China Stimulus

BCA’s Emerging Markets Strategy team’s view remains that US inflation will prove to be sticky. That said, in this report, we examine under what conditions a considerable drop in US core inflation, whenever it transpires, would be bullish for stocks. Potentially significant US disinflation would be bullish for stocks if it is due to an improvement in supply-side dynamics, but bearish if it is demand driven.

In this report, we elaborate on why the Chinese central government has been reluctant to open stimulus taps as much as in the past, especially when it comes to the ailing property market. In recent years, there has been a major shift in Beijing’s assessment of the trade-offs between short-term economic growth, sociopolitical stability and the nation's long-term goals. We explain this difficult balancing act, little-known in the global investment community.

This week’s <i>Global Investment Strategy</i> report titled Fourth Quarter 2022 Strategy Outlook: A Three-Act Play discusses the outlook for the global economy and financial markets for the rest of 2022 and beyond.

Executive Summary EU Metal Industry Under Threat EU Energy Crisis, Strong USD Imperil Bloc’s Metals Industry EU Energy Crisis, Strong USD Imperil Bloc’s Metals Industry Russia’s threat to cut off all remaining exports of natural gas to the EU via Ukraine will further imperil the bloc’s struggling metals industry, particularly aluminum smelting – where half of its capacity already has been shut – and zinc refining. The EU will have to prioritize energy security over its renewable-energy goals, given the challenges its manufacturing industries will confront for the next 3-5 years. Surging imports of raw copper concentrates and unwrought metal will consolidate the global dominance of China’s copper refiners, which sharply increased their treatment and refining charges this week. The US likely will see more investment in metals mining and refining on the back of the EU distress, which realistically cannot be addressed until gas and power prices fall to levels that allow them to sustain their operations. Bottom Line: Ongoing supply shocks to the EU’s base-metals industry will force the bloc to prioritize energy security over its renewable-energy goals. This will drive the bloc’s demand for liquified natural gas (LNG) and oil higher, even after short-term measures to increase LNG intake and distribution capacity are completed over the next 2-3 years. We expect the equities of oil and gas producers to outperform metals miners over this period. After being stopped out, we will be re-instating our long XOP ETF position at tonight’s close. Feature Earlier this month, Eurometaux, the EU metals lobbying group, published a memo to the European Commission drawing attention to “Europe’s worsening energy crisis and its existential threat to our future.”1 This is not hyperbole. At the heart of the industry’s woes is a chronic shortage of energy – in any form – for industrial use. Utilities are signing long-term LNG supply contracts to address this shortage, but they can expect to wait 3-4 years or more before gas arrives on Europe’s shores.2 Spot and one-off cargoes will become available over that time, but most of the existing LNG production is under long-term contract. Oil, coal, and nuclear energy are available for power generation, industrial applications and space-heating, and they increasingly are being used in the bloc, but these too are constrained.3 Measures to address the chronic energy shortage hammering the EU base-metals industry will take years to effect, and could come too late to meaningfully preserve existing refining capacity, which has been contracting for years (Chart 1).4 Most of the EU’s metals production is accounted for by aluminum, copper and zinc, which are extremely energy intensive, copper only less so (Chart 2). The surge in LNG prices following Russia's invasion of Ukraine propelled electricity prices higher, given gas is the marginal fuel for EU power generation (Chart 3). This crushed zinc and aluminum refining. Half of the EU’s aluminum smelter capacity – ~ 1mm MT – will be curtailed or shuttered this year, according to European Aluminum.5 Chart 1EU Metal Industry Under Threat EU Energy Crisis, Strong USD Imperil Bloc’s Metals Industry EU Energy Crisis, Strong USD Imperil Bloc’s Metals Industry Chart 2EU Metals Are Extremely Energy Intensive EU Energy Crisis, Strong USD Imperil Bloc’s Metals Industry EU Energy Crisis, Strong USD Imperil Bloc’s Metals Industry Chart 3EU Power Price Surge Crushes Metals Refining EU Energy Crisis, Strong USD Imperil Bloc’s Metals Industry EU Energy Crisis, Strong USD Imperil Bloc’s Metals Industry The surge in European electricity prices and the resulting curtailment or shuttering of zinc refining paced the 2.6% y/y decline in global output in 1H22, which took global production down to 6.77mm MT, according to the International Lead and Zinc Study group. Europe accounts for ~ 15% of global zinc refining.6 Refined zinc consumption fell 3% y/y in 1H22 to 6.74mm MT. China Bingeing On Copper Global refined copper output in the January – July 2022 period slightly outpaced usage – with 3% growth in the former and 2.6% growth in the latter, according to the International Copper Study Group (ICSG). On the back of this report, we lowered our expected supply growth estimate to 3% this year, (Chart 4). This brings our estimate for total supply down by ~400k MT vs. our previous iteration to 25.3mm MT. We are keeping our estimate of 2023 supply growth rate at ~ 4.5%. Our copper demand estimate is a function of real GDP estimated by the World Bank, and remains at just under 26mm MT and 27.2 mm MT for 2022 and 2023 respectively. As a result of the lower 2022 production growth rate, our forecasted copper deficit has widened to ~ 605k tons in 2022 and 480k tons in 2023. The mismatch in supply and demand levels will keep inventories in China and the West under pressure (Charts 5A and 5B). Chart 4Copper Supply Estimate Lowered Copper Supply Estimate Lowered Copper Supply Estimate Lowered   Chart 5AChinese Copper Inventories Continue To Draw Chinese Copper Inventories Continue to Draw Chinese Copper Inventories Continue to Draw Chart 5BAs Do Stocks In The West As Do Stocks In The West As Do Stocks In The West China’s imports of copper condensates – the raw material used to make refined copper – surged to 16.65mm tons over January – August 2022, up 9% y/y. Imports of unwrought and semi-fabricated copper were up 8% over the same period at 3.9mm MT, according to Mysteel.com. As is to be expected, treatment and refining charges at Chinese smelters also moved higher: for 3Q22, refiners were charging $93/MT, up $13 from 2Q22 levels and $23/MT from 4Q21, according to Reuters. These charges increase when raw-material supplies increase, and vice versa. This is meant to be a floor charged for refining concentrates to produce refined copper. Real USD Matches US PPI After Re-Opening In an unusual turn of events, the USD Real Effective Exchange Rate (REER) has been moving higher along with the US Producer Price Index for all commodities. This trend started as the global economy accelerated its re-opening in 2021 (Chart 6). The USD has a profound affect on commodity prices: Most globally traded commodities are denominated in USD, funded in USD and invoiced in USD. This is the channel through which the Fed’s monetary policy impacts commodity buyers ex-US. A stronger dollar means commodities in local-currency terms are more expensive, and vice versa. It also means production costs in states that do not peg their currencies to the USD go down, and vice versa. Chart 6Real USD Gains With US PPI During Reopening Real USD Gains With US PPI During Reopening Real USD Gains With US PPI During Reopening Given the USD’s elevated level, copper prices in local-currency terms will continue to face a massive headwind on the demand side, and a massive tailwind on the production side. For households and firms buying commodities, or durable goods with a lot of metals in them (copper, stainless steel, etc.), Fed policy has a direct effect on how their budgets get allocated.7 In the short and long run macroeconomic variables such as the USD influence copper prices by increasing the cost of copper ex-US when the dollar rallies, and vice versa. Fundamental variables like tight inventories, which arise when demand is consistently above supply, impart an upward price bias to the copper forward curve (backwardation increases as inventories decrease). Domestic economic factors matter, too.  Copper prices have been pummeled by the meltdown of China’s property sector, which has been the growth engine for the country’s economy, accounting for ~ 30% of its copper demand. The USD has remained well bid following Russia’s invasion of Ukraine, presenting a powerful headwind to commodity prices in general. This is particularly true for refined copper, given China accounts for more than 50% of total global consumption. China’s RMB dropped 11.4% vs. the USD from the start of the year to now. This has not stood in the way of a sharp increase in imports of the copper ore and refined metal this year, despite the country’s weak economic performance. Given China’s property-market slowdown and its zero-tolerance COVID-19 policy and its attendant lockdowns, it is difficult to pinpoint a cause for its increased copper demand. It may be opportunistic purchasing – buying the metal when prices are far lower than their peak earlier this year – or it could signal a post-Communist Party Congress increase in economic activity (e.g., more fiscal stimulus hitting the system) officials are preparing for. Investment Implications The EU’s metals-refining sector faces existential challenges as a result of the bloc’s energy crisis. Significant employers – not just the metal refiners – will be confronting limited energy supply and higher costs for years, given the tightness in conventional energy markets – oil, gas and coal. The renewable-energy sector also faces daunting challenges, as a result of difficulties faced by metals refiners and the energy crisis they presently confront. It is worthwhile noting that none of the renewables technology is possible without metals. Given the abundant lessons re reliance on a single supply source Russia’s invasion of Ukraine has provided, we expect investment in US metals mining and refining to increase, as consumers of copper, aluminum and zinc seek to diversify away from Chinese dominance of this sector. This will take time to build out, just as the increase in LNG supplies will take time. This likely will keep a bid under the USD, as manufacturing, mining and refining capex investment shifts to the US. We expect the EU’s drive to secure conventional energy will drive the bloc’s demand for liquified natural gas (LNG) and oil higher, even after currently planned short-term measures to increase LNG intake and distribution capacity are completed over the next 2-3 years. After being stopped out this past week, we will be re-instating our long XOP ETF position on tonight’s close, consistent with our view.   Robert P. Ryan Chief Commodity & Energy Strategist rryan@bcaresearch.com Ashwin Shyam Research Analyst Commodity & Energy Strategy ashwin.shyam@bcaresearch.com   Commodities Round-Up Energy: Bullish. European Commission President Ursula von der Leyen proposed additional economic sanctions against Russia yesterday including extending price caps on oil to third countries, following the call-up of reserves in Russia last week, and a veiled threat to use nuclear weapons against Ukraine. In a related matter, Gazprom, the state-owned gas producer and trading company, threatened to cut off the remaining gas sales to Europe via Ukraine – close to half the ~ 80mm cm /d still being sold via pipeline to the continent (Chart 7). It is apparent the EU has been anticipating a full shut-off of Russian pipeline gas shipments, which likely motivates von der Leyen’s proposal. Any proposal to increase sanctions on Russia would have to be unanimously approved. Base Metals: Bullish. In a boost to prospective Chile copper production, a BHP executive indicated he expects regulatory uncertainties in the largest copper producing state to ease. BHP mentioned earlier this year that legal certainty in Chile would be key to investing over USD 10 billion in the state. Earlier this month, Chilean voters rejected a constitution, which, among other things, could have curtailed mining operation by including new taxes and environmental regulations. Precious Metals: Neutral. In their Q2 platinum balances report, the World Platinum Investment Council (WPIC) expects FY 2022 surplus to rise more than 50% vs. its Q1 estimates to 974k oz. Weak platinum ETF demand resulting from a strong USD and rising interest rates is expected to outweigh operational constraints in South African and North American mining operations. Bolstering supply is the fact that Russian platinum – which constitutes ~11% of global supply – has been reaching buyers. However, this security of supply may not last. Once buyers’ long-term contracts for Russian platinum end, as in the case with aluminum, companies may self-sanction, turning to the spot market and other producing states instead. For palladium, SFA Oxford sees the metal's surplus dropping to ~92% y/y, as demand is expected to increase and production is forecast to fall (Chart 8). Chart 7 EU Energy Crisis, Strong USD Imperil Bloc’s Metals Industry EU Energy Crisis, Strong USD Imperil Bloc’s Metals Industry Chart 8 Palladium Balances Expected To Drop Palladium Balances Expected To Drop     Footnotes 1     Please see Europe’s non-ferrous metals producers call for emergency EU action to prevent permanent deindustrialisation from spiralling electricity and gas prices, posted by Eurometaux 6 September 2022. 2     See, e.g., Exclusive: German utilities close to long-term LNG deals with Qatar, sources say published by reuters.com 20 September 2022. 3    For additional discussion, please see Energy Security Rolls Over EU's ESG Agenda, which we published 28 July 2022.  It is available at ces.bcaresearch.com. 4    Please see Agenda for a resilient European metals supply for the green and digital transitions, posted by Eurometaux in mid-2020.   5    Please see Reconciling growth and decarbonisation amidst the energy crisis, posted by European Aluminium May 2022. 6    Please see Column: European smelter hits mean another year of zinc shortfall published by reuters.com 17 May 2022.  7    Please see "Global Dimensions of U.S. Monetary Policy" by Maurice Obstfeld, which appeared in the February 2020 issue of International Journal of Central Banking for an in-depth discussion and analysis. Investment Views and Themes Strategic Recommendations Trades Closed in 2022

