Source: Guo Lei Macro Cafe
Guo Lei is the chief economist of GF Securities and a director of the China Chief Economist Forum
Summary of the report
First, according to the Merrill Lynch clock, we should hold bonds during recessions, stocks during recovery, commodities during overheating, and cash during stagflation. But in fact, asset performance is often half ahead of schedule, and the best stage of stocks is generally "late recession" to "early recovery". The former stage is stable policy growth and abundant liquidity; the latter stage is economic stabilization and profit repair.
Second, what stage is the economy at? The current round of economy has initially slowed down since the third quarter, and short-term influencing factors include supply constraints such as the epidemic, double reduction, and double control; at the same time, there is also an important marginal change on the demand side that is the lower step of the real estate sales center, and the average daily real estate transaction in 30 cities has dropped to about 400,000 square meters since August. External demand remains strong, with average growth rates of 14.4%, 14.3% and 14.9% in the first quarter, second quarter and July-August respectively; but according to the empirical law that we have repeatedly pointed out that the export cycle is flat on the PPI cycle, there will be downward pressure on exports in the first half of next year. In short, the economy will slow down in two phases, with the current short-cycle economy in the sense of merrill Lynch clock "pre-recession."
Third, the "pre-recession" in history generally has a "smashing pit" adjustment of equity assets to reflect the downward revision of future profit growth. However, the stock market has basically maintained a volatile characteristic in the third quarter. We understand that it is mainly related to three factors, one is that the stock market's early performance has not deviated significantly from the fundamentals. In the first 8 months of 2021, the cumulative profit of industrial enterprises increased at an average growth rate of 19.5% in two years, while the Wind all-A index increased by an average of 19.4% in two years in the same period; second, the policy launched a "cross-cycle adjustment" different from the previous cycle in the third quarter, such as the unexpected reduction in the reserve requirement in early July; the third is that the supply disturbance in the third quarter also brought a rhythm different from the normal demand law, followed by the reduction of the epidemic pulse, the correction of sports carbon reduction, and the consumption and some industrial sectors may have a small stabilization month-on-month. The market's expectations for the economy are not unilateral; fourth, the supply contraction has led to an increase in upstream prices, the South China Energy Index rose by 27.6% in the third quarter, and the market once had a more concentrated opportunity under the PPI clue mapping. In a sense, this round is equivalent to a smooth version of the "pre-recession".
Fourth, the emergence of the "late recession" in the sense of Merrill Lynch clock requires more typical stable growth of policies, which will bring stable expectations of economic and corporate earnings. At the end of July, the Politburo meeting set the tone for the economy to be "sustained and stable recovery, stable and good" superimposed on "unstable and unbalanced", and did not lay out typical stable growth. We estimate that the Politburo meeting and the Central Economic Work Conference in December will make more comprehensive arrangements. The policy space in the first half of 2022 includes a front-end, more active fiscal policy; long-term rental housing investment; carbon peaking, carbon neutral "1+N" policy system after the introduction of "double carbon" related investment, and systematic measures to promote the consumption of durable consumer goods such as new energy vehicles.
Fifth, outside of this framework, there are important macro cues that are not entirely predictable but may deeply affect risk appetite, which we actually believe are already reflected in current pricing by probability weighting. First, the trend of the global epidemic, which is currently in the decline period of the fourth wave of the epidemic in the world, and the emergence of oral drugs has further affected global expectations; second, there may be room for improvement in Sino-US economic and trade relations, the Ministry of Foreign Affairs pointed out that China and the United States agreed to take action to work together to promote Sino-US relations back to the right track of healthy and stable development.
Sixth, the main risk factor is the global liquidity disturbance represented by the dollar index, which rose from 90 to around 94 in the second half of the year. The negative correlation between the equity market and the DOLLAR index since 2020 is relatively high.
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According to the Merrill Lynch Clock, we should hold bonds during recessions, stocks during recovery, commodities during overheating, and cash during stagflation. But in fact, asset performance is often half ahead of schedule, and the best stage of stocks is generally "late recession" to "early recovery". The former stage is stable policy growth and abundant liquidity; the latter stage is economic stabilization and profit repair.
In The July 2020 "Logical Transition from Late Recession to Pre-Recovery," we built a framework for a Merrill Lynch clock:
Here we make an extension, further dividing the economy into four stages, such as pre-recession, late recession, pre-recovery, and late-recovery, the core spirit of this division is similar to the "Merrill Lynch clock", but we tend to make it more concise and practical. Merrill Lynch Clock's statements about "stagflation" and "overheating" are easily taken literally, causing ambiguity from different perspectives, thus deviating from the neutrality and technicality of these concepts.
Obviously, deflationary transactions occur more in the early and late recessions of the economy; recovery transactions occur more in the early and late recovery periods of the economy.
The stock market is responsive to expectations, so it tends to be very effective. Empirically, there are two periods of systematic opportunity for the stock market: "late recession" (liquidity-driven, valuation expansion) and "pre-recovery" (earnings-driven, balance sheet repair). And due to a series of endogenous characteristics, China's stock market is often characterized by a high slope in the previous stage.
