China

    Executive Summary At our monthly view meeting on Monday, BCA strategists voted to change the House View to a neutral asset allocation stance on equities, with a slight plurality favoring an outright underweight. The view of the Global Investment Strategy service is somewhat more constructive, as I think it is still more likely than not that the US will avoid a recession; and that if a recession does occur, it will be a fairly mild one. Nevertheless, the risks to my view have increased. I now estimate 40% odds of a recession during the next 12 months, up from 20% a month ago. In The Past, When Unemployment Has Started Rising In The US, It Has Kept On Rising Bottom Line: With the S&P 500 down 27% in real terms from its highs at the time of the meeting, the view of the Global Investment Strategy service is that a modest overweight is appropriate. However, investors should refrain from adding to equity positions until more clarity emerges about the path for inflation and growth. Heading For Recession? Every month, BCA strategists hold a view meeting to discuss the most important issues driving the macroeconomy and financial markets. This month’s meeting, which was held yesterday, was especially pertinent as it comes on the heels of a substantial decline in global equities. The key issue that we grappled with was whether the Fed could achieve a proverbial soft landing or whether the US and the rest of the global economy were spiraling towards recession (if it wasn’t already there). I began the meeting by showing one of my favorite charts, a deceptively simple chart of the US unemployment rate (Chart 1). The chart makes three things clear: 1) The US unemployment rate is rarely stable; It is almost always either rising or falling; 2) Once it starts rising, it keeps rising. In fact, the US has never averted a recession when the 3-month average of the unemployment rate has risen by more than a third of a percentage point; and 3) As a mean-reverting series, the unemployment rate is most likely to start rising when it is very low. Chart 1In The Past, When Unemployment Has Started Rising In The US, It Has Kept On Rising Taken at face value, the chart paints a damning picture about the economic outlook. The US unemployment rate is near a record low, which means that it has nowhere to go but up. And once the unemployment rate starts going up, history suggests that a recession is inevitable. Five Caveats Despite this ominous implication, I did highlight five caveats. First, the observation that even a modest increase in the unemployment rate invariably heralds a recession is based on a limited sample of business cycles from the US. Across the G10, soft landings have occurred, Canada being one example (Chart 2). Second, unlike the unemployment rate, the employment-to-population ratio is still 1.1 percentage points below its pre-pandemic level, and 4.6 percentage points below where it was in April 2000. A similar, though less pronounced, pattern holds if one focuses only on the 25-to-54 age cohort (Chart 3). Chart 2G10 Economies Sometimes Manage To Avoid A Recession Amid Rising Unemployment Chart 3The Employment-To-Population Ratio Remains Below Pre-Pandemic Levels   While the number of people not working either because they are worried about the pandemic, or because they are still burning through their stimulus checks, has been trending lower, it is still fairly high in absolute terms (Chart 4). As my colleague Doug Peta discussed in his latest report, one can envision a scenario where job growth remains positive, but the unemployment rate nonetheless edges higher as more workers rejoin the labor force. Chart 4ALabor Supply Should Increase As Covid Fears Continue To Abate And More Workers Burn Through Their Stimulus Savings (I) Chart 4BLabor Supply Should Increase As Covid Fears Continue To Abate And More Workers Burn Through Their Stimulus Savings (II)     Third, the job vacancy rate is extremely high today – much higher than a pre-pandemic “Beveridge Curve” would have predicted (Chart 5). This provides the labor market with a wide moat against an increase in firings. As Fed governor Christopher Waller has emphasized, the main effect of the Federal Reserve’s efforts to cool labor demand could be to push down vacancies rather than to push up unemployment. Fourth, as we have highlighted in past research, the Phillips curve is kinked at very low levels of unemployment (Chart 6). This means that a decline in unemployment from high to moderate levels may do little to spur inflation, but once the unemployment rate falls below its full employment level, then watch out! Chart 5The Fed Hopes That Its Tightening Policy Will Bring Down Job Openings More Than It Pushes Up The Unemployment Rate Chart 6The Phillips Curve Is Kinked At Very Low Levels Of Unemployment   The converse is also true, however. If a small decrease in unemployment can trigger a large increase in inflation, then a small increase in unemployment can trigger a large decrease in inflation, provided that long-term inflation expectations remain reasonably well anchored in the meantime. In other words, it is possible that the so-called “sacrifice ratio” — the amount of output that has to be sacrificed to reduce inflation — may be quite low. Fifth, and perhaps most importantly, there is a lot of variation from one recession to the next in how much unemployment rises. In general, the greater the financial and economic imbalances going into a recession, the deeper it tends to be. US household balance sheets are in reasonably good shape these days. Households are sitting on $2.2 trillion in excess savings (Chart 7). Yes, most of those savings belong to relatively well-off households. But as Chart 8 illustrates, even rich people spend well over half of their income. Chart 7Households Have Only Just Begun To Draw Down Their Accumulated Savings Chart 8Even The Rich Spend The Majority Of Their Income     The ratio of household debt-to-disposable income in the US is down by a third since its peak in 2008. Despite falling equity prices, the ratio of household net worth-to-disposable income is still up nearly 50 percentage points since the end of 2019, mainly because home prices have risen (Chart 9). As is likely to be the case in many other countries, home prices in the US will level off and quite possibly decline over the next few years. In and of itself, that may not be such a bad outcome for equity markets since lower real estate prices will cool aggregate demand, thus lowering inflation without the need for much higher interest rates. The danger, of course, is that we could see a replay of the GFC. This risk cannot be ignored but is probably quite small. The quality of mortgage lending has been very strong over the past 15 years. Moreover, unlike in 2007, when there was a large glut of homes, the homeowner vacancy rate today is at a record low. Tepid homebuilding has pushed the average age of the US residential capital stock to 31 years, the highest since 1948 (Chart 10). Chart 9The US Household Debt Burden Has Come Down Significantly Since 2008, While Net Worth Is Still Higher Than Before The Pandemic Chart 10Tight Supply Conditions In The Housing Market Argue Against A Repeat Of The GFC   A Bleaker Picture Outside The US The situation is admittedly dicier outside the US. Putin’s despotic regime continues to wage war on Ukraine. While European natural gas prices are still well below their March peak, they have recently surged as Russia has begun to throttle natural gas exports (Chart 11). The euro area manufacturing PMI clocked in a respectable 54.6 in May but is likely to drop over the coming months as higher energy prices restrain production. The only saving grace is that fiscal policy in Europe has turned more expansionary. The IMF’s April projection foresaw the structural primary budget balance easing from a surplus of 1.2% of GDP between 2014 and 2019 to a deficit of 1.2% of GDP between 2022 and 2027, the biggest swing among the major economies (Chart 