Please note I will be hosting a live webcast on September 29, 2022 at 9:00 AM HKT for the APAC region. I will discuss the global/China/EM macro outlooks and financial market implications. For clients in the Americas and EMEA, we had a webcast on September 28, 2022. You can access the replay via this link. Arthur Budaghyan Executive Summary Global Semi Stock Prices: Further Downside Ahead Global Semi Stock Prices: Further Downside Ahead Global Semi Stock Prices: Further Downside Ahead Global semiconductor stock prices are still vulnerable to meaningful downside over the next three months. Global semi consumption will contract due to the corresponding waning demand of smartphones, personal computers, and other consumer electronics. Global semi demand in sectors of automobiles and datacenters will continue growing. However, such an increase in demand cannot offset the demand reduction in other sectors. Semiconductor consumption in China has entered a contraction phase.  Semiconductor inventories have swelled. Alongside a sharp upsurge in chip production capacity, this increase in inventories will lead to chip price deflation in the next nine months. Nevertheless, the structural outlook for global semiconductor demand remains constructive. We are waiting for a better entry point for semi stocks.  Bottom Line: There is more downside in global semiconductor share prices as well as Taiwanese and Korean tech stocks. We will seek to recommend buying semiconductor stocks when a more material decline in semi companies’ profits is priced in their share prices. At the moment, we are downgrading Taiwanese stocks from neutral to underweight relative to the EM equity benchmark but are maintaining an overweight stance on the Korean bourse within an EM equity portfolio.   The global semiconductor equity index is breaking below its technical support (Chart 1). The implication is that these share prices are in an air pocket and investors should not chase a declining market. Based on previous cycles, we expect global semiconductor stocks to bottom late this year or early next year and semi sales to trough in 2023Q2. In the previous five cycles, global semi stocks always bottomed before global semi sales and lead times varied from three-to-six months. Chart 2 shows that Taiwan’s semiconductor new export orders lead global semi sales by about three months, and they continue to point to considerable downside in the global semi-industry. Chart 1Global Semi Stocks: Breaking Down Global Semi Stocks: Breaking Down Global Semi Stocks: Breaking Down Chart 2Global Semi Sales: More Downside Ahead Global Semi Sales: More Downside Ahead Global Semi Sales: More Downside Ahead The semiconductor industry has a history of cyclicality. Shortages have been followed by oversupply, which has led to declining prices, revenues, and profits for semi producers. This time is no exception Global Semi Sales: A Cyclical Slump Underway Global semiconductor demand began its downward trajectory in May of this year and will continue to slide in the next three-to-six months. Both the volume and value of China’s semiconductor imports are in a deep contraction and China’s imports from Taiwan have also plummeted (Chart 3). China is the world’s largest consumer of semiconductors, accounting for 35% of global demand. We expect semi sales to remain in contraction in China and to shrink in regions outside China in the next six-to-nine months (Chart 4).  Chart 3China's Semi Imports Plummeted China's Semi Imports Plummeted China's Semi Imports Plummeted Chart 4Semi Sales Will Contract Across Regions Semi Sales Will Contract Across Regions Semi Sales Will Contract Across Regions There are several important reasons for the retrenchment worldwide. First, the lockdowns around the world in 2020 and 2021 generated an unprecedented increase in online activities and a corresponding surge in demand for smartphones/PCs/tablets/game consoles/electronic gadgets. This was the main driving force for the boom in global semiconductor sales from 2020Q3 to 2022Q1. The excessive demand for consumer goods and electronics has run its course and global demand will sag in the next six months. As we have been contending since early this year, global exports are set to contract. Households that bought these goods in the past two years probably will not make new purchases in the near term. In addition, declining real disposable income and rising interest rates will constrain consumer spending. Smartphones, PCs, tablets, home appliances, and other household electronic goods consume about half of global semi output. In addition, rising job uncertainties resulting from China’s dynamic zero-COVID policy and slowing household income growth will curb consumption within China. Here are our takeaways for each segment: Chart 5China's Output Of Mobile Phones And PCs Has Been Shrinking China's Output Of Mobile Phones And PCs Has Been Shrinking China's Output Of Mobile Phones And PCs Has Been Shrinking Mobile phones: Mobile phones are the largest contributor to global semi sales, with a share of 31% as of 2021, based on the data from World Semiconductor Trade Statistics (WSTS). According to the International Data Corporation (IDC), global smartphone shipments are set to decline by 6.5% year-over-year in volume terms in 2022. Smartphone OEMs cut their orders drastically in 2022 because of high inventories and low demand, with no signs of an immediate recovery. China accounts for 67% of global mobile phone production and its mobile phone production has been contracting (Chart 5, top panel).   Traditional PCs and tablets: Based on data from the IDC, global traditional PC1  and tablet shipments are set to decline by 12.8% year-over-year in 2022 and by an additional 2.6% next year in volume terms. Computer production in China, which is the world’s largest computer producer and exporter, also shows massive downsizing (Chart 5, bottom panel).   Home appliances: China is also the largest producer and exporter of air conditioners (ACs), washing machines, refrigerators, and freezers. Except for a slight growth in AC output in response to heatwaves in China and Europe, China’s output of other home appliances will shrink. Globally, these industries accounted for about half of all semiconductor sales in 2021. Given the overconsumption of these goods worldwide over the past two years, we expect a material decline in these sectors in the next six-to-nine months. Second, automobiles, servers, and industrial electronics, which together account for about 30% of global semi sales, will have positive single-digit growth going forward. Yet, such an increase will not be enough to offset the lost demand from the consumer electronic goods sector in the next six-to-nine months.  Chart 6Global Auto Production Will Rise Global Auto Production Will Rise Global Auto Production Will Rise Automotive (accounts for 11% of world chip demand): The chip shortage in this sector has eased only moderately. Auto output levels in major producing countries remain well below their pre-pandemic levels (Chart 6). In light of improved foundry capacity, semiconductor producers will be able to produce automotive chips and reduce lingering shortages. However, for most chips to automakers, there are no supply shortages. Only a small number of categories of automotive chips, such as microcontrollers (MCU) and insulated-gate bipolar transistors (IGBT), are still in tight supply. Given that the total automotive sector only accounted for about 5% of total global semi sales last year, the recovery in global automobile output will contribute only limited growth to global semi sales.   Servers (account for 10% of world chip demand): The surge in online activities resulted in greater demand for cloud services and remote work applications, both of which require computer servers. Total server demand is comprised of data servers for cloud providers and private enterprises, with the former as the main driving force in recent years.  Data center expansion among cloud service providers will be driven by 5G, automotive, cloud gaming, and high-performance computing. After expanding by 10% last year, the pace of annual growth in global server shipments will likely be more moderate, to about 5%-6% in the next couple of quarters.   Chart 7Global Industrial Demand For Chips Is Set to Decelerate Global Industrial Demand For Chips Is Set to Decelerate Global Industrial Demand For Chips Is Set to Decelerate Industrial electronics (account for 9% of world chip demand): The growth rate in semi demand for this sector is falling. The global manufacturing new order-to-inventory ratio has plunged, and global manufacturing production is set to decline for the rest of this year and through to 2023H1 (Chart 7). Nevertheless, given structural tailwinds for industrial electronics, we expect semi demand in this sector to dip to single-digit growth in the near term rather than to contract.  Third, with semiconductor inventories having surged, new orders for chips, and hence their production, will plummet.   The length and intensity of the chip shortage, which started in 2020H2, triggered stockpiling among a broad range of customers, including manufacturers of smartphones and other consumer electronics. Moreover, the recent slowdown in smartphone/PC demand increased the inventory of silicon chips. Chart 8Semiconductor Inventory Overhang Semiconductor Inventory Overhang Semiconductor Inventory Overhang China had also stockpiled semiconductors from 2020Q2 to 2021Q4. With faltering demand, the country will continue its destocking process in the next couple of quarters. Semiconductor inventories in Taiwan and Korea have surged, corroborating the fact that the current cyclical downturn in the global semi sector will be a severe one (Chart 8). Hence, businesses in the semi supply chain will continue to draw upon their inventories rather than increase their semiconductors orders. This will reduce semiconductor demand meaningfully in the coming months. Bottom Line: The cyclical slump in worldwide semiconductor sales has further to go, with the sector’s sale volumes and prices projected to contract in the next six months. Semi producers will experience a substantial decline in their profits. Comparing Cycles Previous cycles may provide insight in the downside of the cyclical slump in global semi sales. In the previous five cycles, global semi sales experienced a contraction, ranging from 7% to 45% (Table 1). In the current cycle, global semi sales still had 7% year-over-year growth in 2022Q2 (Chart 9). Table 1Six Cyclical Downturns In Global Semiconductor Market Have Global Semi Stocks Hit Bottom? Have Global Semi Stocks Hit Bottom? Chart 9Global Semi Stocks And Global Semi Sales Global Semiconductor Market: Sales & Share Prices Global Semi Stocks And Global Semi Sales Global Semiconductor Market: Sales & Share Prices Global Semi Stocks And Global Semi Sales Global Semiconductor Market: Sales & Share Prices In fact, the current downturn could be deeper than the one between 2018 and 2019 (when sales contracted by 16%) for the following reasons: Sales of both cell phones and PCs will likely dwindle further this time than they did in 2018 to 2019. The pandemic boosted demand for consumer electronics, but this also brought forward future demand. In comparison with 2018, the current cycle might have a longer replacement cycle for mobile phones and PCs. Unlike 2019, global demand for consumer goods will likely contract rather than decelerate. This has ramifications for the duration and magnitude of the semi downturn.   Economic growth, and job and income uncertainties in China are much worse now than they were between 2018 and 2019. These factors will likely lead to a bigger cut in IT spending by both consumers and businesses, resulting in a larger downturn in global semi demand in this cycle. The tech battle between the US and China is more intense than in it was from 2018 to 2019. In mid-2018, the U.S. imposed a 25% tariff on Chinese imports of semiconductor goods, including machines and flat panel displays. China retaliated by imposing its own 25% tariff on U.S. exports of semiconductor goods, such as test equipment. This month, the US imposed new restrictions on NVIDIA and AMD in relation to selling artificial intelligence chips to Chinese customers. The US also plans to curb further its shipments of chipmaking tools to China. These plans will cut China’s imports of high-end semi products, for which producers enjoy high profit margins. In addition, the shortage of these chips will stall the development and sales of many consumer products within China, which will thereby reduce demand for other types of chips needed for consumer products. Chart 10Rapid Semi Capacity Expansion Worldwide Rapid Semi Capacity Expansion Worldwide Rapid Semi Capacity Expansion Worldwide Global semi capacity expansion has recently been much stronger in current cycle than it was in the 2016-2018 cycle. This may lead to a bigger supply surplus in this cycle than in the last one. It takes about 18-24 months, on average, to build a new semiconductor fabrication plant. Thus, large capital expenditures by semi producers in 2021-22 entail considerable new supply in 2023-24. According to IC Insights, the annual wafer capacity growth rates were 6.5% in 2020, 8.5% in 2021 and 8.7% in 2022. This compares with 4%-6.5% between 2016 and 2018 (Chart 10). Rapid capacity expansion typically leads to price deflation for chips and is therefore negative for the semi producers’ profitability and their share prices. Are global semi stock prices already pricing bad news? We do not think so. Nearly all major players saw a drop in revenues in the past cycle. In sharp contrast, only Intel’s revenues have dropped so far in the current cycle (Chart 11). Global semi stock prices will continue falling as companies report shrinking sales and earnings in the next couple of quarters. In former cycles when global semi stocks bottomed, investor sentiment – as measured by the net EPS revisions – was more downbeat than it is currently (Chart 12). Chart 11More Semi Companies' Sales Are Likely To Contract More Semi Companies' Sales Are Likely To Contract More Semi Companies' Sales Are Likely To Contract Chart 12Global Semi Stock Prices: Net EPS To Drop More Global Semi Stock Prices: Net EPS To Drop More Global Semi Stock Prices: Net EPS To Drop More Bottom Line: The global semiconductor sector’s cyclical slump could be deeper than it was in the 2018-2019 