Chinese Markets Rebound: February 24

The global equity rally, which fizzled at the start of the year, has picked up steam again in February with almost all major regions posting positive returns. Chinese stocks led global peers with an 8% gain as Beijing increased support for the local stock market by curbing short-selling and quantitative trading activities. The S&P/ASX200 climbed a modest 79 basis points last month while the Australian Dollar continues to languish at US0.65¢ as the price of iron ore fell 10%. US markets had a much stronger month (Chart 1), with the S&P 500 up over 5% and the NASDAQ up 6%. This was propelled by continued investor optimism about stocks seeking to create value through artificial intelligence (AI), despite many trading on high P/E ratios, indicating they are priced very expensively. Conversely, Australian shares are lagging partly due to their low exposure to AI. Meanwhile, the VIX (Chicago Board Options Exchange Volatility Index) continues to trend downward, indicating reduced expected 30-day volatility and a greater level of investor calm.

In bond markets, there has been a year-to-date increase in both long-dated and short-dated yield curves due to a sell-off in Treasuries as a strong economy belies an imminent interest rate cut. The US 10-year treasury yield rose 29 basis points last month and is now at 4.24% with Australia’s 10-year yield just 10 basis points below the US (Chart 2). While the soft landing narrative for the US economy continues to be priced in, bond bullish investor positioning is somewhat fading as the US CPI report for January showed inflation did not cool as much as anticipated. There was a 1% month-on-month (m/m) jump in personal income, which beat expectations of a 0.4% rise. However, real personal spending contracted for the first time in 5 months, falling by 0.1%. The Fed’s favoured inflation gauge, the personal consumer expenditures (PCE) price index decelerated from 2.9% to 2.8% on a year-over-year basis in January, however supercore inflation (core services excluding housing and energy) surged from 0.3% m/m to 0.6%, the highest since December 2021. The conflicting data has seen investors revise their rate cut expectations, bringing them in line with the December Fed projections that forecasted the Fed funds rate would fall by 75 basis points by the end of 2024.

Chinese Equities Rebound on Talk of Beijing Support

This month, we focus on the Chinese economy as Australia’s largest trading partner. After a sustained underperformance last year and a six-month streak of outflows, Chinese stocks led last month’s equity market gains largely due to Beijing’s attempts to prop up the stock market. Global traders resumed purchasing Chinese stocks, resulting in inflows of about US$8 billion. This followed market-rescue measures that supported investor confidence, including direct buying by the nation’s sovereign wealth fund to curbs on high-frequency quantitative trading. However, unless the macroeconomic backdrop improves, the policy-driven rally in Chinese stocks will be short-lived. China’s manufacturing activity contracted in February, with PMI (global manufacturing purchasing managers’ index) now at 49.1 (Chart 3).

China’s domestic economic backdrop will remain a headwind for stocks, which reduces the likelihood of a sustained rebound. Price-to-earnings ratios on the Shanghai Stock Index have fallen to an average of 10.4, below the 12.5 average over the last ten years. These depressed valuations reflect the economy’s fundamental problems, including China’s ongoing property crisis, high debt burden, and contracting PMI. At the same time, Chinese exports have suffered as foreign buyers have sought to diversify supply chains. Chinese policymakers continue to battle deflation to avoid repeating the well-known stagnation experienced in Japan bringing concerns about the impact on the Australian economy. Unlike the United States, which created a global shock when its banks teetered in the wake of its property and stock market crisis, China’s banking system is not as closely linked to the rest of the world. The main effects of China’s financial stresses on Australia will be felt through lower commodity prices and reduced iron ore exports which may put downward pressure on the Australian Dollar.

Portfolio Positioning

Markets continue to exhibit volatility as investors carefully observe economic data and policymaker initiatives to help shape expectations for when central banks will begin to cut rates. While the market remains somewhat optimistic about a soft landing, it is a difficult task for central banks to achieve given the lag between the implementation of monetary policy changes and the effect on the economy.

Maintaining a multi-asset class portfolio diversified across all asset classes, regions, sectors, and fund managers is imperative to capital preservation over the long term, regardless of the short-term market movements affected by institutional trading and irrational investors. LBP maintains its slightly defensive positioning for the first quarter of 2024, seeking relative value in private debt to provide investors with a stable income stream given the current level of global yields. Private markets also typically have a lower sensitivity to market movements that can help smooth returns.

Given a long-term approach, LBP does not make drastic tactical shifts in asset allocation, typically proposing changes based on a relative value approach rather than taking tilts based on macroeconomic views. As such, there is a meaningful allocation to listed and private equities, and real assets. We also continue to explore strategies in alternative investments to diversify portfolio returns and provide uncorrelated income streams to help protect the portfolio during periods of equity and bond market stress.

LBP continues to stress that a robust investment framework, and remaining invested through the cycle is integral to preserving wealth, and that investors should emphasise long-term goals over short-term market movements. Time has shown that the greatest threat to real wealth comes from being underinvested, often due to attempting to time the market; something even the best economists cannot consistently get right.