The Action Is Elsewhere

1500 words – a 4 minute read.

We have been US centric for the past few months given its sharp risk asset rally underpinned by a steady stream of BTE economic data on both the growth and inflation front.

With the upcoming Fed meeting likely to be the least interesting in several years it suggests that the time is ripe to focus elsewhere. Even a cursory glance suggests there is much that is happening, should be happening and will likely be happening in the months ahead – especially in Asia.

We have also focused heavily on our 4 for 24 macro surprises, introduced with our 2024 Outlook back in late October. All are unfolding according to plan, reinforcing surprise #3 in particular – the return to stability.

A return to stability, especially in the US, suggests a catch up opportunity for the ROW, both in policy as well as market terms. The US is leading the way in large part bc it has led policy wise – especially in the shift from monetary policy to fiscal policy; a shift made clear in Q4’s GPD report with investment in manufacturing structures up roughly 12% Y/Y, thanks to the CHIPS Act & other legislation.

Shifting to our 4 for 24 market surprises, we note 3 of the 4 relate to the ROW, the USD and China.  China has been the proverbial pebble in the portfolio shoe for some time, as we have been long and wrong since last Fall. We downsized the position several months ago but have retained an OW within our Global Multi Asset (GMA) model.

On the other hand, we have been aggressively OW Japanese equity for the past year plus and that has worked out well as Japan outperformed the US last year in local currency terms. Back to today’s title – we expect a fair bit of Asian action both policy wise and market wise in the coming months.

We remain focused on Europe as well (our Tri Polar World framework demands we focus on all 3 main regions: Asia, Europe & The Americas) but here we expect fewer fireworks & more of a gradual economic recovery as fiscal stimulus kicks in & the ECB begins its rate cutting cycle this summer if not before. With record low UER consumption remains fine; EU credit conditions appear to be bottoming as MS is up 4 months in a row & we expect a gradual rebound in the industrial production side as Germany, Europe’s “tired man”, starts to figure a way out of its industrial malaise.

Back to Asia.  We expect the action in Japan to begin this Spring led by the BOJ’s decision to exit NIRP and YCC which should impact the domestic rate structure, widely undervalued Yen, the economic and earnings outlook. Our buddy Stephen Jen, former MS FX strategist, thinks $/Yen could fall to 130 from roughly 148 today.

Markets of course tend to front run policy shifts and that is true in Japan as elsewhere. Here the front run has been concentrated in the banking sector which has led the broad equity market to 33 year highs in nominal terms (but not yet ATHs). This week’s sharp, 4% rally in Japanese banks was one of the data points that led to today’s title.

Stephen argues that the best time for the BOJ to act is when Japanese inflation & US rates are falling which just so happens to coincide with exactly what is occurring today. We expect that the BOJ will exit NIRP and YCC even as inflation falls UNDER its 2% target on a Y/Y basis. Beyond the BOJ policy catalysts, JPM argues that TSE reforms could lead to a 20% appreciation in Japanese equity values.

US rates have already rallied considerably from their YE overshoot; we believe the Fed will validate the real rates are too high argument we have been making by early summer. As such it is quite likely that the BOJ will exit its current policy stance in the coming months, suggesting that the world can celebrate the end of deflation, which as some will surely recall, was the big worry pre Covid.

Current swap market pricing sees a 70% chance of a 10 bp April rate hike vs 40% odds a week ago. This would take the BOJ’s target rate from -.10% to flat, thereby ending NIRP with the YCC exit to follow. We think these policy shifts could lead to not only continued foreign investor interest in Japan but also a domestic investor shift away from bonds and back to stocks as bonds sell off (10 yr. JGB’s, now yielding roughly 70 bps, are expected to reach 1.5-2.0% according to Stephen Jen).

China is where the action has really gotten interesting. After as much as 10 failed stabilization efforts according to Bloomberg, it looks like the Govt under Premier Li Qiang is ready to get serious. The main intent is on stabilizing both the housing and equity markets in an attempt to restore consumer confidence, badly damaged during Covid and as yet showing no signs of picking up. Given the economy grew 5% last year we remain unconvinced that China will deploy massive stimulus a la post GFC but that’s not to say there isn’t plenty it can & will do.

Many highlight the diverging path between US and Chinese equity over the past few years and it is indeed striking & suggestive of a rotation – reversion to the mean set up. We focus on the underlying divergence between record high US household net worth bolstered by rising house and record stock prices vs the exact opposite for the Chinese consumer who has seen housing values decline while stocks have been hammered.

Most know that the big source of wealth and investment in China is in housing, yet Bloomberg notes China also has roughly 200 million individual investors who represent roughly 60% of daily turnover & who, since 2021, are sitting on roughly a 35% loss in equities (= to roughly $6T in losses between China/HK markets).

China has been addressing its issues in fits and starts since it exited its draconian Zero Covid approach slightly more than a year ago with little to show for it. The equity market has also had its fits and starts, running up sharply on the Covid exit before slumping as the expected revenge spending seen in the US and Europe failed to materialize due to the lack of confidence described above. The same holds true for HK equity, increasingly viewed as part and parcel of China. HKSE technicals suggests a massive double bottom while Bloomberg reports HK’s P/B ratio is back to levels seen during important prior bottoms.

Today, events have reached the point where fears of public unrest akin to that which triggered the Zero Covid policy exit may be lurking in policy makers minds. It seems clear that the current crop of policy drops – sudden and bigger than expected Reserve Rate cut, shadow bans on short selling, stories of the State National team stepping in as buyers, rumors of a $280B equity market support package ( = to 8% of free float says MS & vs $240B spent in 2015) & more – reflect a desire to send folks on their upcoming Chinese New Year travels with a smile on their face.

These policy measures and the equity market reaction was the 2nd trigger to today’s title. Stocks have bounced sharply and the set up seems akin to that which existed in the US equity space back in early November. Sentiment at rock bottom (the woe is me China hedge fund closing letter), positioning is empty (record 2023 selling), while technicals are supportive with the Shanghai CSI 300 on support levels that held back in 2015-16. Valuation, while not a timing aid, is at record cheap levels (forward PE of roughly 9x) while the PBOC is busy pumping in liquidity (good for all markets BTW).

Here's GaveKal, well respected China experts: “The Chinese stock market is undervalued against cash, Chinese bonds, gold, and other world stock markets — and it is in a state of total panic,” said Charles Gave, Gavekal’s co-founder.

One could see the main China ETFs rally 10-20% from here and still be good buys over time (KWEB is up 8% off recent low but still roughly 18% below 3M high). Folks are still very negative with JPM’s most recent client survey reporting 67% expect Chinese stocks to go lower. We expect to hold our current allocations to Chinese equity and debt, noting as we did several weeks ago that Chinese junk bonds, mainly property related, bottomed months ago suggesting that things at the epicenter have stabilized.

Who’s ready for some football action? I know where I am going to be Sunday from 3 pm on – how bout you? Who do you have getting to the Super Bowl? My picks are Ravens & Niners with Ravens likely to win it all behind MVP QB Lamar Jackson… lets see.