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Issue 84: Stocks Zigzag Into Q2

May 13, 2024

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This Week’s Highlights

  • Stocks swinging back after mid-April dip
    In a slow week on the macro data front, stocks reacted to last week’s reports of possible weakening in the US economy, taking bad news as good news, in the sense that a softening job market and decelerating growth could help cool off inflation and prompt the Fed to ease sooner.
  • China’s stock market rally gains steam
    It may come as a shock to some investors to hear that Chinese stocks have trounced US shares so far in Q2, with a number of signs—including positive macro surprises, supportive policy, and a U-turn in foreign investor flows—suggesting the rally in China’s market could have legs.
  • Economists expect trade recovery in ’24
    Recent forecasts by groups like the UN, OECD, IMF, and WTO indicate one reason to be hopeful about global growth this year: A robust expansion of world trade activity in the wake of disappointing stats for 2023 amidst scorching inflation, high interest rates, and weak demand.

The CIO’s Take:

  • Recapping stock market action over the past two months, equity investor sentiment has seen some big swings, with disappointing data on inflation through mid-April giving way to early-May signs the US economy may slow just enough to keep the Fed on track for 2024 cuts. We remain cautious in the absence of a stronger trend.
  • One market in which investors are very happy to see growth strengthening is China’s, where upside surprises have pushed mainland stocks higher and kindled a wave of foreign inflows. Our models allocated early and participated in the recent upswing, but we still don’t believe the upside is adequately priced and see greater opportunity here.
  • Part of the good news for China has been a turnaround in demand for its exports, and economists we’re following suggest that there will be a rising tide for economies across the globe in 2024, as last year’s weakness in global trade gives way to a positive ‘growth-exports’ feedback loop in years to come—a boon, in our view, across EM.

Stocks Zigzag Into Q2

US, European markets higher last week
While there wasn’t much happening last week on the macro news front, investors were busy processing the prior week’s data on employment costs and jobs—things we discussed in last week’s Perspectives—which led the broad stock market to rally. The S&P 500 closed up 1.56% through Friday, while European stocks did even better, with the STOXX Europe 600 popping 2.92% for the week and the FTSE 100 climbing 3.20%. The latter index, tracking London-listed blue chips, notched its best week of the year, after GDP data on Friday showed the UK exiting a shallow recession.


But it’s been a wild ride in April/May
As it happens, last week’s rally is the latest leg up in a rally that’s been running since mid-April, after stocks fell at the beginning of that month—quite a rollercoaster for equity investors to start Q2 (see below). Sometimes we’re inclined to attribute overly volatile twists and turns in the daily movement of markets to the fickle “animal spirits” of irrational investor behavior. This time, in our view, it seems investors were actually reacting rather reasonably to fundamental news, which has had its ups and downs in recent months. Let’s take stock of how we got here.

Figure 1 Major Stock Markets

Shares’ fortunes linked to rate cut hopes
April’s sell-off, as we noted at the time in our Perspectives commentary, was the result of uncertainty over the trajectory of Fed policy rates. Readers will recall that markets—which at that time had, we believe, unreasonably high hopes for plentiful rate cuts starting by mid-year—were in the process of digesting three months’ worth of data on resurgent inflation. Stocks are among the riskier assets that tend to react strongly to changes in rate expectations. Equity investors naturally took the dimming prospect of a quick pivot to easing as bad news, leading to the downturn seen above.


Negative macro data? Good news for stocks!
What’s happened recently to set the S&P 500 back on track and keep European stocks running hot? The early-May release of April data showed the US economy may not be as strong as previously thought. In a “bad-news-is-good-news” environment like this, looser labor market conditions and weaker growth suggest the Fed might have reason to move earlier, after all. So long as growth doesn’t dip too much—and it hasn’t yet—there’s still hope for a “Goldilocks” scenario in which the economy cools enough to give the Fed comfort in cuts, but not so much that earnings plummet.


Downside risks keep us cautiously positioned
Despite our cautious view on “risk assets” like the stocks depicted above, we’re happy to see equities rally. Our perception that odds of a soft landing increased in the last six months is precisely what prompted us to boost our models’ equity exposure since then. We still worry, however, that investors are generally too optimistic about rate cuts, and we see a strong likelihood that sticky inflation prevents the Fed from initiating cuts until late this year—if at all in 2024. Until we see data to the contrary, we will maintain a defensive and opportunistic posture on the equity side.

