A Farewell to Tough 2021, Can Hong Kong Stocks Return to Glory in 2022? （I)

As the crisis is about to pass, the focus of policy makers has changed, the financial situation of households and businesses has stabilized, and the pace of technological innovation has continued to accelerate. Compared with the slow growth of the global economy and weak productivity in the past decade, the post-epidemic era may mean a more vigorous economic environment. For investors, especially those who are still maintaining their portfolio allocations during the last economic cycle, these changes will have a crucial impact.

There is no doubt that many factors are fermenting together. In the United States, the Fed’s monetary policy in response to inflationary pressures and a weak job market will also affect the performance of the financial market. In addition, China's ongoing economic transformation may bring downside risks in the short term. In the long run, the global economy needs to adjust and prepare for the deceleration of the structural growth of the world's second largest economy. From a global perspective, the spread of the virus may continue to have a major impact on the economy.

Based on the interaction between the global economy and financial markets, we have found that a goal-oriented risky asset portfolio returns ideally. Corporate earnings growth may push the stock markets of developed countries to new highs; and strong economic growth, coupled with the emergence of benign inflation, may have an adverse impact on the bond market. Taking into account the potential uncertainty of the market, although we are generally optimistic about the future prospects, we still pay attention to the balanced allocation of the investment portfolio.

As the global economy continues to recover from the new crown epidemic, most risk assets will perform well in 2021. However, in recent months, investors have paid particular attention to the potential risks that may arise from economic growth and market returns. Inflation issues have made the central bank’s policy considerations more complicated. Supply shortages continue to affect economic output. Coupled with the recurrence of the new crown epidemic, consumers, companies and investors are generally worried.

But in the long run, compared with the slow growth of the global economy and weak productivity in the past decade, especially for developed countries, the post-epidemic era may mean a more vigorous economic environment. For investors, especially those who maintained their portfolio allocations during the last economic cycle, these changes will have a crucial impact.

The governments of the United States and European countries avoid austerity policies as much as possible, mainly because these measures have led to weak economic recovery after the global financial crisis. The U.S. Congress and the White House have spent more than $4 trillion in response to the new crown epidemic. As of this writing, Congress is discussing the possibility of an additional trillion dollars in fiscal spending in the next 10 years. In Europe, the EU Recovery Fund will continue to provide financial support for the next ten years. Both the Fed and the European Central Bank are committed to maintaining a steady rise in inflation by promoting the recovery of the job market. At the same time, China’s policymakers are shifting the focus of the economy from real estate investment to consumer spending and high-end manufacturing, realizing a comprehensive economic transformation. Transformation will face various challenges, and it will also bring certain potential downside risks to global growth.,

In many advanced economies, household net worth is at a record high and excess savings have increased. A strong labor market and increased debt-raising capacity will continue to drive consumption growth in the next few years. The growth momentum of the US real estate industry is particularly prominent. Corporate profits and profit margins have grown at a healthy rate that has never been seen before, and debt servicing costs have also been at historically low levels. In the supply chain, strong demand needs to be met, and inventory needs to be rebuilt urgently. The company's current profitability will drive future investments and expenditures.

The three major trends of digital transformation, medical innovation and sustainable development will continue to promote R&D and investment to create more value. Digital transformation will only continue to accelerate. Medical innovation will continue to seek breakthroughs and explore solutions under the epidemic. More frequent and more destructive natural disasters have all revealed the importance of paying attention to sustainable investment.

Although the valuations of companies in the above three areas have risen significantly, long-term investors can still explore many investment opportunities in the market. In our investment portfolio, we focus on innovative technologies such as semiconductors, artificial intelligence, network security, and cloud technology that enable change, while at the same time we distribute different geographies and investment styles to balance risk exposure.

Although the current cycle clearly shows the potential for vigorous economic growth, the current environment is also "turbulent." We believe that the economy will continue to expand in 2022, but the degree of expansion may depend on the monetary policies adopted by various countries in response to inflation, the success of Chinese policymakers in achieving economic transformation, and the speed at which the global epidemic evolves into a local epidemic.

Where will the global monetary policy go? From Brazil to New Zealand, many central banks have raised interest rates to fight inflation, but the Fed and the European Central Bank are still standing still. If the increase in inflation is more moderate (in line with our basic view), the Fed and the European Central Bank may be able to suspend interest rate hikes, and the labor market will take this opportunity to further return to pre-epidemic levels.

