To The Moon

Hi, Tiger friends

It is the Year of Tiger now. Perhaps because COVID continues to limit the extent of the usual biggest migration in human society during the Lunar new year, and many must stay where they are, instead of crossing the country to reunite with families at this special moment. Hong Kong is confronting the worst outbreak since the pandemic started, and healthcare resources are under serious constraints.

Meanwhile, fewer red packets of “lucky money” appear to have been exchanged in the WeChat groups, the box office on the first day of the new year plunged, and lending stats for January among the biggest lenders were disappointing. It is almost like a spring without the peach blossoms, except that the Hang Seng sprung 760 points, or 3.2%, on the first day of the lunar new year trading, and continued its recovery from its long-term inflection point .

There has been a void of data during the Chinese New Year, and data release during this period tends to be affected by the strong seasonality and holiday effect, and thus notoriously volatile and difficult to analyze. As such, to forecast the near-term direction of the market, traders tend to look to offshore markets during the period for clues. Unfortunately, in recent months, the onshore market has been diverging from Hong Kong. The CSI300 index has fallen 20% from its peak, a territory customarily defined as bear market, while Hong Kong was the best-performing major index globally in January. Given this divergence, whether the Hang Seng is strong or weak gives little clue for the onshore market.

So, what does the Year of Tiger mean for Chinese Stocks?

We have outlined our forecast for the Year of Tiger in our report titled “Outlook 2022: Shadow Fed Tightening”published on 2021.11.15.

Our thesis is that a peaking current account tends to coincide with a peaking stock market index. As overseas economies continue to recover from the pandemic and start to re-open, the production-consumption relationship between China and the US is bound to reset, with the US producing more while consuming less, resulting in slowing export growth and a waning current account for China. Gradually, we are witnessing this thesis slowly playing out.

We are closely monitoring the changes in China’s current account and export-related statistics, as these are the key inputs to our thesis for 2022. During the holiday, manufacturing PMI of New Export Orders was released and continued to track below 50, a level suggesting a marginal contraction in export growth. We compare this data series with the Shanghai Composite (SHCOMP) in Figure 1 and show the close correlation between the two series. Of course, the data series of PMI for New Export Orders was released with a one-month lag and thus should have been reflected in the downtrodden trend of SHCOMP. But a falling SHCOMP does bode ill for export orders in the coming months.

We further plot excess credit growth, a proprietary indicator we developed as a proxy to gauge the underlying credit conditions in China, against the Exports PMI and SHCOMP inFigure 1. We can show that excess credit growth continues to slow, together with the SHCOMP and Exports PMI. Our proprietary proxy works much better than the traditional monetary aggregates, and the widely-adopted “credit impulse” that tricked many of our competitors calling for a market bottom last July.

This is consistent with the observation that the major lenders had a dismal January, and the anecdotes that credits are still not easy to get for smaller firms. That said, Chinese lending tends to concentrate in the first quarter of the year, so that the loans can have a full year to work in the system. As such, traders are anticipating some sort of recovery in Total Social Financing, especially after various offices started jawboning pessimism.

Figure 1: PMI Export Orders vs SHCOMP vs Excess Credit Growth; exports set to slow

Source: Bloomberg, BOCOM Int’l

During the Chinese New Year holiday, the US market has experienced some of the sharpest corrections and then some of the most dramatic intra-day reversals in recent history. While we remain cautious about the US market, and are more heedful of its risks than its potential returns as laid out in our 2022 outlook report (“Outlook 2022: The Shadow Fed Tightening”), we are more interested to see what the US volatility will mean for China.

Figure 2: Falling NASDAQ return suggests slowing Chinese exports, which in turn augur peaked Chinese small caps

Source: Bloomberg, BOCOM Int’l

Historically, falling NASDAQ return tended to suggest slower China export trade growth in the coming months. This is not a spurious relationship coming out of statistical sleight of hands. Indeed, this relationship arises from the interplay between China and the US economic cycles. And not surprisingly, they are also closely correlated with the movement of China’s CSI 500, an index that tracks the small-cap performance and thus is sensitive to changes in macro conditions (Figure 2).

AsFigure 2shows, NASDAQ’s return has peaked at roughly the same level as its previous two peaks in the past two decades, and is reverting to its long-term mean. As the stock market is a leading indicator of the economy, a waning NASDAQ return suggests that the US economy is at its peak in this short cycle, or may have passed it. A slowing US economy will mean weaker consumption growth, and hence our thesis for a peaked Chinese current account and a peaked onshore market.

We can also see how China’s current account affects the ChiNext, or China’s NASDAQ that listed many of China’s leading tech firms. The ChiNext seems to have peaked around the level last seen during the 2015 stock market bubble, in tandem with the peaked current account. Somehow, the peaks in ChiNext resemble a classic technical “triple top” (Figure 3).

Figure 3: Peaked Chinese Current Account vs. ChiNext’s “triple top”

Source: Bloomberg, BOCOM Int’l

In sum, while many are angsty to know how the onshore market will go once it opens for the Year of the Tiger, it is more important to discern the bigger macro picture that governs the longer underlying trading cycle. In our recent report titled“The PBoC Articulates its Policy Stance”(published on 2022.01.19), we discussed how the biggest risk the market is confronting right now, is that the Fed must tighten even as the US economy starts to buckle under the weight of inflation and a slowing Chinese economic cycle. InFigure 4, we show how the falling Chinese long bond yield amid the slowdown leads US Semi ETF and US EPS growth. This scenario bears striking resemblances to 2018, one of the worst years in Chinese stock market history, and one of the worst fourth quarters for US stocks.

There has been a sell-side chorus chanting monetary easing and the consequent bullishness. But by now everyone knows that, and we have discussed the prospects of such potential easing moves in our 2022 outlook report (“Outlook 2022: The Shadow Fed Tightening”, 2021-11-15). Our forecast of the SHCOMP’s trading range is just below 3,200 to ~3,800, with ~3,000 being the extreme case. Note that the SHCOMP peaked on 13 December 2021 at 3,709, and is now at 3,361. In the very short term, the market is very oversold and thus can see a technical rebound. But such rebound purely technical in nature will be fleeting and difficult to trade. And we note that in July 2018, SHCOMP rebounded briefly at a similar oversold level, and then fell another ~10% before it eventually bottomed six months later. Often, oversold begets oversold, and the oversold condition can be resolved by market falling further.

The Year of Tiger is without doubts a pivotal year, a year to charter the future course for China. How policies will respond to economic contingences can set an example for the decade ahead. Quality over quantity, equality over efficiency, sustainability and safety will be the guiding principles that will fundamentally re-shape the Chinese economy.

In Chinese Zodiac, the Tiger is strong, confident, and capricious. It is harder to find a better zodiac sign to describe what has happened since our 2022 outlook report was published. We are biding our time, for better opportunities as the Tiger strides forward.

We wish you and your family a prosperous New Year of Tiger!

Figure 4: Falling Chinese long bond yield portends US economic cycle to decelerate

Source: Bloomberg, BOCOM Int’l