12). Even the IMF’s numbers probably underestimate the fiscal easing that will transpire considering the need for Europe to invest more in energy independence and defense. Chart 11The European Economy Is Threatened By Rising Gas Prices Chart 12Euro Area Fiscal Policy Is Expected To Be More Expansionary In The Years To Come Than Before The Pandemic   The Chinese economy continues to suffer from the “triple threat” of renewed Covid lockdowns, a shift of global demand away from manufactured goods towards services, and a floundering property market. We expect the Chinese property market to ultimately succumb to the same fate that befell Japan 30 years ago. Chart 13Chinese Stocks Are Cheap Unlike Japanese stocks in the early 1990s, however, Chinese stocks are trading at fairly beaten down valuations – 10.9-times earnings and 1.4-times book for the investable index (Chart 13). With the Twentieth Party Congress slated for later this year and the population jaded by lockdowns, the political incentive to shower the economy with cash and loosen the reins on regulation will intensify. A Scenario Analysis For The S&P 500 Corralling all these moving parts is no easy matter. We would put the odds of a US recession over the next 12 months at 40%. This is double what we would have said a month ago when we tactically upgraded stocks after the S&P 500 fell below the 4,000 mark. The May CPI report was clearly a shocker, both to the Fed and the markets. The median dot in the June Summary of Economic Projections sees the Fed funds rate rising to 3.8% next year, smack dab in the middle of our once highly out-of-consensus estimate of 3.5%-to-4% for the neutral rate of interest. With interest rates potentially moving into restrictive territory next year, equity investors are right to be concerned. Yet, as noted above, if a recession does occur, it is likely to be a fairly mild one. At the time of the BCA monthly view meeting, the S&P 500 was already down 23% in nominal terms and 27% in real terms from its peak in early January. We assume that the S&P 500 will fall a further 10% in real terms over the next 12 months in a “mild recession” scenario (30% odds) and by 25% in a “deep recession” scenario (10% odds). Conversely, we assume that the S&P 500 will be 20% higher in 12 months’ time in a “no recession” scenario (60% odds). Note that even in a “no recession” scenario, the real value of the S&P 500 would still be down 12% in June 2023 from its all-time high. On a probability-weighted basis, the expected 12-month real return across all three scenarios works out to 6.5%, or 8% with dividends (Table 1). That is enough to justify a modest overweight in my view – but given the risks, just barely. Investors focused on capital preservation should consider a more conservative stance. Table 1S&P 500 Drawdowns Depending On Whether The US Will Enter A Recession And How Severe It Will Be Most of my colleagues were more cautious than me, as they generally thought that the odds of a recession were greater than 50%. They voted to shift the BCA house view to a neutral asset allocation stance on equities, with a slight plurality favoring an outright underweight (10 for underweight; 9 for neutral; and 6 for overweight). Peter Berezin Chief Global Strategist peterb@bcaresearch.com   Global Investment Strategy View Matrix Special Trade Recommendations Current MacroQuant Model Scores  

Dear Client, In lieu of our weekly report next week, I will be hosting two webcasts with my colleague Arthur Budaghyan, Chief Emerging Market Strategist: Time To Buy EM/China? June 23, 2022 9:00 AM EDT (2:00 PM BST, 3:00 PM CEST) and June 24, 2022 9:00 AM HKT (11:00 AM AEST). We will discuss the implications of the global macro environment on EM economies and assets, and whether it is time to buy EM/Chinese equities. I look forward to answering any questions you might have. Kind regards, Jing Sima China Strategist Executive Summary Chinese Households Leverage Ratio Fell The Most Since The GFC China’s households may be entering a deleveraging mode.  The level of newly increased household medium- to long-term loans declined in two out of the first five months of this year. The household leverage ratio has also been falling. The deleveraging is driven by both cyclical and structural forces. Depressed economic growth, home prices as well as jobs and incomes, have all curbed borrowing. Structurally, China’s demographic shift and a decline in the working-age population will lead to a steady decrease in the demand for housing and mortgages. The experience in Japan and the US suggests that when households start deleveraging, the trend will likely progress into a decade-long cycle.  The household deleveraging cycle may lead to a structural downshift in real estate investment, consumption of durable goods and money supply in China. As an offset, interest rates in China will shift down. A low interest rate environment may be positive for China’s financial asset valuations. Bottom Line: Both cyclical and structural forces are prompting Chinese households to reduce debt. A prolonged deleveraging cycle will lead to a slump in the demand for housing and consumer durable goods. However, a deleveraging cycle, coupled with a decline in total population, may lead to a structurally lower interest rate environment, which may be positive for Chinese equity valuations in the long run. Feature China’s newly increased consumer medium- to long-term (ML) loans turned negative in February and April this year, the first negative readings since data collection started in 2007. The reading indicates that households are paying off more ML loans than borrowing (Chart 1).  Chart 1Chinese Household New ML Loans Dropped Below Zero Twice This Year In the near term, a slowing economy and uncertainties surrounding job and income prospects, coupled with stagnating housing prices, will curb households’ propensity to take on debt. In the longer term, China’s working-age population peaked in 2015 and its total population is set to decline beginning in 2025. This unfavorable demographic trend will drive down the demand for housing and ML loans. Japan's experience shows that when the working-age population falls along with the household leverage ratio, the growth in real estate investment, consumption of consumer durable goods and money supply M2 will structurally shift to a lower range. Although a weakening demographic profile and deleveraging households are negative factors for economic growth, interest rates in China will likely move down structurally. Lower borrowing costs will make corporate debt-servicing cheaper and increase corporate profitability, thus providing tailwinds to Chinese stocks and government bonds in the long run. An Inflection Point In Chinese Households’ Leverage? Chart 2Chinese Households Leverage Ratio Fell The Most Since The GFC Several signs suggest that Chinese household debt, after more than a decade of rapid expansion, may have reached an inflection point. Newly increased household ML loans, which are mostly mortgage debt, turned negative this year. Although household ML loans were slightly positive in May, the number was one of the weakest in the past 15 years. China’s household leverage ratio (measured by household debt versus disposable income) rolled over, the first such plunge since the 2008/09 Global Financial Crisis (Chart 2). Chinese households’ reluctance to take on debt reflects current dire economic conditions, which have been damaged by the pandemic and collapse in the housing market. Furthermore, structural forces, such as the nation’s unfavorable demographic shifts, will likely drive the ongoing cyclical deleveraging into a sustained secular trend. Related Report  Emerging Markets StrategyA Whiff Of Stagflation? The pandemic and frequent city lockdowns in the past two years in China have significantly reduced households’ income growth, which has increased debt repayment burdens on families. Even though the central bank and more than 100 cities in China recently slashed mortgage rates, the average cost of mortgage loans remains higher than income growth per capita.  