cycle. Hence, shares prices will fall considerably more than they did in late 2018. Ramifications For Taiwanese And Korean Markets Taiwanese and Korean semiconductor stock prices will probably continue to fall in absolute terms. The former recently broke its three-year moving average and the latter its six-year moving average (Chart 13). Chart 13Taiwanese And Korean Semi Stock Prices Will Fall Further Taiwanese And Korean Semi Stock Prices Will Fall Further Taiwanese And Korean Semi Stock Prices Will Fall Further Chart 14TSMC: Smartphone And HPC Make 81% Of Revenue Have Global Semi Stocks Hit Bottom? Have Global Semi Stocks Hit Bottom? For TSMC, the smartphone sector still accounts for 38% of revenues (Chart 14). Hence, a contraction in global smartphone sales in the next six-to-nine months could hurt the company’s top and bottom lines considerably. Meanwhile, the high-performance computing (HPC) sector became the largest contributor of TSMC revenues with a 43% share. A slowdown in data center investment and a decrease in GPU demand due to falling bitcoin prices will also materially affect the company’s profitability. In addition, the US government’s AI chips export restriction policy will decrease NVIDIA and AMD AI sales to China. According to NVIDIA’s news release, approximately US$400 million in potential chip sales to China (including Hong Kong) will likely be subject to this new restriction. AI chips are manufactured by TSMC with its advanced node technology and have a high-profit margin. Hence, the new policy will negatively impact TSMC’s revenues and profits. For Samsung, the memory market is in a free-fall due to plummeting demand (Chart 15). TrendForce expects the average overall DRAM price to drop by 13-18% in 2022Q4 because of high inventories in the supply chain and stagnant demand. The semi shipment-to-inventories ratios for both Taiwan and South Korea nosedived, pointing to lower semi stock prices in these two markets (Chart 16). Chart 15Samsung: Vulnerable To Sinking Prices Of Memory Chips Samsung: Vulnerable To Sinking Prices Of Memory Chips Samsung: Vulnerable To Sinking Prices Of Memory Chips Chart 16Semi Shipments-to-Inventory Ratios Plunged In Taiwan And Korea Semi Shipments-to-Inventory Ratios Plunged In Taiwan And Korea Semi Shipments-to-Inventory Ratios Plunged In Taiwan And Korea Bottom Line: Both TSMC and Samsung stock prices have more downside over the next three months.  Equity Valuations And Investment Conclusions The global semiconductor stock index in USD terms has tumbled by 45% from its recent peak. Multiples of semiconductor stocks are near their long-term average levels (Chart 17 and 18). These multiples could undershoot as they did in 2018-2019, which means even more downside is ahead. Chart 17Multiples Of Semi Stocks Could Undershoot Multiples Of Semi Stocks Could Undershoot Multiples Of Semi Stocks Could Undershoot Chart 18Multiples Of Semi Stocks Could Undershoot Multiples Of Semi Stocks Could Undershoot Multiples Of Semi Stocks Could Undershoot Aside from the profit outlook, higher US bond yields are also causing multiple compression for global semiconductor stocks (Chart 19). As to the allocation to semi stocks within an EM equity portfolio, we recommend downgrading Taiwan from a neutral allocation to underweight and reiterate an overweight stance on the KOSPI. The US-China geopolitical confrontation will escalate in the coming years and Taiwan is at the epicenter of this. These are relative calls, that is against the EM benchmark (Chart 20). We remain negative on their absolute performance. Chart 19Higher US Bond Yields = Multiple Compression In Global Semi Stocks Higher US Bond Yields = Multiple Compression In Global Semi Stocks Higher US Bond Yields = Multiple Compression In Global Semi Stocks Chart 20Downgrade Taiwan To Underweight Relative To The EM Benchmark Downgrade Taiwan To Underweight Relative To The EM Benchmark Downgrade Taiwan To Underweight Relative To The EM Benchmark   Finally, the structural outlook for global semiconductor demand remains constructive. We are waiting for a better entry point. We would recommend buying semiconductor stocks after pricing in a more material contraction in semi companies’ revenues and profits. Ellen JingYuan He Associate Vice President ellenj@bcaresearch.com Footnotes 1     Traditional PCs are comprised of desktops, notebooks and workstations.

Executive Summary The Chinese Economy Is Facing Deflationary Pressures The Chinese Economy Is Facing A Risk of Deflation The Chinese Economy Is Facing A Risk of Deflation China’s economy is facing a deflationary threat. Core consumer price inflation is below 1%, and producer (ex-factory) price inflation has decelerated rapidly and will soon deflate. Bank loan growth remains subdued due to the deepening property market slump and lackluster credit demand in the private sector. In view of the reluctance of households and enterprises to spend, invest and hire, the multiplier of stimulus in this cycle will be lower than in previous ones. China’s property market woes continued in August and a turnaround is not likely in the near term. China’s overseas shipments are set to contract in the months ahead. China needs to reduce interest rates and weaken its exchange rate to battle deflationary pressures and reflate the system. Thus, Chinese authorities will not prevent a further depreciation in the yuan versus the US dollar - as long as the decline is orderly and gradual. Bottom Line: The risk-reward profile remains unattractive for Chinese stocks in absolute terms. For global equity portfolios, we recommend a neutral allocation to Chinese onshore stocks and an underweight stance in investable stocks. Escalating deflationary pressures mean that onshore asset allocators should continue to favor government bonds over stocks.     Recovery prospects for China’s economy remain dim. Despite August’s better-than-expected growth in industrial output and retail sales, economic activity in the months ahead will be weighed down by a lingering real estate slump, recurring disruptions linked to Covid and a budding contraction in exports. Related Report  China Investment StrategyThe Party Congress And Beyond As discussed in our previous report, China’s transition from zero Covid tolerance to a managed approach to living with the virus will be a measured but protracted process. The conditions are not yet in place for a pivotal change in the country’s dynamic zero-Covid strategy. Thus, the risk of outbreaks and ensuing lockdowns still constitute a major hurdle for private domestic demand in the near term. China’s exports are set to shrink in the coming months due to a relapse in global demand for consumer goods (ex-autos). Domestic and external headwinds confronted by China underscore that the primary economic risk is deflation. Chinese policymakers need to lower interest rates and allow the currency to depreciate to battle deflationary pressures. Odds are high that the PBoC will cut rates further. However, the efficacy of reflationary efforts is doubtful due to three factors: uncertainty over the dynamic zero-Covid policy and the outlook for Omicron; persistent real estate woes; and the downbeat sentiment among corporates and households. Chart 1Upsides In Chinese Equity Prices Are Capped Without Aggressive Stimulus Upsides In Chinese Equity Prices Are Capped Without Aggressive Stimulus Upsides In Chinese Equity Prices Are Capped Without Aggressive Stimulus Therefore, our outlook for China’s business cycle remains a U-shaped recovery with risks skewed to the downside in the next few months.  Consistently, the risk-reward of Chinese stocks remains poor. Their absolute performance is also at risk from a further selloff in US/global equities as discussed in the latest Emerging Markets Strategy report. We continue to recommend a neutral stance on Chinese onshore stocks and underweight allocation for Chinese offshore stocks within a global equity portfolio (Chart 1). Depressed Credit Demand And Low Stimulus Multiplier Demand for credit from China’s private sector remains depressed, reflected by a very muted credit impulse when local government bond issuance is excluded (Chart 2). Critically, banks have been unable to accelerate the pace of lending even after the PBoC cut rates and urged them to boost lending (Chart 3). Chart 2The Credit Impulse Remains Muted The Credit Impulse Remains Muted The Credit Impulse Remains Muted Chart 3Subdued Loan Growth Despite Lower Interest Rates Subdued Loan Growth Despite Lower Interest Rates Subdued Loan Growth Despite Lower Interest Rates The growth rate of medium-to-long-term consumer loans, which are primarily composed of residential mortgages, continues to plunge (Chart 4, top panel). New household loan origination is contracting (Chart 4, bottom panel). Our proprietary measure of marginal propensity to spend for households dropped to an all-time low, mirroring consumers’ downbeat sentiment (Chart 5).  Chart 4Household Loan Demand Is Depressed... Household Loan Demand Is Depressed... Household Loan Demand Is Depressed... Chart 5...And Sentiment Remains in The Doldrums ...And Sentiment Remains in The Doldrums ...And Sentiment Remains in The Doldrums Corporate credit flow improved slightly with medium-to-long-term corporate loan growth ticked up in August (Chart 6). While it is difficult to quantify, it is likely that the recent modest improvement in corporate loan growth was mainly due to state-owned banks’ lending to local government financing vehicles (LGFV) to purchase land. The latter is de-facto bailing out local governments that heavily depend on land sales. Land transfer revenues made up 23% of local government aggregate expenditure in the past 12 months (Chart 7). Chart 6Corporate Loan Growth Slightly Improved In August Corporate Loan Growth Slightly Improved In August Corporate Loan Growth Slightly Improved In August Chart 7Land Sales Are Critical For Local Government Financing Land Sales Are Critical For Local Government Financing Land Sales Are Critical For Local Government Financing Chart 8Corporates' Investment Sentiment Is Worsening Corporates' Investment Sentiment Is Worsening Corporates' Investment Sentiment Is Worsening Consistent with poor business sentiment, enterprises’ investment expectation deteriorated in August (Chart 8). Given private-sector’s reluctance to borrow, the multiplier of stimulus will be lower than that in previous cycles. Consequently, China’s policymakers have no choice but to bump up fiscal stimulus and cut interest rates even more. Property Market: No Turnaround In Sight Yet China’s property market woes continued in August with a further weakening in housing market indicators (Chart 9). Home sales tumbled by 25% in August from a year ago. Real estate investment shrinkage deepened and home price deflation accelerated. Property market indicators probably will begin to show a rate-of-change improvement in the coming months due to a more favorable base effect. However, their annual growth rates will remain deeply negative, probably posting a double-digit retrenchment from a year ago. In brief, the level of housing sales will continue withering (Chart 10, top panel). Chart 9Housing Market Activity And Prices Housing Market Activity And Prices Housing Market Activity And Prices Chart 10Shrinking Sales = Less Funding Shrinking Sales = Less Funding Shrinking Sales = Less Funding Shrinking home sales mean a scarcity of funding for real estate developers who heavily rely on advance payments from homebuyers to finance their projects (Chart 10, middle and bottom panels). Hence, a contraction in property investment will remain intact for the next three to six months and housing construction activities will stay depressed (Chart 11). Chart 11Less Funding = Reduced Completions And Investments Less Funding = Reduced Completions And Investments Less Funding = Reduced Completions And Investments Chart 12Households Are Reluctant To Buy When House Prices Are Falling Households Are Reluctant To Buy When House Prices Are Falling Households Are Reluctant To Buy When House Prices Are Falling Interestingly, to revive housing sales, Guangzhou (a southern Chinese metropolis) plans to loosen price controls to allow new house prices to drop up to 20%. Other provinces might follow suit. This would eventually make housing more affordable, but homebuyers might be reluctant to buy until house prices bottom (Chart 12). Therefore, an imminent rebound in home sales is unlikely. Overseas  Shipments Are Set To Shrink China’s export growth, in both value and volume terms, slowed noticeably in August. The global demand for goods continues to dwindle, which does not bode well for Chinese overseas shipments. Imports for processing trade,1 which historically led China’s exports growth by three months, sank in August (Chart 13). In addition, Shanghai’s export container freight index has plummeted sharply (Chart 14). Both signal an impending shrinkage in the country’s exports volume. Chart 13Plummeted Processing Imports Herald A Downtrend In Exports Plummeted Processing Imports Herald A Downtrend In Exports Plummeted Processing Imports Herald A Downtrend In Exports Chart 14A Sign Of Exports Relapse A Sign Of Exports Relapse A Sign Of Exports Relapse Notably, the country’s exports to the US began to wither in August and this trend will only accelerate in the months ahead. We elaborated on the reasons for the global trade contraction in a previous report. Consistently, the continued underperformance of global cyclical stocks versus defensives, which historically has been a good leading indicator of global manufacturing cycles, points to a worldwide manufacturing downturn (Chart 15). This will be bad news for China, which is the largest manufacturing hub in the world. Deflationary Pressures Will Intensify The Chinese economy is facing a deflationary threat with core consumer inflation below 1% and producer (ex-factory) price inflation falling sharply (Chart 16). Chart 15Global Manufacturing Is Heading Into A Contraction Global Manufacturing Is Heading Into A Contraction Global Manufacturing Is Heading Into A Contraction Chart 16The Chinese Economy Is Facing A Risk of Deflation The Chinese Economy Is Facing A Risk of Deflation The Chinese Economy Is Facing A Risk of Deflation As weaknesses in domestic demand, real estate price and exports deepen, deflationary pressures in the mainland economy will likely intensify. Producer prices will begin deflating in the coming months. Manufactured goods prices have already deflated modestly, which will dampen investment in the industrial sector (Chart 17). Deflationary pressures are set to