A report by CYS Global Remit Strategic Sales Management Team
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Over the last two years, central banks worldwide have been elevating interest rates as a measure to control inflation, consequently resulting in more stringent global financial conditions. This escalation has augmented borrowing expenses for governments, businesses, and consumers alike, and is poised to restrain spending well into the following year. The repercussions of central bank tightening are currently permeating the real economy, manifesting in escalating mortgage rates, and rising rents, collectively fostering a climate of heightened consumer caution.
As debt maturities reach their peak in the upcoming years, even if the central bank manages to orchestrate a soft landing for the economy, certain companies may still face prohibitive refinancing costs, leading to defaults and losses for lenders. Consumers are already encountering heightened challenges in securing credit, and regional banks are contending with significant repercussions stemming from the decline in commercial real estate valuations. The question now is whether central banks, which have underestimated the threat of inflation before, will cut interest rates too slowly this time to stem the slowdown in the economy.
Earlier this year, U.S. and euro zone lending surveys showed that credit supply conditions were deteriorating, which could drag down real growth in both regions by 1% to 2% by the end of next year.
Data1 shows that currently in the U.S., banks’ prime lending rate has increased from 3.25% to around 8.50% recently, more than doubled. This has also affected the financing interest rate of Moody’s AAA corporate bonds in the U.S., which has also increased from 2.63% to the recent 5.67%. From the perspective of credit scale, the scale of industrial and commercial loans of U.S. commercial banks has continued to shrink since January this year. The year-on-year growth rate of consumer loans has dropped significantly since October last year, and the year-on-year growth rate of real estate loans has dropped significantly since March this year.
In 2024, the direction of the U.S. economy and inflation trends hold crucial significance for the Federal Reserve's monetary policy stance. Notably, U.S. inflation experienced a significant slowdown in 2023. Influenced by factors such as the diminishing base period effect, elevated housing costs, and global geopolitical uncertainties, there exists a potential risk of a resurgence in food and energy prices. The Federal Reserve's 'last mile' of the inflation fight in 2024 will be nothing but easy, given the challenges encountered in regressing to the 2% inflation target.
Anticipated is the Federal Reserve's commitment to sustaining elevated interest rates (i.e., a prolonged period of higher rates) until the initial quarter of 2024, aligning with its persistent reliance on a data-dependent approach. We envision the Fed scrutinizing economic conditions and risk fluctuations, with the potential for official initiation of interest rate cuts around the midpoint of 2024.
As we peer into 2024, on the equities front, we anticipate the continuation of a broadening bull market in the US equity market, propelled by the Federal Reserve's pivot. To recap, all three major U.S. stock indexes have experienced eight consecutive weeks of gains, concluding 2023 on a positive note. According to Dow Jones Market statistics, the S&P 500 achieved its lengthiest weekly winning streak since late 2017, while the Dow and Nasdaq delivered their most robust performance in the past four years.
Despite stocks currently experiencing strong performance, we cannot dismiss the possibility of turbulent fluctuations and volatility in the market. Even amid the best run of form, U.S. stocks faced a sudden 2% plunge in a brief period last year due to numerous option liquidations. This serves as clear evidence that the market is dynamic and prone to unpredictable swings.
According to a survey conducted by Bank of America Merrill Lynch among fund managers, institutional optimism regarding the outlook for U.S. stocks has achieved a new peak, marking the highest level since January 2022. Over half of the respondents anticipate a global economic slowdown in the coming year, with a prevailing narrative of a soft landing. Concerning industry sectors, technology, banks, and small-cap stocks have emerged as the most crowded trading directions.
In the FX space, we expect most Asian currencies to begin appreciating significantly against the USD for most of 2024, after taking a beating throughout 2022 and much of 2023. The persistent strength of the USD in 2022 and the first half of 2023 was supported by the Fed’s aggressive tightening and US economy resilience narrative. We see a soft USD profile to be favorable for equities.
Reflecting on the past, 2023 commenced with apprehensions of a recession, and by summer, concerns shifted to the potential for systemic inflation. As the year concludes and we cast our gaze into 2024, we find ourselves embracing a Goldilocks narrative. In this scenario, debt growth, economic expansion, and inflation all align in a state that is neither excessively heated nor too tepid. Our perspective anticipates a synchronized global slowdown, although the likelihood of a recession or a hard landing in the U.S. during 2024 appears improbable.
China’s Regulatory Downside Risk
The Hong Kong Stock Exchange experienced a significant sell-off propelled by Tencent, China's tech giant, in response to the introduction of a bill by Chinese authorities enforcing stricter regulations within the gaming industry. This development has sent shockwaves through the gaming sector, as the clampdown is specifically designed to impose limits on both player spending and the time dedicated to playing online games. Renowned for their stylish design, Chinese games allow players to create personalized avatars and indulge in lavish spending.
