China clampdown versus Fed persistent dovishness

Chief Investment Officer's team, 01.08.2021

AT A GLANCE

Fed confirms overly-accommodative stance with economy still a way to go
Strong earnings season across DM keeps volatility in check
China regulatory offensive sends shockwaves across markets

Last week it was all about the US Federal Reserve and China. The former concluded its July meeting with nothing new and nothing done on policy, a continuation of the dovish status quo supportive of financial assets, while the latter sent global shockwaves with its harsh regulatory crackdown. All of this was played against the backdrop of strong earnings in the major Western markets, which closed the five days through Friday with minor losses, caught in the tug of war of these opposing factors. Of course, concerns about the delta variant lurked in the background, but given low hospitalisation rates and no lockdowns, we think that in this summertime the virus is not playing a major role in driving returns. Come the fall or winter, it may be a different story, with more indoors life and lower temperatures increasing covid-related tail risks.

We maintain a procyclical tactical positioning in our portfolios, with emphasis in DM versus EM equities, although we think that by the end of the year the staggered recovery underway should see the EM take the growth baton. Expansion rates have just peaked in the US and should be close to peaking in Europe, leaving the developing countries as the next in line to be at the forefront of the recovery.

Investors will be looking forward to the Jackson Hole meeting in late August as the next venue where the Fed chair could provide some important insights into the tapering process, very much on schedule to be implemented early next year. Stay safe.

Cross-asset Update

As much as unexpected, the Chinese regulatory offensive which last week shook domestic markets and global investors was harsher than the previous ones but represents indeed nothing new in the local landscape. Beijing has consistently been shaping the economy as per the ruling party’s objectives, starting years ago from the systemically important real estate sector, and then stepping into healthcare, information technology and lately for-profit, after-school tutoring. This could be dismissed as the footprint of an authoritarian regime as compared to an extremely liberal democracy like the United States. This misses the point. Our conclusion is that regulatory interventions in China are aimed at achieving longer term stability, hence sustainable growth, at the cost of shorter term, unavoidable pain. While in the United States “government is the problem”, as Ronald Reagan put it, in China it has, at least so far, provided solutions and managed to steer the whole socio-economic system in such a way that the country nowadays is a primary global power to be reckoned with. Hence, we would see Beijing stopping short of suffocating entire swaths of the economy with new regulations, as that would depress expansion rates and engender massive capital flights, ultimately running contrary the authorities’ very goals.

Families straining their balance sheets for supposedly best-in-class tutoring for their, often wise only one, kid’s future would have been standing in the way of having more than one child per family and ultimately also fostered inequality. The increasing of the population to spur growth and a more balanced development are goals ensuring longer-term stability, which the Chinese authorities have been obsessed with. The burden of the necessary redistribution to achieve the purpose has been borne by the education sector, de-facto killed and abruptly transformed from a high-flyer into a sort of utility-like space. Some international investors have been scared and are still selling out of the country’s markets, but the bulk of them should be sharing our same thoughts simply by looking both at Beijing’s track record and publicly declared purposes.

So, where does all of this leave us with our proemerging-market stance? Shorter term, most likely with more pain than gain. Investors will want to see two things before their concerns are allayed: the bulk of disruptive regulatory interventions behind them and the end to the current slow-down phase following the recent tightening. As for the former, we think that we should be quite close, unless Beijing makes a policy mistake by overstepping the mark; as for the latter, we would expect that by year-end new stimulus measures in the form of more fixed asset investments are announced. If internal consumption is growing too slowly and services-driven overseas demand cannot help Chinese manufacturers much, resorting to stimulus is the only option left for Beijing, again to avoid excessive imbalances.

Nothing new under the Chinese sun. “If the reforms are too fast there is chaos. If the reforms are too slow, there is stagnation”, as Cao Siyuan, the deceased architect of the first bankruptcy law in the country in the 1980s, once put it.

Fixed Income Update

Last week the Fed July meeting was concluded with very little in terms of new news. Rates policy was left unchanged, as well as the monthly asset purchase rate, and no update was provided about the timeline for the start of its tapering. With many pockets of the economy having more than fully recovered from the pandemic, it is surprising that Fed officials tie the future course of their policy to how the unemployment rate will be evolving. It is a known fact that the average monthly post-recession employment recovery rate has not changed much since the 1980s, so that one could today more or less project when full employment will be reached simply by extrapolating this rate into the future. Yet, this was the Fed’s decision, so that persistent accommodation still is in place. It all is happening in the face of rising inflationary pressures. Granted, price pressures related to supply bottlenecks will go, being by definition temporary. Yet, the ones from the incredible year-over-year expansion of the money supply, engineered by the Fed itself, will stay. Also, rising wages could well be a 2022 story with the US economy projected to sit above trend-growth throughout the year. For now, markets can enjoy the uber-easing and continue to ride the liquidity wave.