However, if inflation remains high and the labor market is weaker than traditional indicators originally expected, the Fed may adopt more aggressive measures. Although the early start of a new round of interest rate hikes may lead to market turbulence, it should be noted that the global market has long expected short-term interest rates to rise. Patience may bring surprises.,

Policymakers will try to avoid the excessive negative impact of economic transformation on growth, but this is not easy. In the past year, policy makers have taken many actions to strengthen supervision of multiple industries, and investors have also been negatively affected by these policy actions. The market value of China's Internet stocks has shrunk by almost half, and the real estate industry has been deleveraging, leading to a decline in industry growth and severe market volatility. Looking ahead, we believe that global economic growth will be sufficient to offset the adverse effects of China's economic weakness. However, China's simultaneous adoption of a wide range of macro-prudential strategies and strengthening of industrial supervision have indeed increased downside risks.

Although the development path of the new crown epidemic is difficult to predict, investors can now face the uncertainty of the epidemic more calmly. The bad news is that the new crown epidemic may evolve into a long-term endemic epidemic. But the good news is that vaccination, immunity gained from previous infections, and the emergence of new therapies all reduce the risk of epidemic spread. Although some industries are still vulnerable to the impact of the increase in new coronavirus cases, we expect the impact of the epidemic on the global economy and financial markets to continue to weaken.

When considering the interaction between the economy and the market, we find that a portfolio of risky assets that matches the investment objectives can bring ideal returns. We believe that stocks are more attractive than bonds, and bonds are better than cash. The growth of corporate earnings may push the stock markets of developed markets to new highs, and the sustained high growth and high inflation economic environment will have an adverse impact on the bond market. However, in view of the potential "turbulence", we will focus on maintaining our overall optimistic portfolio allocation balance.

Some specific risks may cause recent market volatility, but we believe that the current economic cycle has a healthy and strong driving force. The focus of policy makers, the financial strength of enterprises, excess household savings, and continuous technological innovation may bring investors many dynamic investment opportunities. Compared with the 2010s, these investment opportunities have a wider scope. Investors can consult their own investment advisers to build a suitable investment portfolio that can effectively avoid shocks. However, we believe that it is now a good time to focus on capturing the upward wave, and investors should focus on the expected returns from long-term growth.

China's GDP growth rate was 6.1% in 2019. Influenced by the COVID-19's great impact, China’s 2020 GDP growth plummeted to 2.3%. In the first three quarters of 2021, China's GDP growth rate was 18.3%, 7.9% and 4.9%, respectively, and China's GDP growth rate was expected to rebound to about 8.0% in 2021. This implied a two-year average GDP growth rate of about 5.2% in 2020 and 2021, which was still significantly lower than the growth rate in 2019.

In terms of the contribution of the triad of consumption, investment and net exports to economic growth, in the first quarter of 2021, the contribution of the triad to economic growth is 11.6, 4.5 and 2.2 percentage points respectively, while by the third quarter of 2021, the above indicators fell back to 3.8, 0.0 and 1.1 percentage points respectively. It is easy to see that in 2021, the contribution of consumption and investment to economic growth declined significantly, while the contribution of net exports to economic growth showed a strong resilience.

Before the outbreak of the epidemic, the year-on-year growth rate of total retail sales of consumer goods fluctuated roughly between 7-9%. In 2021, however, the indicator fell back from 33.8% in January-February to 3.9% in November. It is easy to see that the current consumption growth rate is significantly weaker than the level before the outbreak. One of the reasons is that the epidemic has so far still rebounded sporadically in various places, resulting in a still tense situation of epidemic prevention and control, which has affected the consumption growth rate of related industries; second, the epidemic has caused a significant negative impact on the income level of people in the service industry and other industries, and the decline in income growth will naturally affect the consumption growth rate; third, the current consumer expectations are weak in the short term.

The cumulative year-on-year growth rate of fixed asset investment in 2021 was high at the previous stage and low at the latter, slipping from 35.0% in January-February to 5.2% in November. Among the three major fixed asset investments, the cumulative year-on-year growth rate of infrastructure investment declined the fastest (from 36.6% to -0.2% over the same period), followed by real estate investment (from 36.8% to 6.3% over the same period), and manufacturing investment performed relatively more robustly (from 37.3% to 13.7% over the same period).

The most important reason for the significant decline in the growth rate of infrastructure investment is the high pressure of local government debt in most areas, the pressure of debt service is huge, there is not enough financial resources for infrastructure investment. Currently, local party and government officials are directly responsible for preventing and resolving regional financial risks, which makes local governments less motivated to raise debt. Recently, the Ministry of Finance stated that the hidden debts of local governments should be resolved by the local governments themselves. This means that unless the central fiscal expansion is increased, local governments do not have enough capacity to promote a new round of infrastructure construction.

The reason for the rapid decline in real estate investment growth mainly stems from a series of new regulatory policies implemented since the second half of 2020, such as the three red lines on the balance sheet, commercial bank loan concentration management, and centralized urban land bidding and auctioning. The implementation of these policies has made financing for real estate development companies difficult. Some real estate developers with adventurous operations even face the risk of debt default due to broken capital chains (For example, Evergrande Group).