proliferate given that manufacturing output accounts for one-third of China’s GDP and manufacturing investment accounts for 32% of the nation’s overall fixed-asset investment. Investment in the real estate sector deteriorated severely in August. The downtrend in manufacturing and property investments will cap China’s overall capital spending growth through the end of this year, despite the ongoing rebound in infrastructure investment (Chart 18). Chart 17Manufacturing Prices Are Deflating Manufacturing Prices Are Deflating Manufacturing Prices Are Deflating Chart 18Weakness In Property And Manufacturing Investments Will Cap Overall Capital Spending Weakness In Property And Manufacturing Investments Will Cap Overall Capital Spending Weakness In Property And Manufacturing Investments Will Cap Overall Capital Spending Chart 19Sluggish Household Consumption Sluggish Household Consumption Sluggish Household Consumption Weak income growth and an unwillingness by consumers to spend have taken a heavy toll on retail sales and the service sector since early this year. The growth in goods sales volume edged up in August but remains lackluster and well below pre-pandemic levels (Chart 19). In addition, online retail sales of services continued to shrink (Chart 19, bottom panel). More Downside In The RMB  China needs to reduce its interest rates and weaken its exchange rate to battle deflationary pressures. Therefore, Chinese authorities will not mind more deterioration in the yuan versus the US dollar as long as it is gradual. The PBoC lowered the banks’ foreign exchange (FX) deposit reserve requirement ratio (RRR) from 8% to 6%, effective September 15. However, this will have little impact on altering the current weakening trend of the RMB. The balance of FX deposits at commercial banks was US$910 billion at the end of August. A 2% decrease in the FX deposit reserve ratio will only free about US$18 billion in FX liquidity, which is not large compared with US$80 billion in China’s net portfolio outflows through bond and stock connects so far this year. Capital outflows from China will likely persist for the next few months due to the disappointing economic recovery and widening interest rate differential relative to the US (Chart 20). Moreover, slumping exports will heighten selling pressures on the yuan and increase the government’s tolerance for a weaker currency. The FX settlement rate by banks on behalf of clients has continued to drop, which reflects the reluctance of exporters to sell their foreign currency receipts to banks on the expectation that the RMB will weaken even more (Chart 21).   Chart 20China-US Rate Differentials Indicate RMB Depreciation China-US Rate Differentials Indicate RMB Depreciation China-US Rate Differentials Indicate RMB Depreciation Chart 21Contracting Exports Will Weigh On The RMB Contracting Exports Will Weigh On The RMB Contracting Exports Will Weigh On The RMB Furthermore, despite a 12% depreciation against the US dollar since this March, the RMB remains strong in trade-weighted terms (Chart 22). Finally, the RMB is modestly cheap, which does not constitute sufficient conditions for the exchange rate reversal, especially when macro fundamentals warrant a weaker currency (Chart 23). In short, we expect that the RMB has another 5% to fall versus the US dollar. Chart 22RMB Is Strong In Trade-Weighted Terms RMB Is Strong In Trade-Weighted Terms RMB Is Strong In Trade-Weighted Terms Chart 23The RMB Is Modestly Cheap But Might Undershoot The RMB Is Modestly Cheap But Might Undershoot The RMB Is Modestly Cheap But Might Undershoot Stay Cautious On Chinese Equities Deflationary pressures confronted by the Chinese economy suggest that onshore asset allocators should continue to favor government bonds over stocks (Chart 24). Chart 24China's Onshore Stock-To-Bond Ratio Will Continue Relapsing China's Onshore Stock-To-Bond Ratio Will Continue Relapsing China's Onshore Stock-To-Bond Ratio Will Continue Relapsing Chart 25A-Shares Have Broken Below Their 6-Year Moving Average A-Shares Have Broken Below Their 6-Year Moving Average A-Shares Have Broken Below Their 6-Year Moving Average The onshore CSI 300 stock index had broken through its 6-year moving average technical support, which will become new resistance for the index (Chart 25). The Hang Seng Tech index, which tracks Chinese offshore tech stocks/platform companies, has failed to break above its 200-day moving average (Chart 26). The above tell-tale signs raise the odds of cyclical new lows in these indexes. Within Chinese equities, we continue to recommend overweighting interest rate sensitive sectors, such as consumer staples, utilities and autos (Chart 27). Chart 26Chinese Tech Stocks Still Appear Brittle Chinese Tech Stocks Still Appear Brittle Chinese Tech Stocks Still Appear Brittle Chart 27Interest Rate Sensitive Sectors Benefit From Loosening Monetary Conditions Interest Rate Sensitive Sectors Benefit From Loosening Monetary Conditions Interest Rate Sensitive Sectors Benefit From Loosening Monetary Conditions Finally, we reiterate our long A-share index / short MSCI Investable stock index recommendation, a position we initiated in March 2021. Qingyun Xu, CFA Associate Editor qingyunx@bcaresearch.com   Table 1China Macro Data Summary China: Battling Deflationary Pressures China: Battling Deflationary Pressures Table 2China Financial Market Performance Summary China: Battling Deflationary Pressures China: Battling Deflationary Pressures Footnotes 1     Processing trade refers to the business activities of importing raw materials, components and accessories, and then re exporting the finished products after processing or assembly. Strategic Themes Cyclical Recommendations

Executive Summary A Structural Downshift In China’s Real Estate Investment Growth Real Estate Investment Growth In China Will Structurally Shift Lower Real Estate Investment Growth In China Will Structurally Shift Lower The Politburo has set a date for the much-anticipated 20th Communist Party Congress at which President Xi will most likely secure his third term as general secretary. Although we expect China’s leaders to focus on supporting the economy following the Party Congress, there are high odds that the authorities will underdeliver on policy easing. Beijing may recalibrate its stringent zero-Covid policy next year, but the conditions are presently not yet met for a turnaround in the current strategy. China’s structural issues remain, and policymakers will likely continue to tackle them while downplaying the importance of GDP growth. The housing market remains the epicenter of risk to both China’s financial system and social stability. China’s leaders have incrementally introduced accommodative initiatives, but they still continue to seek reduced leverage among property developers. Investors should be prepared for a scenario that China will avoid “irrigation-type” stimulus in the next six months. Therefore, the economy will continue to expand at below potential growth. Bottom Line: There is a nontrivial risk that China’s stimulus will fall short of market expectations following the upcoming Party Congress. This poses risks to Chinese share prices.   Market participants believe that the 20th Communist Party Congress beginning October 16 will be a jumping off point for Chinese leaders to stimulate the economy more aggressively. This would signal a shift in the leadership’s focus, from securing political stability ahead of the Party Congress to ensuring an economic recovery next year. However, to achieve a meaningful and sustainable rebound in economic activity and equity market performance, policymakers will need to overcome two major hurdles: the zero-Covid policy and the "three red lines" regulation for property developers. At the risk of being wrong, we identify some of the factors that will preclude using irrigation type of stimulus after the conclusion of the Party Congress. Given the prevailing headwinds to China’s economy and the lack of “all-in” type of stimulus, we recommend that global equity portfolios stay neutral for now on Chinese onshore stocks and underweight offshore stocks. The Date Is Set! The Politburo’s announcement that the 20th Party Congress would take place earlier than November, in our view, is a sign of political stability and marginally positive for the economy. On the opening day, President Xi will deliver the Party’s work report, which will chart China’s policy trajectory for the next five years and beyond. It is generally believed that President’s Xi’s vision to turn China into an advanced global power will be endorsed by the Party. The earlier date for the Congress is significant for the following reasons: It shows that preparations for the Party Congress are progressing on schedule. President Xi will most likely cement his third term as general secretary, leaving little room for surprises from a political standpoint. The Party Congress will provide some indication whether the leadership will revise policies, including the zero-Covid strategy and industry regulations. Lower-level officials have been waiting to see which way the political winds are blowing. The Party Congress will clarify the situation and allow officials to focus on their economic work. Bottom Line: The Party Congress, along with the Central Economic Work Conference in December, will set the tone for China’s key economic, social, and industry policies for 2023 and beyond. Endgame To The Zero-Covid Strategy? Chart 1The Primary Risk To China's Economic Recovery Is Its Zero-Covid Policy The Primary Risk To China's Economic Recovery Is Its Zero-Covid Policy The Primary Risk To China's Economic Recovery Is Its Zero-Covid Policy The primary risk to China’s economic recovery is its stringent zero-Covid policy, which has significantly impacted the service sector, household income and consumption (Chart 1). In recent months policymakers have incrementally adjusted their Covid-containment measures, such as shortening the quarantine period for international travelers and streamlining mass testing procedures. However, the fundamental goal of eradicating domestic Covid cases remains intact. The best scenario in the coming year, in our view, is that China will adopt hybrid measures to combat Covid. Countries like Japan, South Korea, New Zealand, and Australia have all adopted a mixed series of Covid-control policies. These include a gradual reduction in testing and quarantine protocols, an increase in targeted vaccination among the elderly, an introduction of antiviral drugs and strengthening the quality of primary care. However, China may not tolerate the level of Covid experienced in these countries, especially since their number of new cases and related deaths have risen of late (Chart 2A and 2B). Chart 2ACovid Case Counts In Other Countries Have Risen Or Remain Elevated... Covid Case Counts In Other Countries Have Risen Or Remain Elevated... Covid Case Counts In Other Countries Have Risen Or Remain Elevated... Chart 2B...Along With Number Of Deaths ...Along With Number Of Deaths ...Along With Number Of Deaths   China sees its extremely low case count as proof that the dynamic zero-Covid policy has succeeded (Chart 3). It argues that if it shifts course and re-opens before proper protective measures have been introduced, then the losses might exceed a million deaths. China’s authorities believe that Hong Kong SAR’s high death rate in the spring is stark proof of that possible scenario (Chart 4). Chart 3China Has Managed To Keep Its Covid Case And Death Counts Extremely Low China Has Managed To Keep Its Covid Case And Death Counts Extremely Low China Has Managed To Keep Its Covid Case And Death Counts Extremely Low Chart 4Situation In HK SAR Earlier This Year Has Probably Sent A Warning Sign To The Mainland Situation In HK SAR Earlier This Year Has Probably Sent A Warning Sign To The Mainland Situation In HK SAR Earlier This Year Has Probably Sent A Warning Sign To The Mainland Thus, a sudden pivot from zero-Covid to living with the virus next year seems farfetched. China’s National Health Commission experts recently stated that victory over the virus would require effective vaccines, treatments and mild variants. We examine these three premises as follows: Covid vaccination rate: China’s overall Covid vaccination rate is high at 90% as of August this year. However, more than 35% of Chinese over age 60 have not received a booster dose and only 61% above age 80 have had a primary vaccination. Given that the majority of China’s population has not been exposed to the virus and is immunologically naïve, unlike their Western counterparts, the population relies completely on immunity acquired through Covid vaccines.  Chart 5China's Vaccination Progress Has Stalled China's Vaccination Progress Has Stalled China's Vaccination Progress Has Stalled China’s daily vaccination rate has fallen to below 200,000 per day, sharply down from the peak of 3-5 million per day in March and April (Chart 5). Even if we assume that three doses of China’s domestically produced vaccines are as effective as the West’s mRNA vaccines, at the current pace it would take several years to provide three doses of Covid vaccines to China’s 1.4 billion people. Hence, to significantly loosen zero-Covid policy, we would need to see a huge acceleration in the country’s vaccination rate. Treatment drugs: China okayed the imports and use of Pfizer’s antiviral drug Paxlovid in February and approved its first homegrown Covid antiviral medication “Azvudine” in July. Azvudine’s efficacy in reducing Covid-related hospitalization and deaths remains to be seen. The manufacturer, Genuine Biotech, says that the facility's annual production capacity is 1 billion tablets (each tablet is 1 mg), but is expected to reach 3 billion tablets in the future. Assuming each patient will need 50 mgs of Azvudine to complete a full course of treatment (as instructed by the drug manufacturer), the company can provide enough tablets for approximately 20 million Chinese within one year. To put the number into respective, China has more than 26 million people over age 80, of which more than 10 million have not had their first Covid vaccine. Chart 6The Level Of Beijing's Covid Policy Stringency Remains Elevated The Level Of Beijing's Covid Policy Stringency Remains Elevated The Level Of Beijing's Covid Policy Stringency Remains Elevated ​​​​​​​ Milder variants: Another possibility is if new mild variants emerge next year and they cause no harm or panic among the population. However, there is no guarantee that Beijing will be willing to relent on its Covid policy based on evidence and statistics from other countries where the populations may have received mRNA vaccines. Even statistics provided within China may not warrant a decisive reopening of the economy. A recent study conducted by leading Chinese public health experts found that only 22 of the nearly 34,000 Covid patients hospitalized in Shanghai from March 22 to May 3 developed severe illness. Nonetheless, the study has not prompted policymakers to step back from the tight Covid control protocols (Chart 6). Bottom Line: The conditions do not seem to be met for a drastic change in Beijing’s dynamic zero-Covid strategy. China’s transition from zero tolerance to an orderly, managed approach to life with an evolving Covid virus will likely be long and difficult. The Housing Market Policy Dilemma The other key to achieving a meaningful recovery in China’s economy is through stimulating the country’s housing market. We expect that more accommodative real estate policy initiatives will be introduced later this year and early next year. However, structural headwinds in the property market will limit the government's willingness to stimulate the sector as aggressively as in previous cycles. China’s shrinking working population since 2015 likely led to a peak in the demand for housing in 2017/18. Moreover, it is estimated that China's total population growth will turn negative this year, further suppressing demand (Chart 7). The combination of demographic headwinds and a slowdown in urbanization, means that if policymakers overstimulate the sector as in the past, then they will have a bigger bubble to pop in the future.  