In other words, the current mortgage rates in China are not low enough to reverse the downward trend in households’ ML loans (Chart 3). The investment appeal of real estate has also diminished. Prior to 2018, home prices often appreciated faster than the prevailing mortgage rates. Since late 2019, however, the rate of housing price appreciation in China’s 70 medium and large cities has been falling below the average interest rate on mortgage loans (Chart 4). Home price appreciation has stalled since the second half of last year, whereas mortgage rates are currently about 5.5%. As such, housing’s carry has become negative, discouraging investment purchases of residential properties. Chart 3Mortgage Rates Have Dropped But Still Higher Than Income Growth Chart 4Returns On Leveraged Property Investment Have Diminished In order for consumer ML loans to pick up strongly in the next 6 to 12 months, either the household income growth must significantly improve and/or mortgage rates will have to drop well below home price appreciation. Recent surveys suggest that both will probably not happen in the near term (Chart 5). Chart 5Chinese Households' Income And Investment Outlooks Are Dim Chart 6Demand For Housing Will Dwindle Along With Smaller Labor Force In a previous report we indicated that China’s falling birthrate and working-age population will lead to less demand for housing from a structural point of view. Home sales have fluctuated in a downward trend in the past five years along with a peak in the working-age population in 2015 (Chart 6). Moreover, the sharp deterioration in China’s birthrate will reduce the demand for housing even more significantly in the next 15-20 years. This unfavorable demographic trend will exert powerful downward pressures on the country’s household credit demand. Bottom Line: While the ongoing economic slowdown and housing market slump are curbing ML loans, China’s household loan demand may be entering a structural downturn due to the country’s demographic headwinds. The Economic Impact Of Household Deleveraging The experience in both Japan and the US suggests that when households begin to reduce their debt, the trend may spiral into a secular cycle that lasts up to a decade (Chart 7). A prolonged deleveraging cycle can push the growth in residential real estate investment, consumption of durable goods and money supply to much lower levels.  In Japan’s case, the household debt-to-income ratio rolled over in the late 1990s when the country’s working-age population peaked and began a nose-dive in the early 2000s.  The country’s growth in residential investment fell along with households’ debt reduction, from a 13% average annual rate (nominal) in the 1980s to about 3% in the 2000s (Chart 8). Chart 7Deleveraging Can Spiral Into A Decade##br## Long Cycle Chart 8Japan's Real Estate Investment Growth Slowed Along With Falling Household Leverage... Consumption growth, particularly in consumer durable goods, also dropped from more than 10% in the 1980s to around 0-2% in the late 1990s. It subsequently fell into a prolonged contraction in the 2000s when the household leverage ratio declined (Chart 9). Real estate credit is a major source for China’s money origination. Therefore, a lack of household loan demand will depress the country’s overall credit and money growth. Japan’s money supply grew by less than 4% in the 2000s in nominal terms, compared with a nearly 10% increase in the years prior to the household deleveraging cycle (Chart 10). Chart 9...So Did Demand For Consumer Durable Goods Chart 10Money Supply Growth Also Slowed Bottom Line: Without an imminent and significant improvement in the economy, household deleveraging can progress into a secular trend. A prolonged household deleveraging cycle will drive down the growth in residential property investment, consumption and money supply. Investment Conclusions The combination of declining household debt and total population will weigh on the demand for housing, consumption and investment growth, generating deflationary headwinds for China’s economy. Thus, China’s interest rate regime will likely follow Japan’s example and downshift structurally (Chart 11). A lower interest rate environment will at margin be positive for China’s financial asset valuations in the long run. Related Report  China Investment StrategyExpect A Much Weaker Economy In Q2 Weaker prices on capital will make corporate debt-servicing cheaper and increase corporate profitability. China will likely maintain a very accommodative fiscal policy in the next decade to offset less demand from households and to help implement industrial policies aimed at achieving self-sufficiency in technology and energy. Furthermore, Chinese households may bump up their savings while reducing debt. As returns on residential property investment diminish and yields on risk-free assets shift lower, Chinese households may be increasingly willing to invest in financial assets. This trend could provide tailwinds to Chinese equities in the long term (Chart 12). Chart 11Interest Rates In China Will Likely ##br##Structurally Downshift Chart 12Chinese Households May Shift Their Investment Preference From Properties To Financial Assets   Jing Sima China Strategist jings@bcaresearch.com Strategic Themes Cyclical Recommendations

Special Report

Executive Summary Autocracy Hurts Productivity Over the next six-to-18 months, the Xi Jinping administration will “let 100 flowers bloom” – i.e., relax a range of government policies to secure China’s economic recovery from the pandemic. The first signs of this policy are already apparent via monetary and fiscal easing and looser regulation of Big Tech. However, investors should treat any risk-on rally in Chinese stocks with skepticism over the long run. Political risk and policy uncertainty will remain high until after Xi consolidates power this fall. Xi is highly likely to remain in office but uncertainty over other personnel – and future national policy – will be substantial. Next year China’s policy trajectory will become clearer. But global investors should avoid mistaking temporary improvements for a change of Xi’s strategy or China’s grand strategy. Beijing is driven by instability and insecurity to challenge the US-led world order. The result will be continued economic divorce and potentially military conflicts in the coming decade. Russia’s reversion to autocracy led to falling productivity and poor equity returns. China is also reverting to autocratic government as a solution to its domestic challenges. Western investors should limit long-term exposure to China and prefer markets that benefit from China’s recovery, such as in Southeast Asia and Latin America. Bottom Line: The geopolitical risk premium in Chinese equities will stay high in 2022, fall in 2023, but then rise again as global investors learn that China in the Xi Jinping era is fundamentally unstable and insecure. Feature Chart 1Market Cheers China's Hints At Policy Easing In 1957, after nearly a decade at the helm of the People’s Republic of China, Chairman Mao Zedong initiated the “Hundred Flowers Campaign.” The campaign allowed a degree of political freedom to try to encourage new ideas and debate among China’s intellectuals. The country’s innovative forces had suffered from decades of foreign invasion, civil war, and repression. Within three years, Mao reversed course, reimposed ideological discipline, and punished those who had criticized the party.  