Among the three major investments, the growth rate of manufacturing investment has maintained the strongest resilience. However, the leading indicators on manufacturing investment are currently mixed. On the one hand, the manufacturing purchasing managers' index experienced seven consecutive months of decline between April and October 2021, falling from 51.9 to 49.2, though it rebounded to 50.1 in November, returning above the threshold. On the other hand, the year-on-year growth rate of industrial value added of industrial enterprises above the scale rebounded for two consecutive months in October and November (3.5% and 3.8%, respectively) after a continuous decline from March to September 2021 (from 52.3% to 3.1%).

China's export growth performed astonishingly in 2021. Even leaving aside the superb 60.6% growth in January-February, the average monthly growth rate of China's exports from March to November remained at 27.2% year-on-year. The goods trade surplus of US$84.5 billion in October 2021 was also a record high. The strong contribution of net exports to China's growth was an important support for the country's ability to reach 8% economic growth in 2021. The reason why China's exports continue to be strong is that the global epidemic has boosted Chinese exports in specific sectors (e.g. medical substances and equipment, laptops, telecommuting equipment, etc.), the contrast between the raging global epidemic and China's excellent prevention and control has led to a short-term rise in the position of Chinese companies in the global chain instead of a fall, and the rise in import demand due to the fall back of the epidemic in developed countries. However, China's export growth rate cannot always stay above 20% growth rate. For example, the new export orders index in the PMI has been below the threshold for seven consecutive months between May and November 2021, which implies that external import demand may weaken in the future.

China's inflation in 2021 shows a low CPI growth rate and a rapid increase in PPI growth rate. From January to November 2021, the CPI growth rate rose from -0.3% to 2.3%, while the PPI growth rate climbed from 0.3% to 12.9%. The main reason for the low CPI growth rate is the low food prices, especially pork prices. However, pork prices and food price growth have bottomed out since October 2021. The PPI growth rate has climbed all the way up mainly due to the rapid rise in global commodity prices after the COVID-19 epidemic. However, compared with the peak of 13.5% in October, the PPI growth rate started to fall back in November.

After the outbreak of the epidemic, China's urban survey unemployment rate once rose to 6.2% in February 2020. From January to November 2021, the indicator declined from 5.4% to 5.0%, indicating a stable labor market operation. However, it is worth noting that the survey unemployment rate for young people aged 16-24 rose from 12.7% to 14.3% within the same period, implying some structural unemployment pressure in the Chinese labor market.

The Central Economic Work Conference held in early December 2021 pointed out that China's economic development is currently facing the triple pressure of demand contraction, supply shock and weakening expectations. Therefore, the economic work in 2022 should be "stable in progress", and all regions and departments should take up the responsibility of macroeconomic stability, and all parties should actively launch policies that are conducive to economic stability, with policies that are appropriately forward-looking.

Based on the above statements, I believe that macroeconomic policies in 2022 will be more expansionary compared to those in 2021.

In terms of fiscal policy, the central fiscal deficit to GDP ratio is expected to remain in the 2.8%-3.0% range, and the scale of local debt issuance is expected to rise significantly (the actual issuance scale of local debt may reach about 4.5 trillion yuan in 2022), and fiscal policy will be required to be front-loaded (concentrated on the first half of the year). At present, from the central to the local level, they are emphasizing that the economic growth rate in the first half of 2022 should be stabilized and try not to be lower than the growth rate in the 4th quarter of 2021, which means that fiscal spending will be advanced and significantly powered in the first half of 2022.

In terms of monetary policy, there had been two rate cuts in the second half of 2021 and the LPR rate was cut by 5 basis points on December 20. Further rate cuts (around 2 times) and interest rate cuts (20-40 basis points) are expected in 2022 (especially in the first half of 2022), and structural monetary policy operations are also expected to make further efforts. Considering that this Central Economic Work Conference particularly emphasized the coordination and linkage between fiscal and monetary policies, the concentration of monetary policy in the first half of 2022 will also help reduce the financing costs on the fiscal side

In addition to macro policies, the regulation and control policies for the real estate market will also be adjusted to a certain extent, as the Central Economic Work Conference, while mentioning adherence to "Housing Without Speculation", also proposed to "promote the virtuous cycle and healthy development of the real estate industry". The toughest time for the real estate market may have passed, but attention should still be paid to the risk of concentrated default by real estate developers and local financing platforms in 2022.

Considering the above policy adjustments, my forecast is that China's GDP growth is expected to reach 5.3-5.5% throughout the year 2022, with quarterly economic growth remaining low at the previous stage and high at the latter. The annual CPI growth rate will reach 2-3% and PPI growth rate will fall back to 6% or below. The urban survey unemployment rate is stable at 5% or below. This means that China's economy will continue to maintain stable and rapid growth and will continue to make important contributions to the global economic recovery in the post-epidemic era.