There is no indication that the authorities will stop focusing on deleveraging and reducing financial risks in the real estate sector. The magnitude of mortgage rate cuts so far this year is much smaller than in the 2008/09 and 2015/16 cycles. Moreover, mortgage rates remain higher than growth in household income and home prices (Chart 8). The positive gaps between mortgage rates and both household income growth and house price appreciation discourage house purchases. Chart 7Demand For Housing In China Is On A Structural Downtrend Demand For Housing In China Is On A Structural Downtrend Demand For Housing In China Is On A Structural Downtrend Chart 8Current Rate Cuts Are Not Enough To Meaningfully Spur Demand For Housing Current Rate Cuts Are Not Enough To Meaningfully Spur Demand For Housing Current Rate Cuts Are Not Enough To Meaningfully Spur Demand For Housing Importantly, while policymakers have intervened and provided liquidity to cash-strapped real estate developers, the “three red lines” policies restraining developers’ leverage remain intact. The message is clear: Beijing will use all necessary tools to prevent systemic risks and social unrest by ensuring the completion of existing housing projects. However, the authorities will continue to force developers to structurally shift their business models and reduce their leverage. Chinese authorities would be more incentivized to bail out the sector if there were risks of widespread mortgage loan defaults among households. In our view, this risk remains low in the next 6 to 12 months. The mortgage down payment ratio is relatively high in China and mortgages are full recourse loans as borrowers are personally liable beyond the collateral (i.e., the property asset). This combination reduces the incentive for homebuyers to stop paying mortgages even in a situation of negative equity (i.e., when the value of the property asset falls below the outstanding mortgage). Indeed, ongoing mortgage boycotts have been isolated to unfinished apartments in stalled projects. The boycotts are driven by homebuyers to pressure developers to finish these projects and are not due to household financial difficulties. There will likely be more defaults by overleveraged developers next year. The sector will consolidate further, with opportunistic, well-funded developers taking advantage of the situation to acquire distressed assets at a discount. Many of these may be state-owned or state-backed companies and investment funds. Chart 9Real Estate Investment Growth In China Will Structurally Shift Lower Real Estate Investment Growth In China Will Structurally Shift Lower Real Estate Investment Growth In China Will Structurally Shift Lower Bottom Line: Policymakers will continue to feed the housing sector with stimulus measures, but the leadership might be reluctant to overstimulate the sector. China’s real estate market dynamics, particularly the completion of existing projects, will likely improve on the margin in the next 6 to 12 months. Structurally, however, China’s home sales and real estate investment growth will continue shifting to a lower gear (Chart 9).    Investment Conclusions At the start of the year, China was expected to aggressively stimulate its economy. This was based on the premise that policymakers would not tolerate slower economic growth ahead of the Party Congress. Nonetheless, Chinese leaders downplayed the annual GDP growth target this year, a major deviation from the past. Post October’s Party Congress, we think that the authorities will continue to roll out measures to support the economy, but we recommend that investors remain realistic about the magnitude of policy easing. There are nontrivial risks that policymakers will continue to tackle structural issues, while allowing the economy to muddle through. With piecemeal stimulus, China may still be able to manage a soft landing in its property market and prevent the risks from spilling over to other sectors of the economy. In this case, we will monitor macro and financial market dynamics and change our stance on Chinese equities if warranted (Chart 10A and 10B). Chart 10AWithout More Aggressive Stimulus, Upsides In Chinese Equity Prices Are Capped Without More Aggressive Stimulus, Upsides In Chinese Equity Prices Are Capped Without More Aggressive Stimulus, Upsides In Chinese Equity Prices Are Capped Chart 10BWithout More Aggressive Stimulus, Upsides In Chinese Equity Prices Are Capped Without More Aggressive Stimulus, Upsides In Chinese Equity Prices Are Capped Without More Aggressive Stimulus, Upsides In Chinese Equity Prices Are Capped Lastly, investors should be prepared for greater emphasis of common prosperity policies at the Party Congress. Reducing income inequality and improving social welfare will remain core principles of President Xi’s political agenda. Common property policies mean that there will be a continued shift towards a larger share of labor compensation versus capital in the country’s national income (Chart 11). The pandemic in the past 2.5 years has likely exacerbated the country’s income inequality and discontent among middle-class households. Chart 11Implications Of China’s Common Prosperity Policy Implications Of China's Common Prosperity Policy Implications Of China's Common Prosperity Policy Arthur Budaghyan Chief Emerging Markets Strategist arthurb@bcaresearch.com ​​​​​​​Jing Sima Consulting China Strategist Strategic Themes Cyclical Recommendations

Executive Summary The Recovery of Chinese Property Market Relies On Home Sales The Recovery of Chinese Property Market Relies on Home Sales The Recovery of Chinese Property Market Relies on Home Sales Property sales, starts, developers’ total financing, and construction activity will likely continue to contract in the next three-to-six months, albeit at a slower rate. More supportive government policies will be released in the coming months, including mortgage rate cuts. It will take time for a recovery in sales and construction activity to occur, because of enormous excesses in the mainland property market/industry. Plus, China’s economy is challenged by the dynamic zero-COVID policy, a budding contraction in exports, and generally weak income growth.   Property developers started to shift their business model from “pre-selling, then completing” to “completing first, selling after.” The move is a long-term positive for China’s property market by reducing financial stability risk. However, it means that the industry will take a longer time to contribute to growth in the broader economy. Bottom Line: We continue to hold a bearish view on the share prices of both onshore and offshore Chinese property developers in absolute terms and relative to China’s overall equity benchmark. A continued weakness in construction volume in the next few months implies less demand for commodities, such as iron ore, steel, cement, and glass.   Chart 1Low Sentiment in Both Current and Future Income Low Sentiment in Both Current and Future Income Low Sentiment in Both Current and Future Income The turmoil in China’s property market has not abated. Homebuyers remain unwilling to buy houses because of concerns over widespread sold but unfinished properties, falling confidence in future incomes, and worsening employment expectations (Chart 1). Property sales, starts, and completions have all collapsed by 25-45% from their mid-2021 peak (Chart 2 and 3). However, these variables will likely start to improve on a rate-of-change basis (i.e., the pace of contraction will moderate) in the months ahead (Chart 3). The rationale is that accelerated policy easing in the housing sector will help on the margin. Notably, policies curbing housing demand have loosened much more this year than they did in 1H2020. Plus, the authorities will introduce more accommodative real estate policy initiatives later this year and early next year, including additional mortgage rate cuts. Chart 2Property Sales, Starts, And Completions Will Further Decline In Their Level Terms… Property Sales, Starts And Completions: Further Decline In Their Level Terms... Property Sales, Starts And Completions: Further Decline In Their Level Terms... Chart 3...Albeit Improving On A Rate-Of-Change Basis ...Albeit Improving On A Rate-Of-Change Basis ...Albeit Improving On A Rate-Of-Change Basis Nevertheless, the construction industry, its suppliers, and the entire economy will take small consolation from the moderating pace of decline in the property sector. The basis for this response is that the level of activity will continue falling in the next three-to-six months, albeit at a slower rate than that of the present moment. Overall, aggressive policy easing will take time to produce a meaningful recovery in the mainland’s property market because it is occurring amid the structural breakdown in the real estate market and a confidence crisis among stakeholders. Policy Support Has Accelerated  Chinese authorities have accelerated their policy initiatives in the real estate sector to restore homebuyers’ confidence and stabilize the sagging domestic property market. Chart 4The Recovery of Chinese Property Market Relies On Home Sales The Recovery of Chinese Property Market Relies On Home Sales The Recovery of Chinese Property Market Relies On Home Sales A nearly 30% year-on-year decline in floor space sold in residential commodity buildings has exacerbated a liquidity crisis among property developers. Deposits, advanced payments, and mortgage payments originating from property pre-sales, have historically contributed to about 50% of property developers’ financing (Chart 4, top panel). Hence, renewed homebuyers’ confidence and a revival in house purchases would alleviate the liquidity crunch among cash-strapped developers (Chart 4, bottom panel), who could then complete more housing units under construction. Chinese authorities have introduced an assortment of supportive housing measures, including the following: Measures To Help Complete Pre-Sold Apartments In response to the homebuyer confidence crisis, the Politburo demanded that local governments be responsible for ensuring the delivery of housing projects. Since July, at least 36 local governments in 15 provinces have released concrete policies in this respect (Box 1).   Box 1 Local Governments:  The Delivery Of Pre-sold Housing Units Turns into a Political Task "Pre-sale fund supervision"1 is an important policy related to "guaranteed delivery" for presold properties. Real estate development enterprises must deposit pre-sale funds into a bank's special supervision account, which can only be used for the construction of a specific project and cannot be withdrawn or used at will. Another important policy is implementing "one building, one policy" and stipulating local government involvement to resolve problems. With the support of local government, a fund required to complete an unfinished building can be raised in various ways including, but not limited to the following: 1) increasing financing from local banks or asset management companies;2  2) encouraging good SOEs or high-quality homebuilders to take over stalled projects; 3) local governments purchasing back unused land from property developers; or 4) asking desperate buyers of those pre-sold and unfinished projects to contribute additional funds.3   Last month, the authorities also established a real estate fund of initially RMB 80 billion, which was funded by China Construction Bank and the central bank. In mid-August, China introduced procedures to ensure property projects are delivered to buyers through special loans from policy banks. The amount of this special loan will be about RMB 200 billion.4 This will be also a part of the real estate fund established last month, which could potentially be increased to RMB 300-400 billion and will be used only to ensure the delivery of presold but unfinished projects. Moreover, the government started to ease policies on property developers’ onshore bond issuance. In August, Chinese regulators instructed China Bond Insurance to provide guarantees for onshore bond issuance by private property developers. We expect more policy easing on developers raising funds though bank loans and more onshore bond issuance (Chart 5).  Measures To Increase Homebuyers’ Affordability The average mortgage rate has been decreased three times so far this year, falling to 4.3% for first-time home buyers. This is the lowest rate since 2009 (Chart 6).  Chart 5Chinese Developers Needs More Policy Easing On Their Borrowing Chinese Developers Needs More Policy Easing On Their Borrowing Chinese Developers Needs More Policy Easing On Their Borrowing Chart 6Easing Policies On Mortgage Rate Easing Policies On Mortgage Rate Easing Policies On Mortgage Rate Since the beginning of this year, over 80 cities relaxed their restrictive policies on loan borrowing. Among these cities, nearly 60 lowered their down payment ratio for a first home purchase, while about 40 reduced their down payment ratio for a second home purchase.5 Local governments also offered financial support for shantytown renewal and cash rebates for home purchases. Multiple cities have also issued incentives to encourage households with second or third children to buy additional properties. Bottom Line: Authorities have ramped up their supportive housing policies in recent months.  