In brief
- Equity investors cheered slower inflation in the U.S. and China’s announcement to ease COVID restrictions.
- While equities look attractive for long-term investors, there are still some short-term headwinds that investors should prepare for.
- Active management is key in selecting the sectors and companies that could ride on weaker growth in the U.S., and better consumer sentiment in China.
Both the Chinese and the U.S. equity markets had something to cheer about in the past week. In the U.S., the October inflation data came in lower than expected and prompted market expectation that the Federal Reserve (Fed) could slow down its monetary policy tightening. In China, the State Council announced on November 11 some easing in COVID restrictions, notwithstanding the rising number of infections in the past two weeks.
The October U.S. Consumer Price Index rose 0.4% month-over-month (m/m), below market expectation and core inflation at 0.3%. While energy inflation rose again, core goods, especially used cars, have seen some significant decline in prices. Core services inflation is still showing firm momentum, much of this was driven by shelter costs. In fact, core inflation ex-shelter fell by 0.1% m/m. This reflects that inflation momentum is indeed cooling in goods’ prices.
Admittedly, this is only one month of data, and it is too early to declare victory against inflation, especially since services inflation is still sticky. Nonetheless, slower price momentum prompted investors to speculate that the Fed can afford to raise rates at a slower pace as soon as the December Federal Open Market Committee meeting with a 50-basis-points increase, and the possible peak in the policy rate by 1Q 2023.
The Chinese government announced 20 measures to optimize COVID control on November 11. This includes reducing the quarantine period for close contacts of infected people and inbound travellers from seven days of centralised quarantine and three days of home quarantine to five and three days, respectively. Stopping the circuit breaker of inbound international flights, improving capacity for treatment and a push forward with vaccination.
While these quarantine measures are still strict by global standards, the adjustments are seen as the first step to facilitate economic recovery and restore consumer and business confidence. The emphasis on raising the vaccination rate and enhancing capacity for treatment could be to prepare the country for reopening, and subsequent increase in infections. With the upcoming winter months and the National People’s Congress in spring, it might be difficult for the government to be too aggressive in reopening, but the months ahead would allow the authorities to prepare a greater movement of people across the country in spring and summer of 2023.
Exhibit 1: Investors looking for catalysts to boost U.S. and Chinese equities’ returns
Source: FactSet, MSCI, Standard & Poor’s, J.P. Morgan Asset Management. Returns are total returns in U.S. dollars based on MSCI indices, except the U.S., which is the S&P 500, and China A, which is the CSI 300 index in U.S. dollar terms. China return is based on the MSCI China index. 10-yr total (gross) return data is used to calculate annualized returns (Ann. Ret.) and annualized volatility (Ann. Vol.) and reflect the period 30/09/12 – 30/09/22. Past performance is not a reliable indicator of current and future results. Guide to the Markets – Asia. Data reflect most recently available as of 14/11/22.There is no doubt that the slower pace of inflation in the U.S. and fresh progress in reopening in China are good news for investors. Light investor positioning in equities and elevated cash holdings could add fuel to an impressive rebound before the year-end. That said, these are just two pieces of the jigsaw puzzle that would facilitate a more sustained recovery in global equities.
In the U.S., corporate earnings are still being revised lower and economic growth has not fully reflected the impact of higher policy rates yet. This implies that economic momentum could decelerate further in the months ahead. Following the 3Q earnings season, market consensus of earnings growth in 2023 is around 6%. We believe weaker revenue growth and profit margin compression could lead to a low single-digit contraction in earnings next year. Hence, we could still see more volatility until economic data stabilizes and earnings expectations reach a more realistic level.
For China, the latest policy announcement is indeed a step in the right direction. We could see China’s economic growth to be on an accelerating path in 2023 when the U.S. and Europe economies contract. A key would be the pace of reopening to revive economic growth without putting too much stress on the healthcare system. This trial-and-error process could take several quarters to reach the equivalent of where other Asian economies are today. We should also see fiscal and monetary policy playing a role to compliment improvement in sentiment.
Investment Implications
The valuation de-rating in both U.S. and Chinese equities in the past year is offering long-term investors a more attractive entry point for these markets. The latest inflation data in the U.S. and economic reopening in China are indeed positive news, but there are still challenges ahead. Active management in sector and company selection remains essential.
In the U.S., the rising risk of a recession due to tighter monetary policy should put investors’ focus on defensive sectors, as well as quality companies with strong balance sheets and ample cashflow. Possible peaking in U.S. Treasury yields should be constructive for growth stocks.
In China, economic reopening should support e-commerce companies, who have spent the past year reducing their cost base and adjusting their business model to comply with regulations. Stronger consumer confidence should also buoy consumer discretionary and industrials. Yet, the challenges facing the real estate sector could take longer to resolve, despite additional bank finances made available to developers.
Investors can also look into broader Asian markets that could benefit from China’s reopening. This could be companies feeding into Chinese consumer demand either in goods or services. With many parts of Asia already adopting the live-with-COVID strategy, China’s policy shift could add to their earnings momentum.