The Fed is responding to inflation pressures that are running — by some measures — at the fastest rate in nearly 40 years.

If everything goes according to plan, the Federal Reserve in a little over two months will enact its first rate increase in three years, a move policymakers deem necessary and that markets and the economy are grudgingly coming to accept.

The Fed last raised rates in late 2018, part of a “normalization” process that happened in the waning period of the longest-lasting economic expansion in U.S. history.

Just seven months later, the central bank retreated as the expansion looked increasingly fragile. Eight months after that initial cut in July 2019, the Fed was forced to roll back its benchmark borrowing rate all the way to zero as the nation confronted a pandemic that threw the global economy into a sudden and shocking tailspin.

So as officials prep for a return to more conventional monetary policy, Wall Street is watching closely. The first trading day of the new year indicated the market is willing to keep pushing higher, in the midst of the gyrations that have greeted the Fed since it indicated a policy pivot a month ago.

“When you look back historically on the Fed, it’s usually multiple tightenings before you get in trouble with the economy and the markets,” said Jim Paulsen, chief investment strategist at the Leuthold Group.

Paulsen expects the market to take the initial hike – likely to be enacted at the March 15-16 meeting – without too much fanfare, as it’s been well telegraphed and will still only bring the benchmark overnight rate up to a range of 0.25%-0.5%.

“We’ve developed this attitude on the Fed based on the last couple decades where the economy was growing at 2% per annum,” Paulsen said. “In a 2% stall-speed economy world, if the Fed even thinks about tightening it’s damaging. But we don’t live in that world anymore.”

Fed officials at their December meeting penciled in two additional 25-basis-point hikes before the end of the year. A basis point is equal to one one-hundredth of 1 percentage point.

Current pricing in the fed funds futures market points to about a 60% likelihood of a hike in March, and a 61% probability that the rate-setting Federal Open Market Committee will add two more by the end of 2022, according to the CME’s FedWatch Tool.

Those subsequent hikes are where the Fed could see some blowback.

The Fed is hiking rates in response to inflation pressures that are running by some measures at the fastest rate in nearly 40 years. Chairman Jerome Powell and most other policymakers spent much of 2021 insisting that prices would ease soon, but conceded toward the end of the year that the trend was no longer “transitory.”

Whether the Fed can orchestrate an “orderly coming down” will determine how markets react to the rate hikes, said Mohamed El-Erian, chief economic advisor at Allianz and chair of Gramercy Fund Management.

In that scenario, “the Fed gets it just right and demand eases a little bit and the supply side responds. That is sort of the Goldilocks adjustment,” he said Monday on CNBC’s “Squawk Box.”

However, he said the danger is that inflation persists and rises even more than the Fed anticipates, prompting a more aggressive response.

“The pain is already there, so they are having to play massive catch-up, and the question is at what point do they lose their nerve,” El-Erian added.

Market veterans are watching bond yields, which are expected to indicate advanced clues about the Fed’s intentions. Yields have stayed largely in check despite expectations for rate hikes, but Paulsen said he expects to see a reaction that ultimately could take the benchmark 10-year Treasury to around 2% this year.

At the same time, El-Erian said he expects the economy to do fairly well in 2022 even if the market hits some headwinds. Likewise, Paulsen said the economy is strong enough to withstand rate hikes, which will boost borrowing rates across a wide swath of consumer products. However, he said he figures a correction will come in the second half of the year as rate increases continue.

But Lisa Shalett, chief investment officer at Morgan Stanley Wealth Management, said she thinks market turbulence would be more pronounced even as the economy grows.

Markets are coming off a prolonged period of “a long decline in real interest rates, which allowed stocks to break free from economic fundamentals and their price/earnings multiples to expand,” Shalett said in a report for clients.

“Now, the period of declining fed funds rates which began in early 2019 is ending, which should allow real rates to rise from historic negative lows. This shift is likely to unleash volatility and prompt changes in market leadership,” she added.

Investors will get a closer look at the Fed’s thinking later this week, when minutes of the December FOMC meeting are released Wednesday. Of particular interest for the market will be discussions not only about the pace of rate hikes and the decision to taper asset purchases, but also when the central bank will start reducing its balance sheet.

Even as the Fed intends to halt the purchases in the spring, it will continue to reinvest the proceeds of its current holdings, which will maintain the balance sheet around its current $8.8 trillion level.

Citigroup economist Andrew Hollenhorst expects balance sheet reduction to start in the first quarter of 2023.

There is no doubt that 2021 was a bullish year for the oil market, with Goldman Sachs, the flag bearer for commodities, giving a target price of $100 for crude oil. With global central banks generally tightening policy in 2022, the momentum driving the oil price is fading from the perspective of market liquidity, but this does not mean that there will be a sharp decline, as supply and demand factors still dominate.

Global Economy Continue To Recover