What stage is the economy at? The current round of economy has initially slowed down since the third quarter, and short-term influencing factors include supply constraints such as the epidemic, double reduction, and double control; at the same time, there is also an important marginal change on the demand side that is the lower step of the real estate sales center, and the average daily real estate transaction in 30 cities has dropped to about 400,000 square meters since August. External demand remains strong, with average growth rates of 14.4%, 14.3% and 14.9% in the first quarter, second quarter and July-August respectively; but according to the empirical law that we have repeatedly pointed out that the export cycle is flat on the PPI cycle, there will be downward pressure on exports in the first half of next year. In short, the economy will slow down in two phases, with the current short-cycle economy in the sense of merrill Lynch clock "pre-recession."
In 2020, the impact of the epidemic brought about rapid clearance, and consumption, investment and exports fell to historical lows. From the perspective of the main driving forces, the first stage is the repair of necessary consumption; the second stage is the recovery of real estate sales and optional consumption; and the third stage is the further advancement of exports and the driving of manufacturing.
The economy continued to repair steadily in the first half of 2021. The strong performance of exports is one of the main driving forces, with export growth of up to 38.6% in the first half of the year. The average two-year growth rate of real GDP in the first quarter and the second quarter was 5.0% and 5.5%, respectively.
From the third quarter of 2021, the downward pressure on the economy has initially emerged, and the main drag factors include:
First, the real estate sales center goes down the steps. From June to September, the average daily transaction volume of 30 city real estate was 600,000 square meters, 560,000 square meters, 420,000 square meters and 420,000 square meters, respectively.
Second, the double reduction will have a far-reaching positive impact on the norms of the education and training industry, but it will bring certain constraints to the service industry in the short term; since the rebound of the regional epidemic since late July, the prevention and control has heated up, affecting the performance of consumption and service industries.
Third, the lack of power supply superimposes the dual control of energy consumption, and the production limit of electricity is widespread.
Relative to domestic demand, external demand in the third quarter still maintained a strong performance. In The Nine Macroeconomic Questions, we point out that exports and PPIs are empirically cyclical. At present, the whole is in the top area, and it is estimated that it will hover high or slightly decline during the year. In the absence of the addition of other exogenous variables (vaccines, tariffs, etc.), it is likely to enter a range of rising pressures next year.
This means that from the perspective of economic trends in the 3-4 quarters, real estate in the second half of this year and exports in the first half of next year will be the terminal drivers of the two-stage slowdown of the economy. The current short-cycle economy is in the "pre-recession" in the sense of merrill Lynch clock.
Historical "pre-recession" generally has a "smashing pit" adjustment of equity assets to reflect the downward revision of future profit growth. However, the stock market has basically maintained a volatile characteristic in the third quarter. We understand that it is mainly related to three factors, one is that the stock market's early performance has not deviated significantly from the fundamentals. In the first 8 months of 2021, the cumulative profit of industrial enterprises increased at an average growth rate of 19.5% in two years, while the Wind all-A index increased by an average of 19.4% in two years in the same period; second, the policy launched a "cross-cycle adjustment" different from the previous cycle in the third quarter, such as the unexpected reduction in the reserve requirement in early July; the third is that the supply disturbance in the third quarter also brought a rhythm different from the normal demand law, followed by the reduction of the epidemic pulse, the correction of sports carbon reduction, and the consumption and some industrial sectors may have a small stabilization month-on-month. The market's expectations for the economy are not unilateral; fourth, the supply contraction has led to an increase in upstream prices, the South China Energy Index rose by 27.6% in the third quarter, and the market once had a more concentrated opportunity under the PPI clue mapping. In a sense, this round is equivalent to a smooth version of the "pre-recession".
In the first 8 months of 2021, the cumulative profit of industrial enterprises averaged 19.5% in two years, while the Wind All A Index increased by an average of 19.4% in two years in the same period, and the Wind300 Index (excluding finance) increased by an average of 20.4% in two years.
On July 15, the central bank lowered the reserve requirement ratio of financial institutions by 0.5 percentage points, and reduced the RRR to release long-term funds of about 1 trillion yuan. At the end of July, the Politburo meeting pointed out that "it is necessary to do a good job in cross-cycle adjustment of macro policies, maintain the continuity, stability and sustainability of macro policies, make overall plans for the convergence of macro policies this year and next year, and keep the economy operating in a reasonable range." The RRR cut in July was largely more than expected, and further opened up the market's imagination of macro policies.
The South China Energy Index rose by 9.0%, 9.4% and 27.6% respectively in the first three quarters.
Within the medium-term trend of the two-stage slowdown, there will also be small cycles. Under the superposition of various factors, the quarterly growth rate of total retail sales of social consumer goods from July to August was -0.19% and 0.17% respectively, and the growth rate of consumption in the fourth quarter was more likely than this data. Under the influence of power curtailment, it is expected that the growth rate of industrial added value in September may be lower than that of the previous month, and there will be a certain degree of correction in the fourth quarter.
