Weekly Market Update

The recent rally is well supported by macro data, property and tech policy easing, capital market reforms, and fund inflows from government along with private sources.

Several structural problems we’re watching have not been addressed but may be mitigated. The longevity of the rally would depend on a potential rebound in earnings growth as current valuations remain historically low.

We believe that China is returning to a more normal range of valuations after the worst bear market in two decades. This is because the domestic policy and macro backdrop has stabilized, which could enable the return of earnings growth.

Structural impediments and external risks remain but investors could still find lucrative opportunities as we potentially enter a stable era for China equities.

So far, earnings remain in the doldrums. 2023 annual reports gave no hints of stronger corporate outlooks.

Consensus estimates were revised lower year-to-date for all sectors except Consumer Discretionary, which reflected the recovery in travel and leisure.

First quarter results are being reported now, but recent policy shifts are unlikely to be reflected in these numbers until the next quarter. Looking at the past several rallies, those that were followed with earnings growth (2009-11, 2016-17, 2020-21) lasted one to two years, while those that weren’t supported by earnings (2014-15, 2022-23) fizzled out in about six months.

Still, the price to pay for a potential return to earnings growth in China remains historically low.

TRADE WAR IMPLICATIONS: Tariffs and defense alliances could differ widely post November, depending on which nominee wins the US Presidential election. Potential changes will have to be discounted by investors.

Candidate Trump has again pledged large tariff increases that might amount to as much as 2% of US GDP, paid for by importers of foreign goods and some services. This includes a 60% prospective tariff on China and 10% for all other trading partners, regardless of existing tariff agreements.

Like 2018, its imposition is likely to lead to tit-for-tat retaliation. President Biden is also reportedly considering severe but more targeted tariffs on electric vehicles along with other key clean energy materials.

This is not, however, where the largest risk lies. It’s consumer price and inflation expectations in a world that has recently experienced negative, and sometimes crippling, consequences of higher inflation.

In our view, portfolios should be constructed for a range of possible positive and negative outcomes in mind, not just the highest returns. Growth amid concerns over trade continuity, civil unrest, security risks and technological possibilities - such as a state-sponsored cyber-attacks - call for a combination of higher and lower risk investments in portfolios.

Fortunately, growth and solid yields for safer income now coexist.

We have also argued for hedging portfolio risk as hedging costs are historically low.

Russia’s expected counter-offensive in the summer of 2024 could worry investors. The hope is that the provision of supplementary military aid and financial assistance to Kiev will avoid a negative scenario.

The risk of escalation remains sizeable and would most likely weigh on the euro and dampen appetite for European assets after a period of positive surprises for the region. The lasting focus on deterring Russia may ultimately boost defense shares.

But what will it mean for global markets more broadly? As we’ve showed previously, geopolitical shocks and threats to security have generated remarkably few cases of lasting impact on a global scale.

Only the advent of World War II and the OPEC embargo 50 years ago catalyze a negative turning point in the world economy.