Key Takeaways
- Policy announcements that include a $278 billion rescue package have given Chinese equities a boost.
- Longer-term, economic fundamentals will likely remain the key driver – deflation remains an issue and authorities need to defuse the property bubble.
- Despite near-term challenges, China remains a potential beneficiary of long-term strategic planning around themes like clean energy.
- Japanese equities continue to benefit from ongoing improvements in corporate governance as well as the country’s gradual exit from deflation.
- Despite some concerns about an appreciating yen, the outlook for Japan remains a broadly positive one.
Despite rising bond yields, exemplified by the 0.2% climb in the US 10-year, global equities have shown resilience year-to-date. Supporting the “soft landing” narrative, macroeconomic data suggests sustained US growth. Further bolstering this is the strength observed in fourth-quarter S&P aggregate earnings.
After a shaky start, Chinese equities received a much-needed boost last week following a flurry of policy announcements. Headlines announcing a potential $278 billion equity market rescue package, allowing policymakers to tap into state-owned enterprise offshore accounts, were followed by the new central bank governor’s pledge to expedite monetary easing. Notably, the 0.5% reduction in the reserve requirement ratio, the percentage of deposits banks must hold as reserves, triggered the strongest daily performance in the CSI 300 this month. However, the index remains significantly below its 2021 peak. There was a surge in investor interest in using options to capitalise on potential upside in Chinese equities last week.
The reserve requirement ratio cut extends a long-standing trend dating back to 2011. While its effectiveness in stimulating the economy or stock market has been mixed, it serves as a tool for liquidity adjustment. Major interest rate cuts are unlikely due to concerns about their negative impact on bank margins and currency depreciation.
Economic fundamentals will likely remain the key driver of China’s long-term equity performance. Deflation remains a pressing issue, requiring authorities to carefully navigate the delicate task of defusing the property bubble without excessive stimulus. Policymakers are actively restructuring the economy to pivot away from property dependence and towards advanced manufacturing, relying on fiscal measures to maintain acceptable growth.
China’s openness to new technologies like clean energy signifies a deliberate departure from older economic models. Despite challenges like debt reduction and trade barriers, there’s a clear commitment to enduring short-term difficulties for potential long-term gains. The success of the electric vehicle revolution demonstrates the viability of this strategic shift. In this context, undervalued Chinese tech stocks may warrant closer consideration. However, past rallies driven by proposed policies have tended to fade, so policy follow through is important.
In contrast to China, Japanese equities have outperformed their Chinese counterparts both this month and significantly over the past year. Our positive stance on Japan stems from the anticipated benefits of its gradual exit from deflation and ongoing improvements in corporate governance.
Enhanced governance, championed by stricter Tokyo Stock Exchange guidelines, is fostering value creation and encouraging companies to prioritise capital efficiency by maximising their return on equity. Notably, the latest report revealed that nearly half of listed companies have taken steps towards this goal. Japan’s demographic headwinds could ironically become tailwinds as companies are forced to boost productivity amidst labour shortages, potentially bolstering margins.
From a macroeconomic perspective, the potential upturn in the machine tool cycle bodes well for Japan, particularly in industrials, technology, and autos. While industrial machinery appears to be reaching a trough, the technology sector is poised for an upcycle. Although auto companies enjoyed a strong performance last year, optimism is tempered as the COVID recovery cycle matures. Notably, Japan, traditionally a global cycle play, currently exhibits a degree of resilience less reliant on external economic fluctuations. The combined forces of exiting deflation, rising wages and appreciating house prices contribute to a positive outlook.
While concerns about yen appreciation remain, its impact hinges on the global economic backdrop. If it coincides with a strong global demand for durable goods, the benefits could outweigh the potential headwinds of a stronger currency. However, a scenario of yen appreciation alongside a significant global downturn could significantly pressure earnings. We prefer to hold Japanese equity exposure unhedged.
Data highlights for the week ahead include the Bank of Japan’s meeting summary, Purchasing Managers’ surveys in China and payrolls in the US.