In terms of valuation, the tech giant Tencent Holdings faced a substantial decline, with its market value plummeting by HKD 367.05 billion (approximately RMB 334.8 billion), nearly equivalent to the entire market value of Xiaomi (approximately HKD 393.1 billion, approximately RMB 358.58 billion). Another major player, NetEase, also listed in Hong Kong, witnessed a dip in its market value, reaching HKD 137.5 billion (approximately RMB 125.4 billion). Given that gaming stands as the primary revenue source for both Tencent and NetEase, the cumulative market value of these gaming leaders suffered a loss exceeding RMB 460 billion in aggregate.
The Chinese government has been no stranger to its exceptionally tough approach to gaming for a very long time, especially for minors and children. Back in 2021, Chinese authorities announced that players under the age of 18 faced restrictions on playtime, capped at three hours per week. The issuance of licenses to online game publishers was halted, leading to an eight-month freeze. It wasn't until April 2022 that the freeze was lifted, following the implementation of enhanced protective measures for minors by gaming companies.
Our perspective on this type of legislation is that it functions more as a social policy and a stringent intervention method rather than promoting economic development. It seems to align with the sentiments of numerous netizens and serves as a tool for control that caters to populism. Essentially, it establishes a regulatory framework that grants legitimacy to the Chinese government for overseeing game companies and intervening in their operations. The level of control is intricate, extending to the regulation of how game companies conduct promotional activities.
In addition, the ambiguity arising from the absence of a defined cap on online spending in the rules is concerning to us. These new regulations extend beyond limitations on minors, encompassing a broader scope. The current apprehension revolves around the extent to which these new gaming rules will be applied.
It is worth mentioning that the draft for comments not only involves the protection of minors, but also clarifies the responsibilities of guardians of minors. It states that parents or other guardians should perform their guardianship duties for minors following the law, guide minors to use online games healthily and rationally, engage in activities beneficial to physical and mental health, develop good living habits, and establish correct concepts of online game consumption.
To prevent and stop minors from being addicted to online games, the draft for comments also recommends parents improve their online literacy, regulate their use of online games, and strengthen the guidance and supervision of minors' use of online games.
Beyond the gaming industry, this bill carries the potential for widespread consequences. There's a looming risk of a ripple effect impacting various sectors of the economy, particularly as private enterprises grow increasingly apprehensive about the unpredictability of economic policymaking. The broader concern revolves around whether other ministries and commissions will follow suit and introduce their regulatory laws.
It's not an overstatement to assert that Chinese policymakers are rife with inherent contradictions. Just in November, Chinese President Xi Jinping extended a warm welcome to foreign investors, signaling a desire for foreign capital in China. This appeared to be an opportune moment for the central government to advance China's economic recovery, aligning with its commitment from this year's Central Economic Work Conference to prioritize economic development, actively attract foreign investment, and foster the growth of the private economy. However, contrary to these pledges, the current trend involves imposing stricter controls to enhance departmental power, contradicting the seemingly positive steps promised just a month ago.
The timing of these curbs is particularly significant, as it comes at the end of a very punishing year for Chinese investors. With a weakened economy, geopolitical concerns, and policy risks prompting many international investors to exit Chinese markets, this development adds to the disappointment for Chinese investors. It follows any fragile optimism that China might be entering a positive phase, and it harkens back to two years ago when Beijing abruptly declared the entire online education industry as non-profit, a move that still resonates with investors.
Looking into 2024, we are of the view that sentiments in China remain weak and could yet turn weaker. We are not convinced the various policies and slogans that promote economic development in China have done enough to reignite investors’ risk-on sentiments. We see bearish sentiments as the default prevailing mood in China.
Improvement in economic fundamentals or green shoots in economic data may not be sufficient to encourage foreign funds to flow back into the world’s second-largest economy. After all, there are more attractive markets in the world to allocate capital and earn a higher rate of return.
In terms of equities, our recommendation is for investors to avoid Chinese markets in 2024, despite the continued affordability of Chinese valuations. The CSI 300 Index experienced a nearly 14% decline in 2023. While the valuations may appear inexpensive, we caution against relying on them to support any investment thesis in China. The persistent high-risk stems from policy and regulatory uncertainties emanating from the Chinese government, presenting a substantial downside risk for international investors.
In the FX space, we see the weaker USD (due to the Fed’s explicit pivot toward cuts in 2024) continue to contribute to the strengthening of the RMB. A further decline toward the psychological key 7 level in 2024 is likely as the RMB passively strengthens against the greenback. The recent RMB exchange rate has returned to the appreciation channel, mainly due to the continuous decline of the USD index and changes in market expectations.
Currently, the market perceives that the U.S. interest rate hike cycle has concluded, prompting a shift toward a more accommodative policy to bolster the U.S. economy. This is reflected in the continuous decline of the USD index, and the narrowing of interest rate spreads between China's 10-year treasury bonds and those of the U.S. Looking ahead, as the unilateral strength of the USD index against non-U.S. currencies diminishes, coupled with robust backing from the steady recovery of domestic economic fundamentals, the RMB exchange rate is expected to gradually ascend to a reasonable price range aligning with its intrinsic value.