Issue 104: Is China a “Buy”?

This Week’s Highlights

• China’s stock market blasts off!
  Heading into the seven-day Golden Week holiday, Chinese stocks posted their best weekly performance in over a decade, driven higher by multiple policymakers’ declarations of support for the economy and markets. But will it be enough to promote a sustained rally?
• Where do commodities fit in?
  With debate over the odds of a US soft landing—and now, potentially, major stimulus in China—cyclical commodities like industrial metals and oil are in the spotlight, though questions about OPEC+ production decisions and geopolitical risk still hang over the latter.
• More updates on jobs, inflation
  Last week brought pretty dismal readings on consumer confidence from the Conference Board, where households seem to have similar reservations to the Fed’s as to the trajectory of the US labor market. On the other hand, PCE inflation cooled again in August.

The CIO’s Take:

• Our models maintain a cautious, quality-focused allocation to Chinese stocks, which we believe have become increasingly attractive as sentiment toward China’s economy has dimmed. That position paid off last week, and while we hope that Beijing will take substantive steps at stimulating demand, this is a better start than we’ve yet seen.
• We’ve also been overweight cyclical commodities since Q2, when incoming macro data suggested to us better odds than the market was pricing of a soft landing. We still believe traders are a bit too pessimistic about demand, and if China does come back into the picture, it would be one more upside catalyst for metals and energy.
• The Fed has very explicitly pivoted in its focus from inflation to jobs, and data we saw last week validated that move: PCE inflation continues softening, while consumer confidence about jobs suggests the labor market is also cooling. We agree with the Fed that a recession seems a ways off, and continue to expect a smaller 25-bps cut in November.​​​​​​

Is China a ‘Buy’?

Big rally in Chinese shares
Many investors in Chinese stocks have been nursing losses, with the world’s second-largest economy struggling over the last few years amidst a property slump and flagging domestic confidence. We have been among those maintaining an allocation to a market we see trading at bargain valuations, given longer-term growth opportunities—though, admittedly, we had no idea when a catalyst for revaluation might come. Last week, we finally got a taste of that redemption, as the CSI 300 Index posted a 15.7% return, its biggest weekly move since November 2008 (see below).

Investors cheer Beijing stimulus calls
Back in 2008, Chinese stocks were rallying on the heels of massive stimulus unleashed in response to stress from the Global Financial Crisis. Last week’s move was also prompted by news of government support: first, an announcement by the People’s Bank of China (PBoC) on Tuesday, including rate cuts, a reduction in banks’ reserve requirements, and lower downpayments required of homebuyers; then, on Thursday, China’s Politburo announced its own stimulus push on the fiscal side, including a commitment to stabilize the nation’s struggling housing market.

Monetary policy won’t be enough
Tuesday’s PBoC moves weren’t its first effort to ease financial conditions since China’s problems began a few years ago. Seeing the central bank ‘go big’ was reassuring, because it signaled policymakers recognize how serious the situation is. That said, as we’ve been commenting for a long time, additional liquidity can’t get China’s economy going again because even if loans are available, businesses and consumers are too anxious to borrow. Rather, our view was that we won’t see a sustained China recovery until we get fiscal measures to help rekindle domestic demand.

Politburo could bring fiscal firepower
As such, we believe the Politburo’s proclamations are a much more decisive positive signal for Chinese stocks. As usual, the official statement was vague and we’ll want to see follow-through in terms of real measures being taken. Even so, the kinds of policies referenced—ultra-long-term special treasury bond issuance, local government bond issuance, explicit support for home prices—are things Beijing has been less inclined to promote, but which we deem as critical in getting China’s growth back on track and settling stocks into a sustained bull market.

We see plenty more room for upside
Ultimately, our take on last week’s stimulus—and the reason markets reacted so strongly—is that it should dramatically reduce one of the biggest perceived risks to investing in China: that President Xi is willing to let the economy implode in pursuit of his own political aims. Even after last week’s rise, the CSI 300 Index trades at just 13.5x forward earnings. That’s quite low, given the growth we expect Chinese firms to deliver with a revival of domestic demand—and especially if a US soft landing materializes and trade-war rhetoric cools off post-election, keeping China’s exports up.

Closer Look at Commodities

Commodities up since Fed cut
For commodities, renewed hope that China’s economy could be back on a path to recovery was music to traders’ ears, building on positive momentum established when the Fed began easing. As of last Friday, the Bloomberg Commodity Index was up nearly 3.4% since the Fed’s announcement of a 50-bps cut on September 18th. Not surprisingly, industrial metals have performed especially well, with that highly cyclical component of the commodity basket up 5.8% since the FOMC—and almost 12% higher since we added metal miners to our asset allocation in mid-March.

