Peaking current account surplus caps index upside
Since Covid, China exports and saves, while the West imports and consumes. The accumulation of China’s current account surplus reflects the strength of foreign demand relative to China’s. But such surplus accumulation is set to slow, as Covid subsides and the world reopens. Indeed, China’s surplus may have peaked in March 2021 for this cycle. Historically, peak surplus coincided with peak stocks, as in late 2007 to early 2008, mid-2015, and again in February 2021. Meanwhile, our proprietary model suggests that the top of the trading range in the next 12 months varies little from the peak in 2021.
China’s foreign currency deposits are the “shadow Fed,” and it is tightening
China’s forex fund position and forex reserve have barely budged, despite the rise in current account surplus to around its 2007 peak. Instead, foreign currency deposits in commercial banks have been the reservoir to hold dollar liquidity, and have risen to around $1 trillion — in tandem with the Fed’s balance sheet expansion during different phases of quantitative easing.
We term it China’s “shadow Fed,” and as such, it has a lot of bearing on China’s risk asset prices. As the Fed tapers and China’s exports slow, the rise in foreign currency deposits will likely stall, capping the market’s potential gains. If on the contrary Covid rages on, disrupting the supply chain and causing sticky inflation, the Fed must tighten beyond expectations. If so, it would be even worse — it would be stagflation killing both stocks and bonds.
Focus on the “underdogs” of 2021
Instead of betting on the overall index with limited potential, we suggest focusing on the “dogs” of 2021 — the sectors that have been ravaged by the tightening regulation, namely, consumer and internet. Even though property can rebound technically as perception shifts, fleeting as it may be. And energy still looks good. These sectors’ earnings are defensive, but are still underweighted by investors. Investors’ sectoral positioning has been slow to reflect a cyclical slowdown, and thus is vulnerable to a rude awakening.
Targeted easing to manage systemic risks
As the economic short cycle descends from peak to trough, policy will gradually turn supportive to manage the downside risks. That said, blanket easing towards property is unlikely for now. Policy will instead tango with market expectations, balancing the resolve to the tame property speculation and the need to manage systemic risks. Targeted easing and even reserve requirement ratio cuts at some stage are likely.
As the expectation of ever-rising property price starts to shift, a re-allocation of funds from property towards other asset classes will promote a better capital market for the long run. The yuan will depreciate somewhat in the interim. Bond yield will fall, too, in an environment that is more conducive to safe-haven assets.
Hong Hao is managing director and head of research at Hong Kong-based Bocom International Holdings Co. Ltd.
The views and opinions expressed in this opinion section are those of the authors and do not necessarily reflect the editorial positions of Caixin Media.
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