I. Year-to-date (2023/01/01 - 2023/01/27) performance review
1. Major assets returns
Source: Bloomberg; dollar-denominated returns
So far this year, as of January 27, the majority of global assets have risen favorably. Bitcoin is the top gainer. $NASDAQ Golden Dragon China Index(HXC)$ and $HSI(HSI)$ representing overseas Chinese stocks gained much; while the $CSI300(000300.SH)$ and CSI 500 were up nearly 10% before the Chinese New Year holiday break.
Expectations of a recovery in China are gradually shining into reality, with consumption and travel data during the Chinese New Year period, both showing a marked recovery. Meanwhile, US Q4 GDP beat expectations, and earnings reports from big companies like $Tesla Motors(TSLA)$ were also surprising. Expectations of a soft landing in the US are fermenting, driving a sharp rally in US stocks.
2. Major strategies' gains
The specific indices are Macro CTA: HFRX Macro CTA Index; Commodity Trend: Bloomberg Goldman Sachs Commodity Trend Index; Equity Neutral: HFRX Equity Hedged Strategy Index; Global 6040: Bloomberg Global 6040 Index.
Source: Bloomberg
The returns of our strategies are as follows.
In the recent month, US/China New Dynamic benefited from the strength of US and Chinese stocks and recorded a very good positive return;
the returns of Tiger GTAA improved as we allocated assets such as China and developed countries' stocks, gold and Japanese yen on top of mainly US bonds;
Tiger GTAA Conservative mainly invested in short-term US Treasuries and has a stable return.
Source: Bloomberg
II. Market interpretation
1. US macroeconomic data is fair, earnings are not bad
During the Spring Festival holiday, the US macroeconomic data has picked up. In addition to the US Q4 real GDP rose as much as 2.9% from the initial value, new orders for durable goods rose 5.6% from the previous quarter, far exceeding market expectations of 2.5%; the Michigan Consumer Sentiment Index rebounded to 64.9 in January, exceeding expectations of 64.6.
White line: US quarterly new orders for durable goods (left axis); Blue line: Michigan Consumer Sentiment Index (right axis); Source: Bloomberg
As of January 26, 110 large companies in the $S&P 500(.SPX)$ have released their earnings reports for Q4 last year. According to Credit Suisse,they beat earnings estimates by 2%. Although this is the smallest margin of exceeded expectations in the past seven years, the earnings of large companies led by $Tesla Motors(TSLA)$ basically satisfied investors. The good news has certainly lifted the gloom of an impending US recession.
Source: Credit Suisse
Meanwhile, US inflation-related data released in January, including CPI and PPI, and PCE all continued the previous downward trend, confirming to the market that the Fed will further slow down interest rate hikes. The Fed's benchmark interest rate futures have priced in a more than 98% chance of a rate hike of just 25 basis points for the Feb. 1 FOMC meeting.
Source: CME FedWatch
As a result, the peak of rate hikes with a pending US recession make US stock markets likely repeat mild recession trades similar to early 2019. A further rally in the valuation of US stocks has overwhelmed a modest downside on the earnings.
2. Overseas institutions are frantically raising bets on Chinese stocks
Of course, Chinese stocks are still the most bullish asset for overseas institutions so far this year. According to a global fund manager survey conducted by Bank of America in early January, 91% of global fund managers expect China's economy to continue to grow strongly, the highest level of optimism since '06. In practice, northbound funds have been flowing significantly into Chinese stocks for three months in a row, with net buying in January this year (up to the Chinese New Year holiday) exceeding the total volumn of last year.
Source: Bank of America
According to historical data, China's major stock indexes tend to perform well after overseas institutions begin to raise their bets.
Then, after the first month of the last 10 times since 2015 when there was significant net northbound buying, the Hang Seng Technology Index and the Nasdaq Golden Dragon Index, which represents Chinese stocks in the US, would have even better returns on average, in addition to benefiting stocks in China.
Source: Bloomberg, dollar-denominated returns
Three consecutive months of significant net buying by northbound funds have only been seen from April to June 2020. The macro environment in China at that time was also a post-pandemic recovery overlaid with accommodative fiscal and monetary policies. Major China stock indices still perform very well in 1 year later despite of 3 months of significant gains.
Source: Bloomberg, all gains above are in USD
III. Future outlook
Most global assets have seen encouraging gains so far this year, mainly from two strong expectations: first, China's recovery, Europe and the United States will only fall into shallow recession; second, inflation is under control and the Fed is about to turn. Currently, these two strong expectations are like Schrodinger's cat (neither fully confirmed nor disproved), in terms of both macro data and earnings reports. Therefore our next asset allocation strategy will revolve around how strong expectations and the three realities of strong, neutral and weak.
For strong expectation 1, the median institutional forecast for China's real GDP in 2023 according to Bloomberg is 5.1%. We can consider 5%-5.5% real GDP growth in China plus GDP growth in Europe and the US around 0% as neutral reality, while real GDP growth above/below the above figure as strong reality/weak reality.
For strong expectation 2, we take the Fed's economic forecast given by the FOMC in December (year-end PCE inflation 3%, benchmark interest rate around 5%-5.5%) as neutral reality, and the final figure is weak reality if it is higher, and strong reality if it is lower.
We will start with the high-frequency data of Chinese travel consumption during the Spring Festival, combined with the recent US macroeconomic data and earnings reports. Strong expectation 1 at least for now fall between strong reality and neutral reality. We assume that the probability of strong reality, neutral reality and weak reality are 30%, 50% and 20% respectively.
By contrast, despite the decline in US inflation data, it is still well above the Federal Reserve's 2% average inflation target. Recent speeches by overseas central bank officials have not revealed the intention to pivot. Therefore, the strong expectation 2 is still likely to fall above the neutral reality, and the likelihood of a weak reality is greater than a strong reality. We believe the probabilities of strong reality, neutral reality and weak reality are 10%, 70% and 20% respectively.
The probabilities of the three realities corresponding to the two strong expectations are multiplied together to obtain the probabilities of the nine combinations of scenarios. We then add the assets that may benefit from the 9 scenarios (in order of ranking), and we get the following chart.
In the coming week, big events include Fed meeting and the ECB meeting, the earnings releases of 110 S&P 500 component companies including $Apple(AAPL)$ , $Alphabet(GOOG)$ and $Amazon.com(AMZN)$ , and the January non-farm payrolls report are coming. The big test is coming up as to how long the current mild recession trades can last.
We will still allocate assets based on the nine probable scenarios mentioned above. And anytime based on new information, we will adjust the probabilities of strong, neutral and weak reality that eventually correspond to the two expectations and the proportion of asset allocation.
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