It turned out that the new communist regime could not maintain political control while allowing liberalization in the social and economic spheres.1 This episode is useful to bear in mind in 2022 as General Secretary Xi Jinping restores autocratic government in China. In the coming year, Xi will ease a range of policies to promote economic growth and innovation. Already his administration is relaxing some regulatory pressure on Big Tech. Global financial markets are cheering this apparent policy improvement (Chart 1). In effect, Xi is preparing to let 100 flowers bloom. However, China’s economic trajectory remains gloomy over the long run – not least because the US and China lack a strategic basis for re-engagement. Chinese Leaders Fear Foreign Encroachments Mao’s predicament was not only one of ideology and historical circumstance. It was also one of China’s geopolitics. Chinese governments have always struggled to establish domestic control, extend that control over far-flung buffer territories, and impose limits on foreign encroachments. Mao reversed his brief attempt at liberalization because he could not feel secure in his person or his regime. In 1959, the Chinese economy remained backward. The state faced challenges in administration and in buffer spaces like Tibet and Taiwan. The American military loomed large, despite the stalemate and ceasefire on the Korean peninsula in 1952. Russia was turning against Stalinism, while Hungary was revolting against the Soviet Union. Mao feared that the free exchange of ideas would do more to undermine national unity than it would to promote industrialization and technological progress. The 100 flowers that bloomed – intellectuals criticizing government policy – revealed themselves to be insufficiently loyal. They could be culled, strengthening the regime. However, what followed was a failed economic program and nationwide famine. Fast forward to today, when circumstances have changed but the Chinese state faces the same geopolitical insecurities. Xi Jinping, like all Chinese rulers, is struggling to maintain domestic stability and territorial integrity while regulating foreign influence. Although the People’s Republic is not as vulnerable as it was in Mao’s time, it is increasingly vulnerable – namely, to a historic downshift in potential economic growth and a rise in international tensions (Chart 2). The Xi administration has repeatedly shown that it views the US alliance system, US-led global monetary and financial system, and western liberal ideology as threats that need to be counteracted. Chart 2China: Less Stable, Less Secure In addition, Russia’s difficulties invading Ukraine suggest that China faces an enormous challenge in attempting to carve out its own sphere of influence without shattering its economic stability. Hence Beijing needs to slow the pace of confrontation with the West while pursuing the same strategic aims. Xi Stays, But Policy Uncertainty Still High In 2022  2022 is a critical political juncture for China. Xi was supposed to step down and hand the baton to a successor chosen by his predecessor Hu Jintao. Instead he has spent the past decade arranging to remain in power until at least 2032. He took a big stride toward this goal at the nineteenth national party congress in 2017, when he assumed the title of “core leader” of the Communist Party and removed term limits from its constitution. This year’s Omicron outbreak and abrupt economic slowdown have raised speculation about whether Xi’s position is secure. Some of this speculation is wild – but China is far less stable than it appears. Structurally, inequality is high, social mobility is low, and growth is slowing, forcing the new middle class to compromise its aspirations. Cyclically, unemployment is rising and the Misery Index is higher than it appears if one focuses on youth employment and fuel inflation (Chart 3). The risk of sociopolitical upheaval is underrated among global investors. Chart 3AStructurally China Is Vulnerable To Social Unrest Chart 3BCyclically China Is Vulnerable To Social Unrest Yet even assuming that social unrest and political dissent flare up, Xi is highly likely to clinch another five-to-ten years in power. Consider the following points: The top leaders control personnel decisions. The national party congress is often called an “election,” but that is a misnomer. The Communist Party’s top posts will be ratified, not elected. The Politburo and Politburo Standing Committee select the members of the Central Committee; the national party congress convenes to ratify these new members. The Central Committee then ratifies the line-up of the new Politburo and Politburo Standing Committee, which is orchestrated by Xi along with the existing Politburo Standing Committee (Diagram 1). Xi is the most important figure in deciding the new leadership. Diagram 1Mechanics Of The Chinese Communist Party’s National Congress There is no history of surprise votes. The party congress ratifies approximately 90% of the candidates put forward. Outcomes closely conform to predictions of external analysts, meaning that the leadership selection is not a spontaneous, grassroots process but rather a mechanical, elite-driven process with minimal influence from low-level party members, not to mention the population at large.2  The party and state control the levers of power: The Communist Party has control over the military, state bureaucracy, and “commanding heights” of the economy. This includes domestic security forces, energy, communications, transportation, and the financial system. Whoever controls the Communist Party and central government exerts heavy influence over provincial governments and non-government institutions. The state bureaucracy is not in a position to oppose the party leadership. Xi has conducted a decade-long political purge (“anti-corruption campaign”). Upon coming to power in 2012, Xi initiated a neo-Maoist campaign to re-centralize power in his own person, in the Communist Party, and in the central government. He has purged foreign influence along with rivals in the party, state, military, business, civil society, and Big Tech. He personally controls the military, the police, the paramilitary forces, the intelligence and security agencies, and the top Communist Party organs. There may be opposition but it is not organized or capable. Chart 4China: Big Tech Gets Relief ... For Now There are no serious alternatives to Xi’s leadership. Xi is widely recognized within China as the “core” of the fifth generation of Chinese leaders. The other leaders and their factions have been repressed. Xi imprisoned his top rivals, Bo Xilai and Zhou Yongkang, a decade ago. He has since neutralized their followers and the factions of previous leaders Hu Jintao and Jiang Zemin. Premier Li Keqiang has never exercised any influence and will retire at the end of this year. None of the ousted figures have reemerged to challenge Xi, but potential rivals have been imprisoned or disciplined, as have prominent figures that pose no direct political threat, such as tech entrepreneur Jack Ma (Chart 4).  Additional high-level sackings are likely before the party congress. China’s reversion to autocracy grew from Communist Party elites, not Xi alone. China’s slowing potential GDP growth and changing economic model raise an existential threat to the Communist Party over the long run. The party recognized its potential loss of legitimacy back in 2012, the year Xi was slated to take the helm. The solution was to concentrate power in the center, promoting Maoist nostalgia and strongman rule. In essence, the party needed a new Mao; Xi was all too willing to play the part. Hence Xi’s current position does not rest on his personal maneuvers alone. The party has invested heavily in Xi and will continue to do so. Characteristics of the political elite underpin the autocratic shift. Statistics on the evolving character traits of Politburo members show the trend toward leaders that are more rural, more bureaucratic, and more ideologically orthodox, i.e. more nationalist and communist (Chart 5). This trend underpins the party’s behavior and Xi’s personal rule. Chart 5China: From Technocracy To Autocracy Chart 6China: De-Industrialization Undermines Stability Xi has guarded his left flank. By cornering the hard left of the political spectrum Xi has positioned himself as the champion of poor people, workers, farmers, soldiers, and common folk. This is the political base of the Communist Party, as opposed to the rich coastal elites and westernizing capitalists, who stand to suffer from Xi’s policies. Ultimately de-industrialization – e.g. the sharp decline in manufacturing and construction sectors (Chart 6) – poses a major challenge to this narrative. But social unrest will be repressed and will not overturn Xi or the regime anytime soon. Xi still retains political capital. After centuries of instability, Chinese households are averse to upheaval, civil war, and chaos. They support the current regime because it has stabilized China and made it prosperous. Of course, relative to the Hu Jintao era, Xi’s policies have produced slower growth and productivity and a tarnished international image (Chart 7). But they have not yet led to massive instability that would alienate the people in general. If Chinese citizens look abroad, they see that Xi has already outlasted US Presidents Obama and Trump, is likely to outlast Biden, and that US politics are in turmoil. The same goes for Europe, Japan, and Russia – Xi’s leadership does not suffer by comparison.  