​
China demand a big factor
Back when we started getting bullish on industrial metals, we obviously had no idea China would make a late-Q3 stimulus push to get growth back on track, though we were tracking US data suggesting to us a greater likelihood of a soft landing, and believed tight supply and better-than-expected demand could be a recipe for strong returns. That’s what’s happening now, as traders bet that fiscal stimulus—and, in particular, anything that increases activity in China’s housing market—will drive prices on things like copper and iron considerably higher.

Traders see less upside in energy
Gains in the energy sector have been positive, but slightly weaker, and here the situation is a little more complicated. According to a survey released by Bloomberg Intelligence on September 24th, despite the Fed’s pivot and Powell’s insistence that there’s no recession in sight, most experts expect oil to finish 2025 in a range of $60–80/barrel (see below), probably not what most investors would expect in a soft-landing scenario.

Just a few weeks ago, we noted that markets seemed to be placing too much emphasis on the demand side, pricing in a high likelihood the landing is hard. Last week, there was some negative news on the supply side, as well, with Saudia Arabia announcing it was considering production increases this December, and the conclusion of a political standoff in Libya bringing its oil fields back online after a month-long shutdown.

Geopolitics possibly underappreciated
Referring back to the Bloomberg Intelligence survey, its notable that “OPEC+ policy” was the top factor expected to drive oil prices over the next two years, cited by 30% of respondents. Of course, the “China demand story” was ranked a close second in importance, making last week’s stimulus kickoff a potentially crucial development for energy bulls. Interestingly, 69% of those polled by Bloomberg said the premium in oil prices for geopolitical risk was less than $2/barrel, such that escalating tensions in the Middle East and Russia-Ukraine offer further upside catalysts.

US Jobs & Inflation

More data on ‘two-sided’ risks
If a soft landing does end up driving commodities higher, the Fed will be quite pleased with the way it’s managed US monetary policy over the last few years. Based on Powell’s statements after this month’s FOMC, it seems likely many at the central bank see things trending in that direction, as the Fed shifts its focus from inflation to jobs. Of course, we’re making our own assessments of those odds, and to that end, the last week brought news relevant to both sides of the Fed’s ‘dual mandate’.

Consumer confidence slipping
First, on Tuesday, we got a report from the Conference Board, which tracks American households’ perceptions of the strength of the US economy. Headline consumer confidence slid from 105.6 in August to 98.7 this month: the greatest one-month decline since just over three years ago, and far short of economists’ consensus expectation of 104. Though all five demographics sampled felt confidence slip, the largest decline came within the 35–54 age group, among those earnings less than $50,000/year.

Households fear softening jobs
What accounted for sagging consumer confidence? Consistent with the Fed’s two objectives, inflation and jobs seemed to be the weak spots. Rising prices sat atop the list of consumers’ concerns, as 12-month inflation expectations increased to 5.2%. Meanwhile, the difference between respondents citing jobs as “plentiful” and those finding them “hard to get”—called the labor market differential—registering its eighth straight monthly decline (see below).

While pandemic-era dynamics have made this a strange cycle, such a drop in job market confidence has boded poorly for risk of an economic contraction. A more explicit measure in the survey, the expectations index, dropped 4.6 points to 81.7, with a value of less than 80 generally signifying a recession. It’s worth noting that the Conference Board survey took place one day before the Fed’s September 18th rate cut.

PCE inflation keeps cooling
As interesting as the Conference Board data were, more eyes were focused on Friday’s release from the Bureau of Economic Analysis (BEA): a report on the Fed’s preferred inflation gauge, the personal consumption expenditures (PCE) index for the month of August. Things looked better here, on the face of it, with core PCE increasing just 0.1% month-over-month, showing prices rising at a three-month annualized clip of 2.1%, just a tick above the Fed’s target level. Consumer spending, adjusted for inflation, also rose by 0.1%, softer than a 0.4% gain the month prior.

Enough for another half-point cut?
Data from the Conference Board and BEA show the economy cooling—a fact the Fed would likely point to as justifying its recent 50-bps cut—though not by enough, in our view, to warrant another jumbo reduction in rates for November. Fed funds futures barely budged, rising from a 50% chance of another half-point cut to around 53% probability. Interestingly, the Atlanta Fed on Friday updated its GDPNow estimate for growth from 2.9% to 3.1%. So, it’s true the economy is cooling, but it’s also easy to see why Powell downplayed the prospect of a near-term recession.