Inflationary Wave & Election Volatility Imminent?
Following a 50 bps rate cut at September's widely anticipated Federal Reserve meeting, it appears that the Fed is effectively engineering a soft economic landing in the U.S. as it keeps inflation in check while maintaining full employment. Whether that proves to be the case going forward is TBD, but investors certainly took a positive view in the seasonally weak month of September, helping the S&P 500 Index climb another 2.14% on a total return basis, 2.70% above its 20-year monthly average of -0.56%.
Nonetheless, headwinds for U.S. stocks remain.
With election day in one month, the contentious U.S. Presidential Election is in its final stretch and could bring about increased market volatility as investors attempt to anticipate the President Elect. With volatility to manage domestically, investors also need to be mindful of rising geopolitical tensions between Israel and Iran. Time will tell if these factors lead to heightened volatility.
China’s Incredible Price Momentum
Since 2000, the Hang Seng Composite has spent just under 8% of its trading days within 5% of an all-time high. In contrast, the S&P 500 has done so about 37% of the time over the same time period. Despite the risks, we believe Chinese stocks can no longer be ignored.
The People’s Bank of China’s various monetary stimulus measures are playing the main role in driving Chinese equities higher, but there might be some very early signs of fundamental improvement. As we noted in our recent China Stimulus blog, earnings estimates for 2024 and 2025 have been improving since May. From a sentiment perspective, forward next twelve month price to earnings ratios reflect investor pessimism. This has catalyzed a historical discount relative to global equity peers and could be added fuel to drive flows into the Chinese markets.
From a price action perspective, the broad participation and incredible momentum from Chinese equities is hard to dismiss. The Hang Seng Composite Index, a benchmark for over 500 equities listed in Hong Kong, is one of several indexes showcasing this historic price action. Five days following the announcement of the PBOC’s stimulus measures, 85% of the Hang Seng Composite traded to a one-month high. This is just shy of the 2015’s 87% reading, the highest on record back to January 2002. In tandem with the surge of stocks trading to new highs has been the surge in percentage of Hang Seng Composite stocks trading above various moving averages. 95% now trade above their respective 50-day moving average (a 99th percentile reading that has only occurred 56 times since 2002) while 85% of stocks currently trade above their 200-day moving average.
Does this price action bode well for investors?
Historically, when the percentage of the Hang Seng Composite trading above the 50-day moving average exceeds the 99th percentile of all historical observations, this has been a bullish signal. The forward performance over the next one, three, six and twelve months have exceeded historical returns on average.
Time to Embrace China?
While it's easy to say “this time it’s different” regarding China equities, it’s fair to be cautious with the country’s stocks given their shaky track record. Booms and busts of various magnitudes highlight how important timing is in the Chinese market. China also has its own differentiated set of risks as it attempts to reinvigorate its economy to achieve its growth targets. Naturally, Chinese equities are highly exposed to consumer confidence and their population’s proclivity to spend. Will the PBOC’s stimulus bazooka perform as intended? Time will tell.
For now, the prudent approach for investors could be to seek exposure to the China Dragons, which are the largest technological innovators in the Chinese market. These names offer investors a targeted China equity allocation, while balancing the broader risks associated with smaller, less-proven Chinese equities. This is not so different from what we saw recently in the U.S. market, when investors gravitated toward the Magnificent Seven stocks to avoid the uncertain earnings from smaller companies. Similar to any investment, a vigilant and deliberate approach to China may be necessary to appropriately manage the risk/reward profile.
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Glossary:
The Hang Seng Composite Index is a market-cap weighted index that covers about 95% of the total market capitalisation of companies listed on the Main Board of the Hong Kong Stock Exchange. The base value of the index is 2000 on base date of January 3rd 2000. HSI started to price this index end of day March 8th.
