No, China did not invade Taiwan, but its government and central bank in coordination, finally decided to act and act big to save the economy from further downturn. In a week that reminded the response to the 2008 crisis, they slashed interest rates, initiated measures to help listed firms buy back their own (beaten down) shares, announced direct financial help to the poorest households and promised increased government spending, among other things. Emphasizing the urgency and the strong message to the markets, the Politburo meeting which announced the fiscal measures was an extraordinary one, as it should have taken place at the end of October and came just two days after the first positive shock to the markets when the Central bank took action. The meeting also mentioned the objective for “stopping the decline and stabilizing the property market” for the first time as a goal. Financial markets responded swiftly.
When monetary policy blends with fiscal policy the result can be explosive for the economy. The examples of the sharp comeback of most western economies after the pandemic are very recent. China could afford spending more, as its government debt and fiscal deficits are in control for now, contrary to the US and most European countries (Germany is the exception) where government spending has already reached its limits. And on top of that, China's inflation is on the borderline of zero, which gives it ample space for flooding the economy with liquidity. President Jinping has been reluctant to engage in "cowboy" type of measures to electroshock the economy. Well, this now seems to have changed.
The markets reaction was the expected one, as the main beneficiaries of such a game-changer action are the local markets and European consumer names or other companies with significant exposure. China's equities rallied by 15%, and European consumer-related companies jumped by 15-20%, as the broad European indices rallied by about 4%. The expensive parts of the markets were sold and traders/investors rotated into the beaten down autos, luxury, materials and anything with significant revenues from China. We had recently highlighted the long-term attractiveness of high quality consumer names such as the Swiss Richemont (owner of Cartier), the French Hermés and LVMH, whose valuation had fallen to five and then year lows, to name but a few. Of course we did not expect the rally to happen so soon and so furious.
This begs the question on what to do now. To be clear, nothing will change overnight in the Chinese economy. And Europe still faces sticky core inflation and economic growth is , at best,stagnant. But what can change overnight is the sentiment and the intention of the market's collective mind to "forgive" short-term profit warnings and falling revenue guidance by European consumer names, in the face of a) already beaten down valuations and b) a brighter 2025 thanks to a revived Chinese consumer. Hence, we should see increased volatility ahead as the moves were violent and profit taking could ensue, but most probably the 2024 laggards will become "buy on dips" from now on and until somethng spoils the narrative again. We would not be surprised to see the markets' heavily crowded trades to unwind (in Asia for example, India and Japan being aggressively sold and China rallies further) as the market reallocates capital in the region.
Are western Central Banks going to be "happy" with China's moves ? In theory yes, because fiscal and monetary easing in the world's second largest economy provides a growth boost to the world. If inflation were to remain close to 2%, albeit a little higher in the US and the Eurozone while China's recovery provide a nice tailwind for their slowing economies, that would be a dream scenario. And up to last week, China was "exporting" its deflation in consumer goods and helping the life of Mrs Lagarde and Mr Powell as it was only consumer services that they had to worry about. Today things have changed a little, and we suspect that both and their colleagues are back "on their toes". It will be very interesting to see if China is mentioned in the ECB October meeting, in just a couple of weeks.
Speaking of inflation, US August Personal Consumer Expenditure index (PCE) came in as expected. For the headline PCE the 9bp monthly increase was slightly better than expected (0.12%) with the 12-month change at 2.24% (expected 2.2%). Headline PCE price inflation is now very close to the FED's 2.0% target down from its peak of 7.1% in June 2022. The Core PCE (which excludes food & energy) were also tame for a fourth month in a row with a 0.13% increase in August (also slightly below expectations). On a 12-month basis core PCE inflation was announced at 2.7% through August — a little higher than the 2.62% published last month, but in line with expectations.
The Eurozone September inflation numbers are due this week (Tuesday 1st). However with two main countries (France and Spain) having already announced better than expected and unless Germany (today) surprises negatively, one would expect a positive surprise on the Euro Composite index (expectations for 1.8%). In France, the CPI dropped a whopping 0.7% to 1.5% y/y and compared to expectations of 1.9% y/y) with weaker consumer services' prices being a surprise. In Spain, September inflation also declined more than expected falling 0.7pp to 1.7% y/y (expectations for 1.9% y/y).
Bonds managed to hold on to their recent gains, despite the equity euphoria. That was partly because US Consumer Confidence index plunged in September, with the most important element in the report being the new data on the labor market. The share of consumers who viewed jobs as being "plentiful" dropped to 30.9%, the lowest since March 2021, from 32.7% in August. And 18.3% of consumers said jobs were "hard to get," up from 16.8% last month. This 12.6% differential is the lowest in more than two years, offering another excuse to investors to keep buying bonds. The worsening geopolitical situation is another reason bonds are well bid.
As an appendix, here are the most important measures announced by Chinese authorities.
a 50bp cut in the bank reserve requirement ratio (corresponding to a liquidity injection of CNY1trilion), recapitalization of the six main commercial banks, for the first time since 2008 totaling USD142bn (about 0.8% of GDP),
lowering of the minimum down payment on second home purchases from 25% to 15%, after having reduced it in May from 35% to 25%.
average 50bp cut on existing residential mortgage rates. This is estimated to benefit 150 million people, reducing their annual interest charges by about CNY150bn (0.15% of GDP),
direct transfers to the poorest households nationwide and further additional transfers to Shanghai1 households in the shape of purchase vouchers (about 0.8% of GDP).
Chart of the Week : China, can 2015 be repeated ?
It was February 5th of 2024, that we devoted the cover story of our weekly to China with the title "Will history repeat itself, 10 years later ? " The main reason for this was the fact that the country had started the celebrations of the Chinese New Year, but also the fact that the local stock market had made a new low (as seen through the CSI300 index). A few days later a rally started which lost steam after a month or so and a new corrective started which finished last week. And the low of the index last week was at the same levels as in February, a formation usually called "double bottom". With the fierce rally going on and the current change in investor sentiment, we now show you what we meant in February, with a chart. This is what happened ten years ago and it is highlighted with a red elliptical shape. The stock market went ballistic for almost a year, producing returns of almost 150%. Hence a 15% rise in just a week sounds (and is) a lot, but history has shown that this 15% can only be a "blip" if the market truly explodes higher, with the mass participation of the local investor. Can this happen again ? Another great question, for which we do not have the answer. But at least you were informed about the possibility of it back in February.
Disclaimer
• The content of this document has been produced from publicly available information as well as from internal research and rigorous efforts have been made to verify the accuracy and reasonableness of the hypotheses used. Although unlikely, omissions or errors might however happen.
• The data included in this document are based on past performances and do not constitute an indicator or a guarantee of future performances. Performances are not constant over time and can be positive or negative.
• This document is intended for informational purposes only and should not be construed as an offer or solicitation for the purchase or sale of any financial instrument and it should not be considered as investment advice. The market valuations, views, and calculations contained herein are estimates only and are subject to change without notice. Any investment decision needs to be discussed with your advisor and cannot be based only on this document.
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• Sources: Chart of the Week : FactSet
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