Key Takeaways
- Chinese PPI, Chinese 10-year yield and US NFIB hiring data suggest US inflation has peaked. These are obscure indicators/relationships. But slowing inflation augurs for a US recession – it is not a cause for rejoice.
- The hedging relationship between stocks and bonds still works in China - unlike in the US. As such, China is still a normal market where prices can be more informative.
- Hong Kong is deeply oversold. Despite US recession risks, there is a trade here.
1. US Inflation has peaked
The alternative economic indicators that we used to track the global inflation cycle are also suggesting slowing US growth and falling US demand ahead. For instance, job openings are getting easier to fill, according to the NFIB. This measure tends to lead the US CPI by up to six months (Figure 1). If tight labor supply is being alleviated, then inflation pressure will likely lessen in the coming months due to waning demand.
Figure 1: NFIB jobs openings are getting easier to fill, auguring well for peaking US CPI.
Figure 2: China’s long bond yield leads US demand by up to 18 months.
Figure 3: Falling Chinese PPI/bond yield suggest peaking US CPI; China’s 10y leads US inflation
2. Hong Kong is truly madly deeply oversold
Chinese 10-year yield has indeed started to notch up, diverging from China’s growth assets represented by Chinese internet platform companies (Figure 4). Given a tepid inflation outlook in China, this uptick in bond yield probably suggests a growth recovery, no matter how mild it is going to be.
As the world gradually adjusts to the post-COVID state, the relationship between Chinese bond yield and Chinese growth should normalize to what it was before 2020, when rising bond yield suggested growth and growth assets responded in tandem.
Figure 4: Chinese internet diverging from Chinese 10-year yield.
But not just Chinese internet, the entire Chinese market is not responding to the growth signal, however faint it may be. The Hang Seng is at its lowest in more than a decade, and is at a similar level of 1997 during the Asian Financial Crisis.
In Figure 5, we show the extent of oversold of the Hang Seng Index. We can see that both relative strength and the constituents that are above their 200-day moving average are at their lowest in history.
Figure 5: Hang Seng is truly madly deeply oversold.
3. US market is still in the face of uncertainty
As discussed above, the US market is still undecided about the US inflation outlook. Thus, the US market sentiment is fickle and can turn on a dime. It is one of the reasons why we don’t rely on sentiment indicators to time this cycle, as many historical relationships have become unreliable, and the hedging relationship between stocks and bonds in the US has flipped.
We look at the actual positioning of stocks in portfolios instead. We note that stock positioning is still too high, given the professed depressed market sentiment (Figure 6). Granted, the last data point on stock positioning we had is for the end of August, and should be lower than what it is now after a month of selloffs. But it still won’t be at a level that historically augurs for a market bottom. If so, the US will continue to be a source of volatility for China’s on-and off-shore markets, as they striving to find their footings.
Figure 6: US market sentiment most depressed ever, but stock allocation far from it
Conclusion
The US inflation has peaked. Falling Chinese 10-year yield over the past year has long heralded the arrival of this day in the coming months. But it is not a cause for rejoice, as slowing inflation reflects waning demand, and hence a US recession.
Instead of reading into a dysfunctional US market where the long-held hedging relationship between stocks and bonds has broken down, we take cues from Chinese 10- year bond yield instead. It is notching up, hinting at a mild growth recovery ahead. If so, Chinese growth assets such as the Hang Seng and Chinese internet, should respond eventually.
Of course, daunting geopolitical challenges remain. And the US clearly has not bottomed, and will remain as a source of volatility for the Chinese markets. We are torn between our former sell-side ego to call a bottom and maximize return, and our current buyside self to preserve capital and minimize risks.
Regardless, there is a trade here for the brave.
This is an excerpt from Hao Hong, CFA's research. To learn more about the research, you can click http://research.growim.com/20221009growresearchEN.pdf
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