We expect more policy stimulus (e.g., another mortgage rate cut) to be announced over the next three-to-six months. Housing Turnaround Takes Time Despite considerable supportive policies in place, housing starts and construction activity will continue to contract and home prices will deflate further in the next three-to-six months. The policies will take time to work, especially ones related to ensuring the delivery of pre-sold housing. A significant amount of financing will be required for problematic projects that real estate developers are unable to build and deliver. Many local governments are also facing financial distress. Therefore, it will take time to arrange financing from third parties. Even after securing financing for incomplete housing projects, there will be delays in the construction and delivery of these units. Potential homebuyers may be willing to purchase in installments and provide funds to developers, but only if they witness increased deliveries of pre-sold homes. These funds are critical to developers as they account for about half of their total financing (Chart 4 above). The willingness to buy has been suppressed by falling confidence over future incomes, worsening future employment expectations and weakening growth of current income (Chart 1 on page 2). The willingness of households to save recently hit a record level; it is higher than during the first outbreak of COVID-19 in early 2020. Meantime, the propensity to invest has tumbled to a multi-year low (Chart 7). Chart 7More Chinese Households Intend To Save Rather Than Invest More Chinese Households Intend To Save Rather Than Invest More Chinese Households Intend To Save Rather Than Invest Chart 8Property Sales In Rich Eastern Provinces: Still In A Deep Contraction Property Sales In Rich Eastern Provinces: Still In A Deep Contraction Property Sales In Rich Eastern Provinces: Still In A Deep Contraction The growth of residential floor space sold in the eastern provinces often leads the rest of China (Chart 8). The Eastern provinces account for about 44% of China’s total residential floor space sales. Residential floor space sales in the Eastern provinces were still down by 30% in July.  The lack of an upturn in the Eastern provinces, especially after the re-opening in Shanghai and Shenzhen, indicates that a property market recovery will not be imminent or V-shaped. Chart 9A Majority Of Key Cities Have Declining Housing Prices A Majority Of Key Cities Have Declining Housing Prices A Majority Of Key Cities Have Declining Housing Prices Currently still 70% and 85% of the 70-city house price indexes are showing year-over-year price declines in newly constructed houses and secondary houses, respectively (Chart 9).  Shrinking pre-sales mean less financing for homebuilders and, ultimately, contracting property investment in the next three-to-six months (Chart 10). Many developers will continue to struggle to attract sufficient financing. Hence, they must cut their starts and completions (Chart 11). Chart 10Shrinking Pre-sales Will Lead To Falling Property Investment Shrinking Pre-sales Will Lead To Falling Property Investment Shrinking Pre-sales Will Lead To Falling Property Investment Chart 11Property Developers Have Been Starting And Preselling But Not Completing Property Developers Have Been Starting And Preselling But Not Completing Property Developers Have Been Starting And Preselling But Not Completing High prices/low affordability, speculative behavior of both developers and homebuyers, very high leverage and risky financing schemes, large volumes of supply and high inventories and vacancies , all need to be absorbed. A dynamic zero-COVID policy, a budding contraction in exports and generally weak income growth will challenge China’s economy in general.  Chart 12Insufficient Financing Will Lead To Weaker Construction Activity Ahead Insufficient Financing Will Lead To Weaker Construction Activity Ahead Insufficient Financing Will Lead To Weaker Construction Activity Ahead Bottom Line: The authorities’ supportive policies will take time to relieve the liquidity crisis among property developers and boost sentiment among homebuyers. Property sales, starts, developers’ total financing and construction activity will likely continue to contract in the next three-to-six months, albeit at a slower rate (Chart 12). A Structural Shift In Developers’ Business Model Chinese property developers started to shift their business model from “preselling, then completing” to “completing first, selling after.” The move is a long-term positive for China’s property market. It will lower the leverage of and curb real estate assets hoarding by developers and, thereby, improve stability in the industry. The old model of “preselling then completing” is not sustainable. In the past decade, Chinese real estate developers aggressively pursued a business model of “buying land, quickly starting property projects, and preselling unfinished homes but not completing them.”6  Chart 13A Structural Shift In Developers' Business Model A Structural Shift In Developers' Business Model A Structural Shift In Developers' Business Model As this model was essentially raising funds via launching property starts despite shrinking completions (Chart 13, top panel), it has resulted in a significant increase in Chinese property developers’ liabilities and unfinished construction carried on the balance sheet of developers. In short, as we have argued before, real estate developers have been involved in a massive carry trade. This is one of the root causes of the current crisis in China’s real estate sector. With this business model, developers carried real estate assets (land and started properties) on their balance sheets to benefit from the positive “carry”; i.e., the difference between the cost of funding and real estate asset price appreciation. However, the carry has turned negative as property asset prices are now flat or deflating rather than rising at double-digit rates. Hence, developers are under pressure to liquidate their assets and reduce their debts. Yet, to sell their not-pre-sold housing projects that are under construction, they first need new funds to complete unfinished homes before they can be sold. Furthermore, both the “three-red lines” policy for property developers and the new bank lending regulations limiting lending to the real estate sector – both put into effect in H2 2020 – remain in place. This means that Chinese real estate developers have no choice but to change their business model to a more sustainable one – the one with more sales coming from existing properties instead of pre-sales. The new model of “completing first, selling after” is a sustainable one. Homebuyers fear buying unfinished houses, preferring existing ones. Critically, increasing sales of existing houses will provide extra funds to debt-laden builders. In contrast, delivery of pre-sold units does not generate new cash for developers because most cash are received long before completion of a dwelling. Facing a liquidity crunch, there is no incentive for developers to complete pre-sold units. Chart 13 shows such a shift has been underway since mid-2021. Sales of completed houses increased considerably, while properties sold in advance plummeted. This trend also reflects a rising preference among homebuyers for completed properties. Buyers can visit and check the quality of a construction-completed unit versus paying for a future unknown unit. Meanwhile, property developers’ leverage will decline with this new business model. A caveat is that less financing from pre-sales means that developers will have a diminished ability to complete projects already started, and that they also need to reduce land purchases and land hoarding. Local government financing will remain tight as land sales account for 23% of local government aggregate expenditure. This will have negative ramifications on infrastructure spending. Bottom Line: Chinese real estate developers have begun shifting from an unsustainable and high-leverage business model to a new way of operating by which sales of completed properties will be prioritized at the expense of falling pre-sales. This will reduce financial stability risks in the future. Investment Implications We expect a continued decline in property sales, starts, completions, and property price deflation in the next three-to-six months. Thus, we maintain our bearish view of both onshore and offshore Chinese property developers’ share prices in absolute terms and relative to China’s overall equity benchmark (Chart 14).  Construction volume will be persistently weak in the coming months, which means less demand for commodities, such as iron ore, steel, cement, and glass. Hence, we expect prices for those commodities to drop further in the near run (Chart 15). Chart 14Chinese Property Developers' Stocks: Structural Breakdown Chinese Property Developers' Stocks: Structural Breakdown Chinese Property Developers' Stocks: Structural Breakdown Chart 15Bearish On Prices Of Construction-related Commodities Bearish On Prices Of Construction-related Commodities Bearish On Prices Of Construction-related Commodities   Ellen JingYuan He Associate Vice President ellenj@bcaresearch.com   Footnotes 1     Supervision of pre-sale funds of presold properties refers to the third-party supervision of such funds by the real estate administrative department in conjunction with the bank. 2     This year, at least six asset management companies injected funds into stalled property projects. So far, the total funds raised for three projects amounts to RMB 17 billion. Source: https://m.huxiu.com/article/644633.html?f=rss 3    Desperate buyers face two options: either add funds to build an unfinished home or continue to wait for an indeterminate period. Buyers tend to increase funds to enable the resumption of construction. 4    Source: https://www.bloomberg.com/news/articles/2022-08-22/china-plans-29-billion-in-special-loans-to-troubled-developers  5    Source: https://news.stcn.com/sd/202208/t20220826_4822460.html  6    Please see China Investment Strategy Special Reports "China’s Property Market: Making Sense Of Divergences," dated May 9, 2019, and "China: Is The Property Carry Trade Over?" dated October 28, 2021, available at cis.bcaresearch.com Strategic Themes Cyclical Recommendations

Listen to a short summary of this report.     Executive Summary Housing Activity Should Start To Stabilize By The End Of The Year Housing Activity Should Start To Stabilize By The End Of The Year Housing Activity Should Start To Stabilize By The End Of The Year Home prices in the US are set to decline, almost certainly in real terms and probably in nominal terms as well. Unlike in past episodes, the impact on construction from a drop in home prices should be limited, given that the US has not seen pervasive overbuilding. The drag on US consumption should also be somewhat muted. In contrast to what happened during the mid-2000s, outstanding balances on home equity lines of credit declined during the pandemic housing boom. US banks are on a strong footing today. This should limit the collateral damage from falling home prices on the financial system. Outside the US, the housing outlook is more challenging. This is especially the case in smaller developed economies such as Canada, Australia, New Zealand, and Sweden. It is also the case in China, where the property market may be on the verge of a Japanese-style multi-decade slide. ​​​​​ Bottom Line: Softening housing markets around the world will weigh on growth. However, against the backdrop of high inflation, that may not be an unambiguously bad thing. We expect global equities to rise into year end, and then retreat in 2023. The Canary in the Coalmine On the eve of the Global Financial Crisis, Ed Leamer delivered a paper at Jackson Hole with the prescient title “Housing IS the Business Cycle.” Leamer convincingly argued that monetary policy primarily operates through the housing market, and that a decline in residential investment is by far the best warning sign of a recession. Table 1 provides supporting evidence for Leamer’s conclusion. It shows that residential investment is not a particularly important driver of GDP growth during non-recessionary quarters but is the only main expenditure component that regularly turns down in the lead-up to recessions. Table 1A Decline In Residential Investment Typically Precedes Recessions The Risks From Housing The Risks From Housing US real residential investment was essentially flat in Q1 but then contracted at an annualized pace of 16% in Q2, shaving 0.83 percentage points off Q2 GDP growth in the process. The Atlanta Fed GDPNow model forecasts that real residential investment will shrink by 22% in Q3, largely reflecting the steep drop in housing starts and home sales observed over the past few months. Chart 1Housing Activity Should Start To Stabilize By The End Of The Year Housing Activity Should Start To Stabilize By The End Of The Year Housing Activity Should Start To Stabilize By The End Of The Year The recent decline in construction activity is a worrying indicator. Nevertheless, there are several reasons to think that the downturn in housing may not herald an imminent recession. First, the lag between when housing begins to weaken and when the economy falls into recession can be quite long. For example, residential investment hit a high of 6.7% of GDP in Q4 of 2005. However, the Great Recession did not start until Q4 of 2007, when residential investment had already receded to 4.2% of GDP. The S&P 500 peaked during the same quarter. Second, recent weakness in housing activity largely reflects the lagged effects of the spike in mortgage rates earlier this year. To the extent that mortgage rates have been broadly flat since April, history suggests that housing activity should start to stabilize by the end of this year (Chart 1). Third, unlike in the mid-2000s, there is no glut of homes in the US today: Residential investment reached 4.8% of GDP last year, about where it was during the late 1990s, prior to the start of the housing bubble (Chart 2). The construction of new homes has failed to keep up with household formation for the past 15 years (Chart 3). As a result, the homeowner vacancy rate stands at 0.8%, the lowest on record (Chart 4). Chart 2Residential Investment Is Well Below