Chart 7China’s Declining International Image External actors are neither willing nor able to topple Xi. Any outside attempt to interfere with China’s leadership or political system would be unwarranted and would provoke an aggressive response. The US is internally divided and has not developed a consistent China policy. This year the Biden administration has its hands full with midterm elections, Russia, and Iran, where it must also accept the current leadership as a fact of life. It has no ability to prevent Xi’s power consolidation, though it will impose punitive economic measures. Japan and other US allies have an interest in undermining Xi’s administration, but they follow the US’s lead in foreign policy. They also lack influence over the political rotation within the Communist Party. The Europeans will keep their distance but will not try to antagonize China given their more pressing conflict with Russia. Russia needs China more than ever and will lend material support in the form of cheaper and more secure natural resources. North Korean and Iranian nuclear provocations will help Xi stay under the radar.  There is no reason to expect a new leader to take over in China. The Xi administration’s strategy, revealed over the past ten years, will remain intact for another five-to-ten years at least. The real question at the party congress is whether Xi will be forced to name a successor or compromise with the opposing faction on the personnel of the Politburo and Politburo Standing Committee. But even that remains to be seen – and either way he will remain the paramount leader. Bottom Line: Xi Jinping has the political capability to cement another five-to-ten years in power. Opposing factions have been weakened over the past decade by Xi’s domestic political purge and clash with the United States. China is ripe for social unrest and political dissent but these will be repressed as China goes further down the path of autocracy. Foreign powers have little influence over the process. Policy Uncertainty Falls In 2023 … Only To Rise Again What will Xi Jinping do once he consolidates power? Xi’s administration has weighed heavily on China’s economy, foreign relations, and financial markets. The situation has worsened dramatically this year as the economy struggles with “A Trifecta Of Economic Woes” – namely a rampant pandemic, waning demand for exports, and a faltering housing market (Chart 8). In response the administration is now easing a range of policies to stabilize expectations and try to meet the 5.5% annual growth target. The money impulse, and potentially the credit impulse, is turning less negative, heralding an eventual upturn in industrial activity and import volumes in 2023. These measures will give a boost to Chinese and global growth, although stimulus measures are losing effectiveness over time (Chart 9).  Chart 8China's Trifecta Of Economic Woes Chart 9More Stimulus, But Less Effectiveness This pro-growth policy pivot will continue through the year and into next year. After all, if Xi is going to stay in power, he does not want to bequeath himself a financial crisis or recession at the start of his third term. Still, investors should treat any rally in Chinese equity markets with skepticism. First, political risk and uncertainty will remain elevated until Xi completes his power grab, as China is highly susceptible to surprises and negative political incidents this year (Chart 10). For example, if social unrest emerges and is repressed, then the West will impose sanctions. If China increases its support of Russia, Iran, or North Korea, then the US will impose sanctions.     Chart 10China: Policy Uncertainty And Geopolitical Risk To Stay High In 2022, Might Improve In 2023 Chart 11China Needs To Court Europe The regime will be extremely vigilant and overreact to any threats this year, real or perceived. Political objectives will remain paramount, above the economy and financial markets, and that means new economic policy initiatives will not be reliable. Investors cannot be confident about the country’s policy direction until the leadership rotation is complete and new policy guidance is revealed, particularly in December 2022 and March 2023. Second, after consolidating power, investors should interpret Xi’s policy shift as “letting 100 flowers bloom,” i.e., a temporary relaxation that aims to reboot the economy but does not change the country’s long-term policy trajectory. Economic reopening is inevitable after the pandemic response is downgraded – which is a political determination. Xi will also be forced to reduce foreign tensions for the sake of the economy, particularly by courting Europe, which is three times larger than Russia as a market (Chart 11). However, China’s declining labor force and high debt levels prevent its periodic credit stimulus from generating as much economic output as in the past. And the administration will not ultimately pursue liberal structural reforms and a more open economy. That is the path toward foreign encroachment – and regime insecurity. The US’s sanctions on Russia have shown the consequences of deep dependency on the West. China will continue diversifying away from the US. And, as we will see, the US cannot provide credible promises that it will reduce tensions. US-China: Re-Engagement Will Fail The Biden administration is focused on fighting inflation ahead of the midterm elections. But its confrontation with Russia – and likely failure to freeze Iran’s nuclear program – increases rather than decreases oil supply constraints. Hence some administration officials and outside observers argue that the administration should pursue a strategic re-engagement with China.3  Theoretically a US-China détente would buy both countries time to deal with their domestic politics by providing some international stability. Improved US-China relations could also isolate Russia and hasten a resolution to the war in Ukraine, potentially reducing commodity price pressures. In essence, a US-China détente would reprise President Richard Nixon’s outreach to China in 1972, benefiting both countries at the expense of Russia.4  This kind of Kissinger 2.0 maneuver could happen but there are good reasons to think it will not, or if it does that it will fall apart in one or two years. In 1972, China had nowhere near the capacity to deny the US access to the Asia Pacific region, expel US influence from neighboring countries, reconquer Taiwan, or project power elsewhere. Today, China is increasingly gaining these abilities. In fact it is the only power in the world capable of rivaling the US in both economic and military terms over the long run (Chart 12). Secretary of State Antony Blinken recently outlined the Biden administration’s China policy and declared that China poses “the most serious long-term challenge” to the US despite Russian aggression.5  Chart 12US-China Competition