Is China’s Market Back?

China stocks beating S&P in Q2
Although it’s great to see US stocks in the S&P 500 rallying back over the last few weeks, it’s worth noting that so far in the second quarter, the index is still down –0.5%. China stocks in the mainland CSI 300 Index, by contrast, have risen 4.3% in USD terms so far this quarter, through last Friday. That has helped Rayliant’s global equity models, which are overweight cheap, high-quality growth stocks in China. The rebound is also prompting investors who captured the upswing, as well as those on the sidelines, to wonder whether it’s a temporary bounce or something that will sustain.


Foreign flows on upbeat sentiment
There’s little doubt that sentiment toward China has improved since earlier this year, when concerns about the country’s struggling real estate market, its policy direction, signs of deflation, and a slump in growth led some investors to question whether China’s market might even be “uninvestable.” Indeed, beginning in August 2023, when foreign investors’ views toward China seriously soured, outflows from its mainland market over the HK Stock Connect platform accelerated, with over US$30 billion exiting China’s market through mid-January (see below).

Figure 2 Foreign Flows

Beginning in early Q1, however, when it became clear policymakers intended to support the market, foreign money began steadily flowing back into Chinese stocks. By last Friday, cumulative inflows were upward of US$20 billion. And yet, despite those inflows, there are still plenty of doubters, leaving ample potential upside, in our view, for those (like us) with enough conviction in China’s recovery to allocate now.


Room for improvement in nascent recovery
It’s not that the skeptics’ concerns about China’s economic recovery aren’t valid. As we’ve said ourselves, a target of 5% GDP growth is much harder to meet this year without the favorable base effects that gave China a leg up on hitting that same bogey in 2023. Along those lines, while we’re happy to see a state-backed drive to boost factory activity yielding good results—China’s Q1 GDP report showed a 6.1% year-over-year jump in industrial production—consumers will need to be part of the equation. So far, retail sales have lagged and consumer confidence remains low.


We see more upside surprises in store
That said, we believe investors’ expectations are even lower, and we see policymakers increasingly taking measures to directly support consumers in service of hitting their growth target. Last Thursday brought a prime example, as upper tier-two city Hangzhou announced that it would lift all home-buying restrictions, a decisive move to address what is obviously a central source of consumers’ angst. It’s the type of effort that, combined with overly dour investor sentiment, sets the stage, in our view, for upside surprises that should serve to keep mainland stocks’ rally alive.

Trade Outlook Brightens

China saw surprising jump in April exports
Another bright spot for China recently has been export growth, with last week’s report on April exports showing a 1.5% year-over-year rise against consensus expectations of just a 1.3% increase. As mentioned above, China will need domestic demand to pick up for a real recovery to take hold, but exports can definitely provide a tailwind. Will we see a continued turnaround in global trade after years of high inflation and high interest rates put a damper on demand? Interestingly, some pretty big players in economic analysis seem to think so—and not just for China.


Agencies predict global trade recovery in 2024
Among forecasts we’ve been tracking in recent weeks are those put out by a number of intergovernmental agencies suggesting that trade flows, after suffering under years of pressure from the COVID pandemic, supply chain disruptions, and geopolitical tensions, are finally set to rebound in 2024. Take the United Nations, for example, whose Conference on Trade and Development (UNCTAD) reported in March that the first quarter was tracking for a 2.9% year-over-year rise in services trade, while goods trade was expected to increase by 3% (see below).

Figure 3 Global Trade

The Organisation for Economic Co-operation and Development (OECD) likewise sees a pop in global trade this year, projecting a 2.3% expansion in trade for 2024, which should accelerate to 3.3% growth in 2025. In 2023, by comparison, growth was a more tepid 1%. The International Monetary Fund (IMF) was even more optimistic in its recently released World Economic Outlook, citing expectations for 3% growth in trade this year. The World Trade Organization (WTO) only evaluates goods trade, and forecasts 2.6% growth for the full year.


Trade growth could feed a virtuous cycle
So, what accounts for the turnaround? Rising demand, as inflationary pressures arising post-pandemic trend down around the world. Along those lines, the key to the recovery in trade activity, according to Clare Lombardelli, chief economist at the OECD, will be growth in the US economy, along with a broader turnaround in demand from China and East Asia. We see political factors as among potential risks to that narrative, but note that to the extent trade is allowed to recover unimpeded, it should spur further growth: A welcome virtuous cycle, good for the United States and China alike.