The emergence of "late recession" in the sense of Merrill Lynch clock requires more typical stable growth of policies, which will bring stable expectations of economic and corporate earnings. At the end of July, the Politburo meeting set the tone for the economy to be "sustained and stable recovery, stable and good" superimposed on "unstable and unbalanced", and did not lay out typical stable growth. We estimate that the Politburo meeting and the Central Economic Work Conference in December will make more comprehensive arrangements. The policy space in the first half of 2022 includes a front-end, more active fiscal policy; long-term rental housing investment; carbon peaking, carbon neutral "1+N" policy system after the introduction of "double carbon" related investment, and systematic measures to promote the consumption of durable consumer goods such as new energy vehicles.
In "The Logical Transformation from Late Recession to Pre-Recovery", we once proposed a rough criterion: the dividing line between pre-recession and post-recession is policy steady growth; the dividing line between late recession and pre-recovery is PPI bottoming; and the dividing line between pre-recovery and late-recovery is policy convergence.
There are two key points in time that may correspond to the possible increase in the steady growth of the policy, one is the deployment of the fourth quarter economic policy at the Politburo meeting at the end of October, and the other is the Deployment of economic policies for next year at the Politburo meeting and the Central Economic Work Conference in December. We tend to think that the latter has a high probability of further opening up stable growth space. The pressure on local finances brought about by the decline in real estate sales through land transfer fees is still being further transmitted; at present, exports are still at a high level, and the corresponding employment pressure has not yet been formed; next year's export slowdown will bring about an increase in employment pressure. Macroeconomic policies need to be laid out in advance of the six stability and six guarantees.
From the perspective of policy space, there are several points that can be paid attention to:
The premise of fiscal policy. In 2021, the fiscal sector will form a de facto back-end, and a larger proportion of special bonds will be issued in the second half of the year, and some of the impact will fall in the first half of next year; we expect that 2022 may be a forward-positioning rhythm and form an effective connection.
Guide the increase of investment in rental housing. In July, the State Council issued the Opinions on Accelerating the Development of Affordable Rental Housing, which regards the development of affordable rental housing as a key task in the construction of housing in the 14th Five-Year Plan.
Promote carbon-neutral and relevant investments. On August 17, the State Council New Office held a regular press conference, and the National Development and Reform Commission pointed out that the National Development and Reform Commission is working with relevant departments to formulate and improve the "1+N" policy system for carbon peaking and carbon neutrality.
Systematic pro-consumption initiatives. At a press conference held by the Ministry of Commerce on September 26, it was said that automobiles, home appliances, furniture, and catering are the pillars of the consumer market, accounting for about 1/4 of the total amount of the company. The next step is to carry out new energy vehicles to the countryside in depth and promote new car consumption. Accelerate the improvement of the recycling and processing system for waste home appliances, encourage the replacement of old home appliances and furniture with new ones, and promote the consumption of home decoration of home appliances and furniture.
Beyond this framework, there are important macro cues that are not entirely predictable but may deeply influence risk appetite, which we actually believe are already reflected in current pricing in a probability-weighted manner. First, the trend of the global epidemic, which is currently in the decline period of the fourth wave of the epidemic in the world, and the emergence of oral drugs has further affected global expectations; second, there may be room for improvement in Sino-US economic and trade relations, the Ministry of Foreign Affairs pointed out that China and the United States agreed to take action to work together to promote Sino-US relations back to the right track of healthy and stable development.
It is currently in the decline period of the fourth wave of the global epidemic. From September to October, the global average monthly average of new confirmed cases decreased by 16.9% and 22.1% respectively month-on-month. Merck announced that its COVID-19 oral drug is highly effective in phase III clinical trials. Although its impact remains to be seen and evaluated, logically every advance in a vaccine or drug will correspond to a short-term reinforcement of the "coming out of the epidemic" expectation and have a broad impact on the logic of asset pricing.
The Foreign Ministry pointed out at a press conference on October 8 that the high-level meeting between China and the United States was constructive and conducive to enhancing mutual understanding. The two sides agreed to take action to implement the spirit of the september 10 call between the two heads of state, strengthen strategic communication, properly manage differences, avoid conflict and confrontation, seek mutual benefit and win-win results, and work together to promote China-US relations back to the right track of healthy and stable development.
The main risk factor is the global liquidity disturbance represented by the dollar index, which rose from 90 to around 94 in the second half of the year. The negative correlation between the equity market and the DOLLAR index since 2020 is relatively high.
In Exchange Rate Trends and Capital Markets, we pointed out that a strong correlation is the negative correlation between the stock market index and the dollar index, especially after 2019.
Judging from the trend of the US dollar index, the overall shock after the epidemic has declined, and it has bottomed out at the end of 2020. In the first quarter of 2021, there was a round of rebound, the second quarter fell again, and since the third quarter, it has shocked upward again, and has now reached more than 94, which is a new high since October 2020.
Core assumptions of risk: the evolution of the domestic epidemic exceeded expectations, the changes in the external environment exceeded expectations, and the policy deleveraging was stronger than expected.