Time for Chinese growth to drive global markets

China’s pro-growth policy changes are bearing fruit. High-profile official economic data are likely to take some time to testify to the robustness of China’s recovery, because of the lags involved. But more timely high-frequency data already suggest that a durable economic reopening is well underway.

Road traffic, as measured by congestion levels in China’s 15 largest cities, is running at levels not seen since September 2021. Other measures of travel intensity within Chinese cities tell a similar story of enhanced mobility. The strength in demand has been sufficient for Saudi Arabia to raise selling prices to Asia. In addition, Chinese refiners are also on pace to source about twice as much crude this March from the US Gulf Coast compared to the past few years. Refinery utilization rates, particularly for state-owned firms, have been picking up steam to meet this increased appetite. We believe it is only a matter of time until this sequential improvement in demand from both China and developed markets heading into the spring and summer produces more upside in oil prices as the seasonal slow period passes.

Chinese new home prices were steady in January, arresting a 16-month streak of monthly declines. The suite of policy measures designed to improve the supply side, and to a lesser extent, bolster demand, suggest that this important sector should find more stability in 2023 vs. 2022.

One lesson from developed market economies in 2021 is that markets may consistently underestimate the momentum generated by the reopening process. We think that mistake is being made again with regards to China. 12-month forward earnings estimates for Chinese stocks are near levels that prevailed at their 2020 lows. So too are forward price-to-earnings ratios. We believe there is ample scope for Chinese equities to both post surprisingly strong earnings and to re-rate higher in line with emerging market stocks more broadly. In addition, multiples on very expensive US stocks should narrow towards EM equity valuations, amid high rates and earnings headed in the other direction.

We will continue to closely monitor a number of metrics including Chinese mobility (car, subway, and flight utilization), consumer spending, employment data, and oil imports to confirm that its economic rebound continues to gain traction.

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In our view, the factors that interrupted the outperformance of Chinese equities – a resurgent US dollar and geopolitical concerns – will not have much more staying power.

We came into the year with high conviction that calls for an imminent US recession were far too pessimistic. Indeed, US activity and inflation data have started off the year surprisingly strong relative to consensus. This has caused the market’s expectation for the Federal Reserve’s terminal policy to break to the upside after being in a narrow four-month range around 5 percent. (See Exhibit 4). A higher expected terminal rate, along with an unwind of short positioning, has sparked a sharp surge in the US dollar in recent weeks. Dollar strength is typically a headwind to cyclical positions, and especially emerging market equities. This episode has been no exception.

However, even some of the more hawkish Federal Reserve officials who would have preferred to raise rates by 50 basis points in February are reluctant to revise their estimate for the eventual end point for the central bank’s policy rate upwards as of now. We (and they) believe that the US economy is neither as sluggish as December’s data made it out to be, nor in full-blown boom mode as some of the January figures would imply. The truth is probably somewhere in between. It is likely that US economic data still points to a solid expansion in February, but with a step-down in momentum.

Geopolitics have also played a key role in fueling risk aversion for Chinese stocks. The MSCI China Index erased all of its multiple expansion from January after news regarding the entrance of a Chinese spy balloon over US territory. As that issue subsided somewhat, concerns over China’s potential military support for Russia emerged.

In our view, some statements made by US officials are more noise than signal, aiming to deter China from providing military aid to Russia and diminish China’s attempt to position itself as an independent arbiter of a peace process to resolve the war instigated by its ally. Importantly, dialogue between the US and China remains open, with plans for US President Joe Biden and Xi to speak “in the not too distant future,” according to the US National Security Advisor. As mentioned, we have received many signals that Chinese policy has shifted towards prioritizing economic growth. We do not think President Xi plans on compromising that goal by drawing the ire of the US and Europe alike by providing weapons to Russia. Such a course of action would likely see the US and Europe enact crippling sanctions that, in our view, would undo the economic progress China has made to date.

We believe 2023 marks China’s return to being a leader rather than laggard in economic growth. This dynamic, in our view, will prove a more potent catalyst for markets than recent geopolitical disputes or the ultimate peak for the Federal Reserve’s policy rate.

We do not expect US activity and inflation data to be so strong as to provoke a return to 2022 in rates and foreign exchange markets, where expectations for the Fed’s policy rate – and the US dollar vs. other currencies – trended persistently higher. The next leg of the mini reacceleration in global activity will be driven by China – and benefit the assets most sensitive to its economic rebound.

The China growth story, coupled with clear evidence that developed market economies will avoid recession for at least the first half of the year, is key to our preference for cyclical assets, for example: emerging market equities over US stocks, sectors like energy and financials, and value stocks over growth.

The chart below shows the views of our Asset Allocation team on overall asset class attractiveness as of February 28, 2023. The colored squares on the left provide our overall signal for global equities, rates, and credit. The rest of the ratings pertain to the relative attractiveness of certain regions within the asset classes of equities, rates, credit and currencies. Because the ACA does not include all asset classes, the net overall signal may be somewhat negative or positive.

Source: UBS Asset Management Investment Solutions Macro Asset Allocation Strategy team as of February 28, 2023. Views, provided on the basis of a 3-12 month investment horizon, are not necessarily reflective of actual portfolio positioning and are subject to change.