In spite of concerted monetary and fiscal stimulus, US long-dated Treasury yields dropped to new all-time lows, reaching on the 10-year tenor the level of -1.2%. This is not sending a reassuring message about the outlook. On the one hand it could be unabated Fed asset purchases compressing nominal yields with real rates following through, on the other it could be a signal of stagflation ahead. TIPS, Treasury-Inflation-ProtectedSecurities, would be telling us that inflation will still be there once growth has subsided. Only time will tell whether this is going to be the case. For now we can just acknowledge that US growth is already running below expectations, with US Q2 GDP disappointing - reported as slightly above 6% rather than above 8% as for previous forecasts - and US business confidence no longer in the upper-band of its historical range. The Chinese PMI for the month of July this morning printed dangerously close to the 50 threshold, suggesting a continuation to the slowdown phase which started late last year.

In summary, we cannot find any obvious catalysts for long-dated US Treasury yields to be rising from current levels, yet we maintain our year-end fair value for the yield on the 10-year note at 1.75%, considering by how much it is understating the US expansion, unless one contemplates the possibility of no growth for 2022.

Equity Update

It was all about results last week. Developed market earnings updates surprised to the upside on already high expectations, a shift from emerging markets which in the last decade led growth. For Q2, 55% companies in the Stoxx 600 that reported had EPS growth of +140% y/y and the 50% in the S&P 500 that reported +90%. Record profit growth but not record profit as expectations for the rest of 2021 and 2022 are high.

Global equities finished the week lower, but the month of July higher, with markets influenced by various factors: the spreading Delta variant, China's recent crackdown on overseas listed corporates and for-profit education companies, Q2 earnings, the Fed’s continuing accommodative policy and economic data around Q2 GDP releases. Year to date, developed market equity performance leads emerging markets by 15% with EM performance flat for the year, post a 14% fall in China’s main equity Index in July. The UAE and KSA were among the few markets with a positive week. Strong growth in UAE bank earnings buoyed by lower impairment charges, helped sentiment.

China stocks had a volatile week and the uncertainty could continue to weigh on performance. In the last few months there has been a regulatory crackdown on technology companies in the digital payment space (Ant) and those with large data banks, along with investigations into companies listing in the U.S. (Didi) and new regulations for profit making online education companies. While largely driven by data privacy concerns, the last is on reducing social pressure on the funding for tuition beyond school hours. Whilst China company fundamentals are attractive, with the main Index at low valuations and earnings growth in the 30%+ range, till there is clarity on what the regulatory authorities plan, we wouldn’t be bottom fishing. Over the long run, China is an important member of the world economy contributing to c.16% of global GDP. Our positioning continues to have a higher overweight to developed market equities and in the emerging market region whilst we maintain a small overweight, we have been neutral Asia since last month.

US tech companies which generate 60% of revenue from overseas are a contrast to China’s domestic focused tech giants and should see further traction post bumper revenue and earnings growth last quarter. However, forward guidance cannot be anything but cautionary as last quarter profits grew 90% for the big 5. The move to digital has continued even post- openings, a trend accelerated by the pandemic, but there to stay. Facebook reported a revenue increase of 56% and profit growth of 101% y/y driven by higher pricing on ads and its push into ecommerce. In spite of it being the target of government and user activism on use of its data and privacy concerns, monthly active users rose 7% y/y to 2.9 billion. Alphabet grew profits by 200% aided by digital ad sales and notable for Apple was its growth in emerging markets and China, with global paid subscriber accounts over 700 million. Amazon disappointed with lower guidance, though profits grew 50%. The more cyclical European market’s mining and energy companies Shell, Rio Tinto and Total Energies saw earnings grow by up to +200% y/y and more significantly increased dividends and buybacks.