Sows Distrust, Drives Economic Divorce While another decade of US engagement with China would benefit the US economy, it would be far more beneficial to China. Crucially, it would be beneficial in a strategic sense, not just an economic one. It could provide just the room for maneuver that China needs – at this critical juncture in its development – to achieve technological and productivity breakthroughs and escape the middle-income trap. Another ten-year reprieve from direct American competition would set China up to challenge the US on the global stage. That would be far too high of a strategic price for America to pay for a ceasefire in Ukraine. Ukraine has limited strategic value for the US and it does not steer US grand strategy, which aims to prevent regional empires from taking shape. In fact Washington is deliberately escalating and prolonging the war in Ukraine to drain Russia’s resources. Ending the war would do Russia a strategic favor, while re-engaging with China would do China a strategic favor. So why would the defense and intelligence community advise the Biden administration to pursue Kissinger 2.0? Chart 13US Unlikely To Revoke Trump Tariffs Biden could still pursue some degree of détente with China, namely by repealing President Trump’s trade tariffs, in order to relieve price pressures ahead of the midterm election. Yet even here the case is deeply flawed. Trump’s tariffs on China did not trigger the current inflationary bout. That was the combined Trump-Biden fiscal stimulus and Covid-era supply constraints. US import prices are rising faster from the rest of the world than they are from China (Chart 13). Tariff relief would not change China’s Zero Covid policy, which is the current driver of price spikes from China. And while lifting tariffs on China would not reduce inflation enough to attract voters, it would cost Biden some political credit among voters in swing states like Pennsylvania, and across the US, where China’s image has plummeted in the wake of Covid-19 (Chart 14).   Chart 14US Political Consensus Remains Hawkish On China If Biden did pursue détente, would China be able to reciprocate and offer trade concessions? Xi has the authority to do so but he is unlikely to make major trade concessions prior to the party congress. Economic self-sufficiency and resistance to American pressure have become pillars of his support. Promises will not ease inflation for US voters in November and Xi has no incentive to make binding concessions because the next US administration could intensify the trade war regardless.  Bottom Line: The US has no long-term interest, and a limited short-term interest, in easing pressure on China’s economy. Continued US pressure, combined with China’s internal difficulties, will reinforce Xi Jinping’s shift toward nationalism and hawkish foreign policy. Hence there is little basis for a substantial US-China re-engagement that improves the global macroeconomic environment over the coming years. Investment Takeaways Chart 15Autocracy Hurts Productivity Xi Jinping will clinch another five-to-ten years in power this fall. To stabilize the economy, he will “let 100 flowers bloom” and ease monetary, fiscal, regulatory, and social policy at home. He will also court the West, especially Europe, for the sake of economic growth. However, he will not go so far as to compromise his ultimate aims: self-sufficiency at home and a sphere of influence abroad. The result will be a relapse into conflict with the West within a year or two. Ultimately a closed Chinese economy in conflict with the West will result in lower productivity, a weaker currency, a high geopolitical risk premium, and low equity returns – just as it did for Russia (Chart 15). Any short-term improvement in China’s low equity multiples will ultimately be capped. Over the long run, western investors should hedge against Chinese geopolitical risk by preferring markets that benefit from China’s periodic stimulus yet do not suffer from the break-up of the US-China and EU-Russia economic relationships, such as key markets in Latin America and Southeast Asia (Charts 16 & 17). Chart 16China Stimulus Creates Opportunity For … Latin America Chart 17China Stimulus Creates Opportunity For … Southeast Asia     Matt Gertken Chief Geopolitical Strategist mattg@bcaresearch.com   Footnotes 1     Modern scholarship has shown that Mao intended to entrap the opposition through the 100 Flowers Campaign. For a harrowing account of this episode, see Jung Chang and Jon Halliday, Mao: The Unknown Story (New York: Anchor Books, 2006), pp. 409-17. 2     “At least 8% of CPC Central Committee nominees voted off,” Xinhua, October 24, 2017, english.www.gov.cn. 3    Christopher Condon, “Yellen Says Biden Team Is Looking To ‘Reconfigure’ China Tariffs,” June 8, 2022, www.bloomberg.com. 4       Niall Ferguson, “Dust Off That Dirty Word Détente And Engage With China,” Bloomberg, June 5, 2022, www.bloomberg.com. 5    See Antony J Blinken, Secretary of State, “The Administration’s Approach to the People’s Republic of China,” George Washington University, Washington D.C., May 26, 2022, state.gov. Additionally, see President Joe Biden’s third assertion of US willingness to defend Taiwan against China, in a joint press conference with Japan’s Prime Minister Kishida Fumio, “Remarks by President Biden and Prime Minister Kishida Fumio of Japan in Joint Press Conference,” Akasaka Palace, Tokyo, Japan, May 23, 2022, whitehouse.gov.

Special Report

Executive Summary Chinese Infrastructure Investment Growth: A Slowdown Ahead Despite the authorities’ push, China’s infrastructure1  investment nominal growth2 will likely slow from the current rate of 8% to 1-3% in 2022H2, on a year-over-year basis.   Funding shortages will limit local governments’ capability to invest in traditional infrastructure fixed-asset investment (FAI), which will likely grow by only 1-2% in 2022H2. We expect China’s cheap green loans to support a 10-15% growth in tech infrastructure spending in the second half of this year. However, the scale of China’s tech infrastructure investment is too small in absolute terms to offset the weakness in traditional infrastructure spending.  Tech infrastructure plays will likely outperform traditional infrastructure plays in the long term as China continues its efforts to peak carbon emissions before 2030 and reach carbon neutrality before 2060. As new infrastructure investment will accelerate in the coming years, we are positive on the sectors of NEV and NEV charging poles. Given the still-high valuation of the sector and mounting downward pressure that the Chinese economy is currently facing, we look to buy these sectors at a better price entry point. Bottom Line: China’s infrastructure investment growth will likely slow from the current 8% rate to 1-3% in 2022H2 due to funding constraints and a shrinking pool of profitable infrastructure projects. Feature Infrastructure investment growth in China accelerated to 8% (nominal) in the first four months of this year (Chart 1, top panel). The authorities demanded that local governments execute infrastructure projects sooner and faster to offset the strong headwinds to the economy from COVID restrictions and continued property downturn. Nonetheless, China’s infrastructure investment growth will likely slow from the current annual rate (YoY) of 8% to 1-3% in 2022H2 due to funding constraints and a lack of financially feasible projects, bringing the whole year’s growth to slightly below 4%.  