Levels Seen During The Housing Bubble Residential Investment Is Well Below Levels Seen During The Housing Bubble Residential Investment Is Well Below Levels Seen During The Housing Bubble Chart 3Home Construction Has Fallen Short Of Household Formation For The Past 15 Years Home Construction Has Fallen Short Of Household Formation For The Past 15 Years Home Construction Has Fallen Short Of Household Formation For The Past 15 Years Chart 4The Homeowner Vacancy Rate Is At Record Lows The Homeowner Vacancy Rate Is At Record Lows The Homeowner Vacancy Rate Is At Record Lows While new home inventories have risen, this mainly reflects an increase in the number of homes under construction. The inventory of finished homes is still 40% below pre-pandemic levels (Chart 5). The inventory of existing homes available for sale is also quite low, which suggests that a rising supply of new homes could be depleted more quickly than in the past. Chart 5While The Number Of Homes Under Construction Increased, The Inventory Of Newly Built And Existing Homes Remains Low While The Number Of Homes Under Construction Increased, The Inventory Of Newly Built And Existing Homes Remains Low While The Number Of Homes Under Construction Increased, The Inventory Of Newly Built And Existing Homes Remains Low Why Was Housing Supply Slow to Rise? In real terms, the Case-Shiller index is now 5% above its 2006 peak (Chart 6). Why didn’t housing construction respond more strongly to rising home prices during the pandemic? Part of the answer is that the memory of the housing bust curtailed the homebuilders’ willingness to expand operations. Supply shortages also limited the ability of homebuilders to construct new homes in a timely fashion. Chart 7 shows that the producer price index for construction materials increased by nearly 50% between January 2020 and July 2022, outstripping the rise in the overall PPI index. Chart 6Real House Prices Are Above Their 2006 Peak Real House Prices Are Above Their 2006 Peak Real House Prices Are Above Their 2006 Peak Chart 7Producer Prices For Construction Materials Shot Up During The Pandemic Producer Prices For Construction Materials Shot Up During The Pandemic Producer Prices For Construction Materials Shot Up During The Pandemic Chart 8Constraints On Home Building Caused The Housing Market To Clear Mainly Through Higher Prices Rather Than Increased Construction The Risks From Housing The Risks From Housing The lack of building materials and qualified construction workers caused the supply curve for housing to become increasingly steep (or, in the parlance of economics, inelastic). To make matters worse, pandemic-related lockdowns probably caused the supply curve to shift inwards, prompting homebuilders to curb output for any given level of home prices. As Chart 8 illustrates, this meant that the increase in housing demand during the pandemic was largely absorbed through higher home prices rather than through increased output.   A Bittersweet Outcome Chart 9Unlike During The Great Recession, Prices For New And Existing Homes Should Fall In Tandem This Time Around Unlike During The Great Recession, Prices For New And Existing Homes Should Fall In Tandem This Time Around Unlike During The Great Recession, Prices For New And Existing Homes Should Fall In Tandem This Time Around The discussion above presents a good news/bad news story about the state of the US housing market. On the one hand, with seasonally-adjusted housing starts now below where they were in January 2020, construction activity is unlikely to fall significantly from current levels. On the other hand, as the supply curve for housing shifts back out, and the demand curve shifts back in towards pre-pandemic levels, home prices are bound to weaken. We expect US home prices to decline, almost certainly in real terms and probably in nominal terms as well. Unlike during the Great Recession, when a wave of foreclosures caused the prices of existing homes to fall more than new homes, the decline in prices across both categories is likely to be similar this time around (Chart 9).   The Impact of Falling Home Prices To what extent will lower home prices imperil the US economy? Beyond the adverse impact of lower prices on construction activity, falling home prices can depress aggregate demand through a negative wealth effect as well as by putting strain on the banking system. The good news is that both these channels are less operative today than they were prior to the GFC. Perhaps because home prices rose so rapidly over the past two years, homeowners did not get the chance to spend their windfall. The personal savings rate soared during the pandemic and has only recently fallen below its pre-pandemic average (Chart 10). Households are still sitting on about $2.2 trillion in excess savings, most of which is parked in highly liquid bank accounts. Outstanding balances on home equity lines of credit actually fell during the pandemic, sinking to a 21-year low of 1.3% of GDP in Q2 2022 (Chart 11). All this suggests that the coming decline in home prices will not suppress consumption as much as it did in the past. Chart 10Household Savings Surged During The Pandemic Household Savings Surged During The Pandemic Household Savings Surged During The Pandemic Chart 11Despite Higher Home Prices, Households Are Not Using Their Homes As ATMs Despite Higher Home Prices, Households Are Not Using Their Homes As ATMs Despite Higher Home Prices, Households Are Not Using Their Homes As ATMs The drop in home prices during the GFC generated a vicious circle where falling home prices led to more foreclosures and fire sales, leading to even lower home prices. Such a feedback loop is unlikely to emerge today. As judged by FICO scores, lenders have been quite prudent since the crisis (Chart 12). The aggregate loan-to-value ratio for US household real estate holdings stands near a low of 30%, down from 45% in the leadup to the GFC (Chart 13). Banks are also much better capitalized than they were in the past (Chart 14). Chart 12FICO Scores For Residential Mortgages Have Improved Considerably Since The Pre-GFC Housing Bubble The Risks From Housing The Risks From Housing Chart 13This Is Not 2007 This Is Not 2007 This Is Not 2007 Chart 14US Banks Are Better Capitalized Than Before The GFC US Banks Are Better Capitalized Than Before The GFC US Banks Are Better Capitalized Than Before The GFC The final thing to note is that home prices tend to fall fairly slowly. It took six years for prices to bottom following the housing bubble, and this was in the context of a severe recession. Thus, the negative wealth effect from falling home prices will probably not become pronounced until 2024 or later. A Grimmer Picture Abroad The housing outlook is more challenging in a number of economies outside of the US. While home prices have increased significantly in the US, they have risen much more in smaller developed economies such as Canada, Australia, New Zealand, and Sweden (Chart 15). My colleague, Jonathan LaBerge, has also argued that overbuilding appears to be more of a problem outside the US (Chart 16). Chart 15Rising Rates Will Weigh On Developed Economies With Pricey Housing Markets Rising Rates Will Weigh On Developed Economies With Pricey Housing Markets Rising Rates Will Weigh On Developed Economies With Pricey Housing Markets Chart 16Canada And Several Other DM Countries Have Overbuilt Homes Since The Global Financial Crisis Canada And Several Other DM Countries Have Overbuilt Homes Since The Global Financial Crisis Canada And Several Other DM Countries Have Overbuilt Homes Since The Global Financial Crisis Chart 17Slightly More Than Half Of Canadians Opted For Variable Rate Mortgages Over The Past 12 Months Slightly More Than Half Of Canadians Opted For Variable Rate Mortgages Over The Past 12 Months Slightly More Than Half Of Canadians Opted For Variable Rate Mortgages Over The Past 12 Months The structure of some overseas mortgage markets heightens housing risks. In Canada, for example, more than half of homebuyers chose a variable-rate mortgage over the last 12 months (Chart 17). At present, about one-third of the total stock of mortgages are variable rate compared to less than 20% prior to the pandemic. Moreover, unlike in the US where 30-year mortgages are the norm, fixed-rate mortgages in Canada typically reset every five years. Thus, as the Bank of Canada hikes rates, mortgage payments will rise quite quickly.   China: Following Japan’s Path? In the EM space, China stands out as having the most vulnerable housing market. The five major cities with the lowest rental yields in the world are all in China (Chart 18). Home sales, starts, and completions have all tumbled in recent months (Chart 19). The bonds of Chinese property developers are trading at highly distressed levels (Chart 20). Chart 18Chinese Real Estate Shows Vulnerabilities… The Risks From Housing The Risks From Housing Chart 19...Activity And Prices Have Been Falling... ...Activity And Prices Have Been Falling... ...Activity And Prices Have Been Falling... Chart 20...And the Bonds of Property Developers Are Trading At Distressed Levels ...And the Bonds of Property Developers Are Trading At Distressed Levels ...And the Bonds of Property Developers Are Trading At Distressed Levels In many respects, the Chinese housing market resembles the Japanese market in the early 1990s. Just as was the case in Japan 30 years ago, Chinese household growth has turned negative (Chart 21). The collapse in the birth rate since the start of the pandemic will only exacerbate this problem. The number of births is poised to fall below 10 million this year, down more than 30% from 2019 (Chart 22). Chart 21China Faces A Structural Decline In The Demand For Housing China Faces A Structural Decline In The Demand For Housing China Faces A Structural Decline In The Demand For Housing Chart 22China's Baby Bust China's Baby Bust China's Baby Bust A few years ago, when inflation was subdued and talk of secular stagnation was all the rage, a downturn in the Chinese property sector would have been a major cause for concern. Things are different today. Global inflation is running high, and to the extent that investors are worried about a recession, it is because they think central banks will need to raise rates aggressively to curb inflation. A weaker Chinese property market would help restrain commodity prices, easing inflationary pressures in the process. As long as the Chinese banking system does not implode – which is highly unlikely given that the major banks are all state-owned – global investors might actually welcome a modest decline in Chinese property investment. Investment Conclusions The downturn in the US housing market suggests that we are in the late stages of the business-cycle expansion. However, given the long lags between when housing begins to weaken and when a recession ensues, it is probable that the US will only enter a recession in 2024. To the extent the stock market typically peaks six months before the outset of a recession, equities may still have further to run, at least in the near term. As we discussed last week, we recommend a neutral allocation on global stocks over a 12-month horizon but would overweight equities over a shorter-term 6-month horizon. In relative terms, the US housing market is more resilient than most other housing markets. We initiated a trade going long Canadian government bonds relative to US bonds on June 30, when the 10-year yield in Canada was 21 basis points above the comparable US yield. Today, the yield on both bonds is almost the same. We expect Canadian bonds to continue to outperform, given the more severe constraints the Bank of Canada faces in raising rates. Peter Berezin Chief Global Strategist peterb@bcaresearch.com Follow me on     LinkedIn & Twitter Global Investment Strategy View Matrix The Risks From Housing The Risks From Housing Special Trade Recommendations Current MacroQuant Model Scores The Risks From Housing The Risks From Housing      

Executive Summary US Companies Will Attempt To Raise Selling Prices To Protect Their Profit Margins US Companies Will Attempt To Raise Selling Prices To Protect Their Profit Margins US Companies Will Attempt To Raise Selling Prices To Protect Their Profit Margins China needs lower interest rates and a weaker currency to battle deflationary pressures. In the US, the main problem is elevated inflation. This heralds higher interest rates and a stronger currency. Hence, the Chinese yuan will depreciate against the greenback. When the RMB weakens versus the US dollar, commodity prices usually fall, and EM currencies and asset prices struggle. Faced with surging unit labor costs, US companies will continue to raise their prices to protect their profit margins and profitability. This will lead to one of the following two possible scenarios in the months ahead. Scenario 1: If customers are willing to pay considerably higher prices, nominal sales will remain robust, profits will not collapse, and a recession is unlikely. However, this also implies that the Fed will have to tighten policy by more than what is currently priced in by markets. Scenario 2: If customers push back against higher prices and curtail their purchases, then the economy will enter a recession. In this scenario, inflation will plummet, corporate margins will shrink, and their profits will plunge.  In both scenarios, the outlook for stocks is poor. However, one key difference is that scenario 1 is bearish for US Treasurys while scenario 2 is bond bullish. Bottom Line: On the one hand, the US has a genuine inflation problem. The upshot is that the Fed cannot pivot too early. The Fed’s hawkish rhetoric will support the US dollar. A strong greenback is bad for EM financial markets. On the other hand, the Chinese economy and global trade are experiencing deflation/recession dynamics. Cyclical assets underperform and the US dollar generally appreciates in this environment. This is also a toxic backdrop for EM financial markets.   Financial markets have been caught in contradictions. The reason is that investors cannot decide if the global economy is heading into a recession with deflationary forces prevailing, or whether a goldilocks economy or a period of inflation or stagflation will emerge in the foreseeable future. There are also plenty of contradictory data to support all the above scenarios.  