Download PDF

Written By:

Maurice Gravier Chief Investment Officer, MauriceG@EmiratesNBD.com

Anita Gupta Head of Equity Strategy, Anitag@EmiratesNBD.com

Satyajit Singh Fixed Income Analyst, SatyajitSI@EmiratesNBD.com

Giorgio Borelli Head of Asset Allocation, GiorgioB@EmiratesNBD.com

Disclaimer

Emirates NBD Bank PJSC (“Emirates NBD”) is licensed and regulated by the UAE Central Bank and this website aims at providing Internet users with information concerning Emirates NBD Private Banking, its products and activities. Persons having access to information made available by Emirates NBD on this website accept the following rules:

Reliance:
Emirates NBD uses reasonable efforts to obtain information from sources which it believes to be reliable, however Emirates NBD makes no representation that the information or opinions contained in publications on this website are accurate, reliable or complete. Published information may include data/information from stock exchanges and other sources from around the world and Emirates NBD does not guarantee the sequence, accuracy, completeness, or timeliness of information contained on this website provided thereto by unaffiliated third parties. Anyone proposing to rely on or use the information contained on this website should independently verify and check the accuracy, completeness, reliability and suitability of the information and should obtain independent and specific advice from appropriate professionals or experts. Further, references to any financial instrument or investment product are not intended to imply that an actual trading market exists for such instrument or product. Emirates NBD is not acting in the capacity of a fiduciary or financial advisor. Any publications on this website are provided for informational purposes only and are not intended for trading purposes. Data/information provided herein is intended to serve for illustrative purposes and is not designed to initiate or conclude any transaction. The information available on this website is not intended for use by, or distribution to, any person or entity in any jurisdiction or country where such use or distribution would be contrary to law or regulation. This website and anything contained herein, is provided "as is" and "as available," and that Emirates NBD makes no warranty of any kind, express or implied, as to this website, including, but not limited to, merchantability, non-infringement, title, or fitness for a particular purpose or use.

Modifications:
The provision of certain data/information on this website is subject to the terms and conditions of other agreements to which Emirates NBD is a party. Emirates NBD reserves the right to make changes and additions to the information provided at any time without prior notice. The information may be modified or removed without prior notice. No buy or sell orders submitted via the internet or email will be accepted. In addition, the data/information contained on this website is prepared as of a particular date and time and will not reflect subsequent changes in the market or changes in any other factors relevant to the determination of whether a particular investment activity is advisable.

Liability:
Information contained on this website is believed by Emirates NBD to be accurate and true, in all material respects. Emirates NBD accepts no responsibility whatsoever for any loss or damage caused by any act or omission taken as a result of the information contained on this website. Further Emirates NBD accepts no liability for the information and opinions published on the website and is under no obligation to remove outdated information from its website or to mark it clearly as such. The information given on this website may not be distributed or forwarded in whole or in part. Accordingly, anything to the contrary herein set forth notwithstanding, Emirates NBD, its suppliers, agents, directors, officers, employees, representatives, successors, assigns, affiliates or subsidiaries shall not, directly or indirectly, be liable, in any way, to you or any other person for any: (a) inaccuracies or errors in or omissions from the information available on this website including, but not limited to, quotes and financial data; or (b) loss or damage arising from the use of this publication, including, but not limited to any investment decision occasioned thereby. or (c) under no circumstances, including but not limited to negligence, shall Emirates NBD, its suppliers, agents, directors, officers, employees, representatives, successors, assigns, affiliates or subsidiaries be liable to you for direct, indirect, incidental, consequential, special, punitive, or exemplary damages even if Emirates NBD has been advised specifically of the possibility of such damages, arising from the use of the information on this website, including but not limited to, loss of revenue, opportunity, or anticipated profits or lost business. Emirates NBD expressly accepts no liability for losses or damages of any kind arising from using or accessing this website or links to third-party websites or from viewing information on any of its web pages. Furthermore, Emirates NBD accepts no liability for any unauthorized manipulation of users IT systems. Emirates NBD expressly draws user’s attention to the risk of viruses and the threat of hacker attacks

Third Party Website:
Users may be aware that Emirates NBD has no control whatsoever over third-party websites linked to or from this website and therefore accepts no liability for the content of such websites being correct, complete and legally valid for the products and services offered on such websites. Emirates NBD’s express written permission must always be sought before including a link to this website on a third-party website.

Solicitation:
None of the information on this website in any way constitutes a solicitation, offer, opinion, or recommendation by Emirates NBD to buy or sell any security, or to provide legal, tax, accounting, or investment advice or services regarding the profitability or suitability of any security or investment.