Although a 4% YoY growth in infrastructure investment this year would be an improvement from the 0.4% YoY contraction in 2021, it is far below the 12% average rate of infrastructure spending growth over the past decade (Chart 1). Moreover, we estimate that traditional infrastructure investment, which accounts for 95% of China’s total infrastructure spending, will only grow by 1-2% in 2022H2 (Chart 2, top panel). Chart 1Chinese Infrastructure Investment: Moderate Growth In 2022H2 Chart 2Investment Growth In 2022H2: Deceleration In Traditional Infrastructure While Acceleration In Tech Infrastructure For the tech infrastructure, we are more positive as building cutting-edge tech infrastructure– including 5G networks, data centers, artificial intelligence (AI) and Internet of Things (IoT) – has become a top development priority for China. With supportive policies and cheap green loans, we expect a 10-15% YoY growth in Chinese tech infrastructure in 2022H2 (Chart 2, bottom panel). However, the scale of China’s tech infrastructure investment is too small in absolute terms to offset the weakness in traditional infrastructure spending. After all, tech infrastructure currently only accounts for about 5% of the total Chinese nominal infrastructure FAI (Chart 3). Chart 3Breaking Down Chinese Infrastructure Investment Tech infrastructure plays will likely outperform their traditional infrastructure counterparts in the long term as China continues its efforts to peak carbon emissions before 2030 and reach carbon neutrality before 2060. As new infrastructure investment will accelerate in the coming years, we are positive on the sectors of NEV and NEV charging poles. Yet, considering China’s economy is still facing downward pressure and the sector’s valuations are still high, we look to buy these sectors at a better price entry point. Funding Constraints The recent strong rebound in Chinese infrastructure investment was mainly driven by a massive frontload of local government special purpose bond (SPB) sales, as well as funding from last year’s SPB proceeds – both funding resources will not sustain into the second half of this year.   According to the data from the Ministry of Finance, in the first five months of 2022, special bond issuance has already reached 2.03 trillion RMB, significantly higher than the 1.2 trillion RMB issued during the same period last year. In addition, there has been an estimated 1.2 trillion unused SPB proceeds from 2021 that have been carried over to 2022 to fund infrastructure spending. However, such a boost in local government funding of infrastructure investment is unsustainable. We expect Chinese infrastructure investment growth to fall back to the 1-3% range in 2022H2 due to limited financial availability and a shrinking pool of infrastructure projects. Chart 4 shows the breakdown of the major funding sources of Chinese infrastructure investment. Most of them are likely to face considerable constraints over the next six months. Chart 4Major Funding Sources Of Chinese Infrastructure Investment (1) Less Revenues Chinese local governments face tremendous shortfalls of cash, which will impede their ability to meet their nearly 30% contribution to overall infrastructure funding: Land sales by local governments contribute nearly 90% of government-managed funds (GMF3). The latter's revenues, excluding proceeds from SPB issuance, account for 16% of overall infrastructure funding. The deep contraction in home sales has depressed real estate developers’ land purchases, which has considerably reduced local government revenues (Chart 5). This will curb the ability of local governments to finance their infrastructure projects through GMFs. Although we expect a moderate rebound in property sales over the next six months from very depressed levels in recent months, the improvement in local government land sales will likely be very limited as real estate developers are still overleveraged and under severe funding constraints.   In addition to the slump in land sales, tax cuts for corporates and low-income households are also eroding local government revenues, and COVID-related expenses add to spending needs. Shrinking corporate profits will also pose downward risks to the tax revenues of local governments (Chart 6). Chart 5Government-Managed Funds: Headwinds From Falling Land Sales Chart 6Declining Government Tax##br## Revenues   The general budget of local governments,4 which contributes to about 14% of overall infrastructure financing, is extremely tight this year. In the first four months of the year,  revenues of local governments fell by about 18% from the same period last year, while their expenditures increased by 5%. As a result, the general government’s fiscal deficit will likely exceed both the 2.8% target set for this year and the 3.2% fiscal deficit of last year (Chart 7).   Chart 7Government General Budget: Large Deficit (2) Less SPB Available In H2 Chart 8Local Government Special Bond Issuance Will Decrease In 2022H2 Local government SPB issuance, which is used exclusively to fund infrastructure projects, has been another major source of financing for domestic infrastructure projects since 2016 (Chart 8).    As local governments frontloaded 56% of their 2022 SPB quota in the first five months of this year, they will have less fiscal support from SPBs in 2022H2. As net local government SPB issuance made up about 16% of overall infrastructure FAI on average in the past three years, there is quite a financing gap to be filled in 2022H2. (3) Contracting Domestic Loan Demand Domestic loans contribute to about 20% of overall infrastructure financing, with 14% from regular non-household medium-long-term (MLT) lending, and another 6% from domestic green loans. Infrastructure projects are generally long-term investments in nature and hence often require MTL loans. Presently, the impulse of non-household MLT lending is contracting (Chart 9). While not all MLT loans are used for infrastructure, sluggish MLT lending also reflects corporates’ reluctance to borrow for and invest in infrastructure projects. Strong economic headwinds due to COVID-induced lockdowns and the slumping property market, mounting local government debt, and low returns on infrastructure projects will continue to curb corporates’ demand for bank loans to fund infrastructure projects, particularly from the private sector. The “green loans”,5 which are used for but not limited to new energy infrastructure projects, will continue to grow strongly in 2022H2. In 2021, the increase in green loans for infrastructure was 1.64 trillion RMB, or a 62% increase from the previous year. In 2022, we expect new green loans could rise 50%-80% to 2.5-3 trillion RMB, with an increase of 0.6-1.1 trillion RMB in new green loans in the second half of the year. While green loans will help support the overall infrastructure investment, given their small size (green loans accounted for about 8% of China’s total infrastructure investment in 2021), they will unlikely fully offset the shortfall from other financing sources this year (Chart 10). Chart 9Sluggish Medium/Long-Term Bank##br## Lending Chart 10Green Loans: Strong Growth In 2022H2 But Still Small Amount Relative To Overall Infrastructure Investment In the long run, though, to reach peak carbon emissions by 2030 and carbon neutrality by 2060, China will continue to lean heavily on its banking system to accelerate green projects and infrastructure investment. (4) Public-Private Partnerships (PPP) Since 2014, PPPs have become an important financing model for Chinese local governments to fund infrastructure investments. However, to control rising local government leverage, the central government has tightened regulations on PPP projects since early 2018. Heightened scrutiny has resulted in a sharp deceleration in both PPP investment and overall infrastructure investment growth. Consequently, PPP contributions to total infrastructure FAI have been consistently declining, from over 30% in 2017 to about 4% currently (Chart 11). So far this year, the amount of signed and implemented PPP investments has been falling. While the private sector’s propensity to invest has been extremely weak, a shrinking pool of profitable infrastructure projects could be another contributing factor. The number of projects – which are in the preparation stage in the national total project entries – has been falling from its peak of 2,550 in June 2017 to only 465 in March 2022 (Chart 12). Chart 11Public-Private Partnerships Funding: