To The Moon

In the first week of 2023, two giants of US and HK stock market - the declining $Apple(AAPL)$ (orange K-line) and the bottom-bouncing $TENCENT(00700)$ (red and green K-line) converge in terms of their 10-year returns.

Investors who have read the Panning for Gold II: US, Eurozone, China 2023 Economic Outlook can probably understand the expected development of the economic cycle in the US and China, resulting in a "strong Hong Kong stocks, weak US stocks" scenario that is not common in the past decade.

Last week's macroeconomic data and the Fed's moves reinforced the expectation that the US is entering a recession. However, strong US job market continues to constrain the Fed's plans for the magnitude and turning point of interest rate hikes.

1. ISM manufacturing PMI continued to move downward and missed expectations

• What is ISM manufacturing PMI?

ISM manufacturing PMI index is published on the first working day of each month. It reflects the level of economic activity in the manufacturing sector in the United States versus the previous month

Its latest value has fallen to 48.4, the second consecutive month below the key reading of 50. At the same time, the PMI index of new orders relative to own inventory is also declining, reflecting the US manufacturing activity is still facing further downward pressure in the future.

Source: Bloomberg

The S&P Global composite PMI (quarterly) index, which reflects the comprehensive sentiment of small and medium-sized enterprises in major countries around the world, shows that the composite PMIs of the US, China, the EU, the UK and Japan are all below the key reading of 50, continuing to fuel expectations of recession.

Source: Bloomberg

US Labor Market Remains Tight

Last Thursday's US jobless claims showed that the number of first-time jobless claims fell to 204,000 in the last week of last year, significantly lower than the expected 225,000. The four-week average of the value has continued to decline.

Source: TradingEconomics

This suggests that the huge job gap in the US job market that Powell has been referring to is even getting worse.

Last week's non-farm payrolls results showed that Average Hourly Earnings YoY slowed to 4.6%, significantly lower than the consensus estimate of 5%; and that the Participation Rate improved. Both of these are good news to the market.

However, the unemployment rate returned to an all-time low of 3.5%, while private sector job creation also exceeded expectations. TheUS job market is still very strong, and it will not be easy to continue the rapid downward movement in wage inflation over the next few months.

Source: TradingEconomics

Recent Fed Moves

In the minutes of the December FOMC meeting released on Wednesday, the Fed made clear for the first time that there are two risks to balance.

 One risk was that an insufficiently restrictive monetary policy could cause inflation to remain above the Committee's target for longer than anticipated, leading to unanchored inflation expectations and eroding the purchasing power of households, especially for those already facing difficulty making ends meet.

The other risk was that the lagged cumulative effect of policy tightening could end up being more restrictive than is necessary to bring down inflation to 2 percent and lead to an unnecessary reduction in economic activity, potentially placing the largest burdens on the most vulnerable groups of the population.

--from the December FOMC minutes

On Thursday, Bullard, the most hawkish Fed official, spoke at a CFA Institute event titled The Prospects for Disinflation in 2023.

Bullard revealed dovish signals and pointed out that although inflation is still well above the policy target, the benchmark interest rate is close to but has not yet reached a tight enough range. But the Fed's aggressive rate hikes last year have pushed market expectations for inflation down to around 2%, so the theme of 2023 could be disinflation.

The Fed's biggest concern is still that the job market is too oversupplied, with 1 unemployed person corresponding to about 1.7 jobs, meaning job seekers have more bargaining power, making wage inflation sticky.

Source: St. Louis Federal Reserve

Bottom Line

In summary, as the Fed becomes increasingly aware that excessive tightening will trigger an unwanted contraction in demand.

The pace of rate hikes -  Fed slows rate hikes - Fed stops rate hikes - Fed pivots and cut rates - will be determined by how fast hourly wages in the job market fall versus how fast the unemployment rate rises.

But in any case, a slowdown in tightening means that the pressure on the valuation of global equities will not get significantly worse, and equity performance will be determined by expectations on the earnings.

The expected earnings of US stocks will decline as the US economy gradually moves downward, while the expected earnings of Hong Kong stocks will rise as China reopens. The difference between the two expectations will determine which market is stronger or weaker next.