Forward Looking:
The information contained on this website does not purport to contain all matters relevant to any particular investment or financial instrument and all statements as to future matters are not guaranteed to be accurate. Certain matters in this publication on the website are about the future performance of Emirates NBD or members of its group (the Group), including without limitation, future revenues, earnings, strategies, prospects and all other statements that are not purely historical, constitute “forward-looking statements”. Such forward-looking statements are based on current expectations or beliefs, as well as assumptions about future events, made from information currently available. Forward-looking statements often use words such as “anticipate”, “target”, “expect”, “estimate”, “intend”, “plan”, “goal”, “seek”, “believe”, “will”, “may”, “should”, “would”, “could” or other words of similar meaning. Undue reliance should not be placed on any such statements in making an investment decision, as forward-looking statements, by their nature, are subject to known and unknown risks and uncertainties that could cause actual results, as well as the Group’s plans and objectives, to differ materially from those expressed or implied in the forward-looking statements. Past performance is not necessarily a guide to future performance. Estimates of future performance are based on assumptions that may not be realized.

Risk: In addition, before entering into any transaction, the risks should be fully understood and a determination made as to whether a transaction is appropriate given the person’s investment objectives, financial and operational resources, experiences and other relevant circumstances. The obligations relating to a particular transaction (and contractual relationship) including, without limitation, the nature and extent of their exposure to risk should be known as well as any regulatory requirements and restrictions applicable thereto. Data included on this website may rely on models that do not reflect or take into account all potentially significant factors such as market risk, liquidity risk, and credit risk. Emirates NBD may use different models, make valuation adjustments, or use different methodologies when determining prices at which Emirates NBD is willing to trade financial instruments and/or when valuing its own inventory positions for its books and records.

Investment in financial instruments involves risks and returns may vary. Before making such an investment, investors should consult their advisers on the legal, regulatory, tax, business, investment, financial and accounting implications of the investment.

Intellectual property:
The information on this website has been developed, compiled, prepared, revised, selected, and arranged by Emirates NBD and others (including certain other information sources) through the application of methods and standards of judgment developed and applied through the expenditure of substantial time, effort, and money and constitutes valuable intellectual property of Emirates NBD and all present and future rights in and to trade secrets, patents, copyrights, trademarks, service marks, know-how, and other proprietary rights of any type under the laws of any governmental authority, domestic or foreign, shall at all times be and remain the sole and exclusive property of Emirates NBD and/or other lawful parties and you acknowledge that you have no ownership rights in and to any of such items. Except as specifically permitted in writing, the information provided in this website shall not be copied or make any use of any information on this website or any portion of the intellectual property rights connected with this website, or the names of any individual participant in, or contributor to, the content of this website, or any variations or derivatives thereof, for any purpose. Further you shall not use any of the trademarks, trade names, service marks, copyrights, or logos of Emirates NBD or its subsidiaries in any manner which creates the impression that such items belong to or are associated with you or, except as otherwise provided with Emirates NBD’s prior written consent,

Confidentiality:
The information on this website solely for non-commercial use and benefit and the use of this information is not intended for resale or other transfer or disposition to, or use by or for the benefit of, any other person or entity. Information contained in this website shall not be used, transferred, distributed, reproduced, published, displayed, modified, create derivative works from any data contained on this website or disposed of in any manner that could compete with the business interests of Emirates NBD. Any part of this website may not be offered for sale or distribute it over any medium including but not limited to over-the-air television or radio broadcast, a computer network or hyperlink framing on the internet without the prior written consent of Emirates NBD. The information contained on this website may not be used to construct a database of any kind. The data on this website shall not be used in any way to improve the quality of any data sold or contributed by you to any third party.

Recipient Acknowledgements
In accessing this website, you acknowledge and agree that there are risks associated with investment activities. Moreover, you agree that your use of this publication is at your sole risk and acknowledge that the responsibility to obtain and carefully read and understand the content of documents relating to any investment activity described on this website and to seek separate, independent financial advice if required to assess whether a particular investment activity described herein is suitable, lies exclusively with you.

China clampdown versus Fed persistent dovishness

AT A GLANCE

WEEKLY OUTLOOKS

2021 Global Investment Outlook
Investing in the Age of Magic Money

Useful Links & Documents

Segments

Products

Customer Care

Security

Tools & Others

Terms and Conditions

About Emirates NBD

Common Reporting Standard FAQ's

Customer Login

China clampdown versus Fed persistent dovishness

AT A GLANCE

WEEKLY OUTLOOKS

2021 Global Investment Outlook Investing in the Age of Magic Money

Useful Links & Documents

Segments

Products

Customer Care

Security

Tools & Others

Terms and Conditions

About Emirates NBD

Common Reporting Standard FAQ's

Share on

2021 Global Investment Outlook
Investing in the Age of Magic Money