.