Limited Growth In 2022H2 Chart 12A Shrinking Pool Of Public-Private Partnership##br## Projects (5) Other Funding Sources Local government financing vehicles (LGFV) and shadow bank borrowing were major financing sources prior to 2018. However, following the 2017/2018 financial de-risking and anticorruption campaign, local governments have scaled back their shadow bank activities significantly. Shadow banking remains in deep contraction (Chart 13). We expect only a modest pick-up in LGFV leveraging during the rest of the year, given that both the anticorruption campaign and a reshuffling of local government officials are ongoing. Chart 13Shadow Banking Will Remain In Deep Contraction In addition, policy banks could sell special sovereign bonds to help fund domestic infrastructure projects. For example, in a recent State Council meeting, Premier Li Keqiang requested policy banks to provide 800 billion RMB ($120 billion) in funding for infrastructure projects. An 800-billion-RMB additional funding, if fully invested, would only add about 0.4% growth to this year’s infrastructure spending. Bottom line: Due to funding constraints and a shrinking pool of profitable infrastructure projects, China’s infrastructure investment growth rate will likely slow from the current 8% pace to 1-3% in 2022H2. Infrastructure Investment Focus: Shifting From Traditional To New Chart 14China Is Shifting Its Focus Away From Traditional Infrastructure Development… The pace of new infrastructure (including but not limited to tech infrastructure) is set to accelerate both cyclically (in the next 6 to 12 months) and structurally (in the next 3 to 5 years), while traditional infrastructure investment growth will slow. However, over a cyclical time horizon, infrastructure investment in new economy sectors is too small to offset the weakness in spending in traditional sectors. Decelerating Investment In Traditional Infrastructure In 2022H2 And Beyond Chart 14 shows the real growth rate of railways, highways and airports has all dropped to below 3% last year. Correspondingly, investment in transport infrastructure only grew 1.4% in 2020 and 1.6% in 2021, a distinctly slower pace from 3.9% in 2018 and 3.4% in 2019. Similar growth deceleration has also occurred in the Water Conservancy, Environment & Utility Management sector. Investment growth in nominal terms this sector fell from 3.3% in 2018 and 2.9% in 2019 to 0.2% in 2020 and saw a 1.2% contraction in 2021. Most Chinese cities with large populations and/or high population density have already upgraded their sewer system in recent years and, therefore, localities have only been maintaining rather than upgrading these systems. The Water Conservancy, Environment & Utility Management sector and the Transport, Storage and Postal Service sector together account for the lion’s share (78%) of total infrastructure investment. A growth deceleration in these two sectors will likely lead to slower growth in overall infrastructure investment, compared with the first four months of this year, when both sectors grew by 7.2% and 7.4%, respectively, in nominal terms. Accelerating Investment In New Infrastructure In 2022H2 And Beyond Chart 15...To New Infrastructure Development Investment in new economy sectors–such as Electricity, Gas & Water Production and Supply, which currently accounts for about 18% of overall infrastructure investment–will remain strong in 2022H2. Investment in the subsector of ultra-high-voltage electricity transmission (UHV electricity transmission) and smart grid, as well as new electricity infrastructure, such as wind and solar power, will also continue to accelerate. The construction of 5G base stations will grow strongly in the coming years but may see a moderation in growth this year. Network operators such as China Mobile, China Unicom and China Telecom plan to build about 600,000 5G base stations, slightly lower than last year’s 650,000. The construction of new electric vehicle (NEV) charging poles accelerated because of a significant increase in NEV sales (Chart 15). Elevated oil prices and technology improvement in NEV performance have boosted NEV sales in China. As such, investment growth in NEV charging infrastructure is set to rise in the coming years. Bottom line: China’s investment focus is shifting from traditional infrastructure to new economy infrastructure. As such, we expect new infrastructure investment in tech and green energy to rise at the expense of traditional infrastructure (Chart 16). Chart 16"Green Investment" Is Rising, “Dirty Thermal” Investment Is Falling Investment Implications The infrastructure sector accounts for about 10-15% of China’s total steel consumption and about 30-40% of cement consumption (Chart 17). Chart 17A Slowdown In Chinese Infrastructure Spending Will Weigh On Steel And Cement Prices We expect China’s infrastructure investment, particularly in traditional sectors like highway construction, to slow in the second half of the year. As such, steel prices are at risk of falling further. Moreover, sluggish construction activity in property markets will be a drag on steel prices (Chart 18). Slower growth in traditional infrastructure investment in the next six months, as well as structurally will pose downward pressures on the performance of both global and Chinese onshore machinery stocks (Chart 19). Chart 18Dismal Property Markets Will Be A Drag On##br## Steel Prices Chart 19Slower Growth In Traditional Infrastructure Investment Will Weigh On Global/Chinese Machinery Stocks Chart 20Look To Buy NEV Stocks We are positive on China’s NEV sector’s structural outlook and stock performance, based on an acceleration in new economy infrastructure investment in the coming years. However, the near-term outlook on the sector’s stock performance is neutral at best. The sector’s valuations are high, considering China’s economy is still facing downward pressure due to a faltering property market, sluggish household income growth and consumption, falling export demand, as well as heightened risks of further COVID-induced lockdowns. NEV stocks will likely have more shakeouts in the coming six months before any sustainable uptrend. Hence, we look to buy these sectors at a better price entry point (Chart 20).   Ellen JingYuan He Associate Vice President ellenj@bcaresearch.com Footnotes 1  Including both traditional infrastructure and tech infrastructure. For the purposes of this report, the composition of “infrastructure” includes “traditional infrastructure” and “tech infrastructure.” The “traditional infrastructure” comprises three categories – (1) Transport, Storage and Postal Service; (2) Water Conservancy, Environment & Utility Management; and (3) Electricity, Gas & Water Production and Supply. 2 Please note that all growth rates in this report are nominal growth rates. 3 According to the country’s Budget Law, the GMF budget refers to the budget for revenues and expenditures for the funds raised for specific developmental objectives. In brief, GMFs constitute de-facto off-balance-sheet government revenues and spending. 4 The general budget of local governments covers local governments’ day-to-day operation as well as local infrastructure development (mainly in four categories: Environment Protection,  Urban & Rural Community Affairs, and Affairs of Agriculture, Forest  & Irrigation and Transportation). In contrast, the government-managed funds (GMF) excluding proceeds from SPB issuance finances the big ang national-level important infrastructure projects. 5 Last November, the People’s Bank of China (PBoC) launched a carbon emission reduction facility (CERF) to offer low interest loans to financial institutions that help firms cut carbon emissions. The targeted green lending program will provide 60% of loan principals made by financial institutions for carbon emission cuts at a one-year lending rate of 1.75%. The funding will be available retroactively after the loans are made, and can be rolled over twice. Strategic Themes Cyclical Recommendations