As such, financial markets are volatile, swinging wildly as market participants absorb new economic data points. The S&P 500 index has rebounded from its 3-year moving average, which had previously served as a major support (Chart 1). Yet, the rebound has faltered at its 200-day moving average. Its failure to break decisively above this 200-day moving average entails that a new cyclical rally is not yet in the cards. Chart 1The S&P 500 Is Stuck Between Technical Resistance And Support Lines The S&P 500 Is Stuck Between Technical Resistance And Support Lines The S&P 500 Is Stuck Between Technical Resistance And Support Lines The S&P 500 index will remain between these resistance and support lines until investors make up their minds about the economic outlook. The EM equity index has been unable to rebound strongly alongside US stocks. A major technical support that held up in the 1998, 2001, 2002, 2008, 2015 and 2020 bear markets is about 15% below the current level (Chart 2). Hence, we recommend that investors remain on the sidelines of EM stocks. Chart 2EM Share Prices Are Still 15% Above Their Long-Term Technical Support Level EM Share Prices Are Still 15% Above Their Long-Term Technical Support Level EM Share Prices Are Still 15% Above Their Long-Term Technical Support Level BCA’s Emerging Markets Strategy team’s macro themes and views remain as follows: Related Report  Emerging Markets StrategyCharts That Matter In China, the main economic risk is deflation and the continuation of underwhelming economic growth. Core and service consumer price inflation are both below 1% and property prices are deflating. Falling prices amid high debt levels is a recipe for debt deflation. We discussed the government’s stimulus – including measures enacted for the property market – in the August 11 report. The latest announcement about the RMB 1 trillion stimulus does not change our analysis. In fact, we expected an additional RMB 1.5 trillion in local government bond issuance for the remainder of the current year. Yet, the government authorized only an additional RMB 0.5 trillion. This is substantially below what had been expected by analysts and commentators in recent months.   In Chinese and China-related financial markets, a recession/deflation framework remains appropriate. Onshore interest rates will drop further, the yuan will depreciate more, and Chinese stocks and China related plays will continue experiencing growth/profit headwinds. Meanwhile, the US economy has been experiencing stagflation this year. Chart 3 shows that even though the nominal value of final sales has expanded by 8-10%, sales and output have stagnated in real terms (close to zero growth). Hence, nominal sales and corporate profits have so far held up because companies have been able to raise prices by 8-9.5% (Chart 4). Is this bullish for the stock market? Not really. Chart 3US Stagflation: Strong Nominal Growth, But Small In Real Terms US Stagflation: Strong Nominal Growth, But Small In Real Terms US Stagflation: Strong Nominal Growth, But Small In Real Terms Chart 4US Corporate Profits Have Held Up Because Of Pricing Power/Inflation US Corporate Profits Have Held Up Because Of Pricing Power/Inflation US Corporate Profits Have Held Up Because Of Pricing Power/Inflation The fact that companies have been able to raise their selling prices at this rapid pace implies that the Fed cannot stop hiking rates. Besides, US wages and unit labor costs are surging (Chart 9 below). The implication is that inflation will be entrenched and core inflation will not drop quickly and significantly enough to allow the Fed to pivot anytime soon. Overall, US economic data releases have been consistent with our view that although real growth is slowing, the US economy is experiencing elevated inflations, i.e., a stagflationary environment. Critically, wages and inflation lag the business cycle and are also very slow moving variables. Hence, US core inflation will not drop below 4% quickly enough to provide relief for the Fed and markets. Is a US recession imminent? It depends. One thing we are certain of is that faced with surging unit labor costs, US companies will attempt to raise their prices to protect their profit margins and profitability. Our proxy for US corporate profit margins signals that they are already rolling over (Chart 5). Hence, business owners and CEOs will attempt to raise selling prices further. Chart 5US Companies Will Attempt To Raise Selling Prices To Protect Their Profit Margins US Companies Will Attempt To Raise Selling Prices To Protect Their Profit Margins US Companies Will Attempt To Raise Selling Prices To Protect Their Profit Margins This will lead to one of two possible scenarios for the US economy in the months ahead. Scenario 1: If customers (households and businesses) are willing to pay considerably higher prices, nominal sales will remain very robust, and profits will not collapse, reducing the likelihood of a recession. Yet, this means that inflation will become even more entrenched, and employees will continue to demand higher wages. A wage-price spiral will persist. The Fed will have to raise rates much more than what is currently priced in financial markets. This is negative for US share prices. Scenario 2: If customers push back against higher prices and curtail their purchases, output volume will relapse, i.e., the economy will enter a recession. In this scenario, inflation will plummet, corporate margins will shrink (prices received will rise much less than unit labor costs) and profits will plunge.  Suffering a profit squeeze, companies will lay off employees, wage growth will decelerate, and high inflation will be extinguished. In this scenario, bond yields will drop significantly but plunging corporate profits will weigh on share prices. We are not certain which of these two scenarios will prevail: it is hard to determine the point at which US consumers will push back against rising prices. Nevertheless, it is notable that in both scenarios, the outlook for stocks is poor.   Finally, as we have repeatedly written, global trade is about to contract. Charts 10-18 below elaborate on this theme. This is disinflationary/recessionary. Investment Conclusions On the one hand, the Chinese economy and global trade are experiencing deflation/recession dynamics. Cyclical assets struggle and the US dollar does well in this environment. This constitutes a toxic backdrop for EM financial markets. On the other hand, the US has a genuine inflation problem. The upshot is that the Fed cannot pivot too early. The Fed’s hawkish rhetoric will support the US dollar. A strong greenback is also bad for EM financial markets. Thus, we do not see any reason to alter our negative view on EM equities, credit and currencies. Investors should continue underweighting EM in global equity and credit portfolios. Local currency bonds offer value, but further currency depreciation and more rate hikes remain a risk to domestic bonds. We continue to short the following currencies versus the USD: ZAR, COP, PEN, PLN and IDR. In addition, we recommend shorting HUF vs. CZK, KRW vs. JPY, and BRL vs. MXN.   Arthur Budaghyan Chief Emerging Markets Strategist arthurb@bcaresearch.com Messages From Various US High-Beta / Cyclical Stock Prices US high-beta consumer discretionary, industrials, tech and early cyclical stocks have not yet broken out. The rebounds in high-beta tech and industrials have been rather muted. We are watching these and many other market signs and technical indicators to gauge if the recent rebounds can turn into a cyclical bull market. Chart 6 Messages From Various US High-Beta / Cyclical Stock Prices Messages From Various US High-Beta / Cyclical Stock Prices Chart 7 Messages From Various US High-Beta / Cyclical Stock Prices Messages From Various US High-Beta / Cyclical Stock Prices Falling Global Trade + Sticky US Inflation = US Dollar Overshot On the one hand, US household spending on goods ex-autos is already contracting and will drop further. The same is true for EU demand. The reasons are excessive consumption of goods over the past two years and shrinking household real disposable income. As a result, global trade is set to shrink, which is positive for the US dollar. On the other hand, surging US unit labor costs entail that core CPI will be very sticky at levels well above the Fed’s target. Hence, the Fed will likely maintain its hawkish bias for now, which is also bullish for the greenback. In short, the US dollar will continue overshooting.  Chart 8 Falling Global Trade + Sticky US Inflation = US Dollar Overshot Falling Global Trade + Sticky US Inflation = US Dollar Overshot Chart 9 Falling Global Trade + Sticky US Inflation = US Dollar Overshot Falling Global Trade + Sticky US Inflation = US Dollar Overshot Chinese Exports Will Contract, And Imports Will Fail To Recover Chinese export volume growth has come to a halt. Shrinking imports of inputs used for re-export (imports for processing trade) are pointing to an imminent contraction in the mainland’s exports. Further, Chinese import volumes have been contracting for the past 12 months. The value of imports has not plunged only because of high commodity prices. As commodity prices drop, import values will converge to the downside with import volumes. This is negative for economies/industries selling to China. Chart 10 Chinese Exports Will Contract, And Imports Will Fail to Recover Chinese Exports Will Contract, And Imports Will Fail to Recover Chart 11 Chinese Exports Will Contract, And Imports Will Fail to Recover Chinese Exports Will Contract, And Imports Will Fail to Recover Global Manufacturing / Trade Downtrend Is Intact China buys a lot of inputs from Taiwan that are used in its exports. That is why the mainland’s imports from Taiwan lead the global trade cycle. This is presently heralding a considerable deterioration in global trade.  In addition, falling freight rates and depreciating Emerging Asian (ex-China) currencies are all currently pointing to a further underperformance of global cyclicals versus defensive sectors. Chart 12 Global Manufacturing / Trade Downtrend Is Intact Global Manufacturing / Trade Downtrend Is Intact Chart 13 Global Manufacturing / Trade Downtrend Is Intact Global Manufacturing / Trade Downtrend Is Intact Chart 14 Global Manufacturing / Trade Downtrend Is Intact Global Manufacturing / Trade Downtrend Is Intact Taiwan Is A Canary In A Coal Mine Taiwanese manufacturing companies have seen their export orders plunge and their customer inventories surge. This has occurred in its overall manufacturing and semiconductor companies.  This corroborates our thesis that global export volumes will contract in the coming months. Chart 15 Taiwan Is A Canary In A Coal Mine Taiwan Is A Canary In A Coal Mine Chart 16 Taiwan Is A Canary In A Coal Mine Taiwan Is A Canary In A Coal Mine Korean Exporters Are Struggling Korean export companies are experience the same dynamics as their Taiwanese peers. Semiconductor prices and sales are falling hard in Korea. Export volume growth has come to a halt and will soon shrink. Chart 17 Korean Exporters Are Struggling Korean Exporters Are Struggling Chart 18 Korean Exporters Are Struggling Korean Exporters Are Struggling EM Equities: Cheap And Unloved? The EM cyclically adjusted P/E (CAPE) ratio has fallen to one standard deviation below its mean. Based on this measure, EM stocks are currently as cheap as they were at their bottoms in 2020, 2015 and 2008. EM share prices in USD deflated by US CPI are now at two standard deviations below their long-term time-trend. This is as bad as it got when EM stocks bottomed in the previous bear markets. The reason for EM stocks poor performance and such “cheapness” is corporate profits. EM EPS in USD has been flat, i.e., posting zero growth in the past 15 years. Besides, EM narrow money (M1) growth points to further EM EPS contraction in the months ahead. Chart 19 EM Equities: Cheap And Unloved? EM Equities: Cheap And Unloved? Chart 20 EM Equities: Cheap And Unloved? EM Equities: Cheap And Unloved? Chart 21 EM Equities: Cheap And Unloved? EM Equities: Cheap And Unloved? Chart 22 EM Equities: Cheap And Unloved? EM Equities: Cheap And Unloved? Commodity Prices Remain At Risk China needs lower interest rates and a weaker currency to battle deflationary pressures. In the US, the problem is inflation, which heralds higher interest rates and a stronger currency to fight rising prices. Hence, the yuan will depreciate versus the greenback. When the RMB depreciates versus the US dollar, commodity prices usually fall. Further, commodity currencies (an average of AUD, NZD and CAD) continue drafting lower. This indicator correlates with commodity prices and also presages further relapse in resource prices. Chart 23 Commodity Prices Remain At Risk Commodity Prices Remain At Risk Chart 24 Commodity Prices Remain At Risk Commodity Prices Remain At Risk Oil Prices: A Major Top In Place, But Geopolitics Will Drive Near-Term Fluctuations Chinese crude oil imports have been contracting for almost a year. Global (including US) demand for gasoline has relapsed. Meantime, Russia’s oil and oil product exports have fallen only by a mere 5% from their January level. This explains why oil prices have recently fallen. Oil lags business cycles: its consumption will shrink as global growth downshifts. However, geopolitics remain a wild card. Hence, we are uncertain about the near-term outlook for oil prices. That said, oil has made a major top and any rebound will fail to last much longer or push prices above recent highs. Chart 25 Oil Prices: A Major Top In Place, But Geopolitics Will Drive Near-Term Fluctuations Oil Prices: A Major Top In Place, But Geopolitics Will Drive Near-Term Fluctuations Chart 26 Oil Prices: A Major Top In Place, But Geopolitics Will Drive Near-Term Fluctuations Oil Prices: A Major Top In Place, But Geopolitics Will Drive Near-Term Fluctuations Chart 27 Oil Prices: A Major Top In Place, But Geopolitics Will Drive Near-Term Fluctuations Oil Prices: A Major Top In Place, But Geopolitics Will Drive Near-Term Fluctuations Chart 28 Oil Prices: A Major Top In Place, But Geopolitics Will Drive Near-Term Fluctuations Oil Prices: A Major Top In Place, But Geopolitics Will Drive Near-Term Fluctuations What Is Next For The Chinese RMB? The Chinese yuan will continue depreciating versus the US dollar. China needs lower interest rates and a weaker currency to battle deflationary pressures. While currency is moderately cheap, exchange rates tend to overshoot/undershoot and can remain cheap/expensive for a while. The CNY/USD has technically broken down. Interestingly, the periods of RMB depreciation coincide with deteriorating global US dollar liquidity and, in turn, poor performance by EM assets and commodities. Chart 29 What Is Next For The Chinese RMB? What Is Next For The Chinese RMB? Chart 30 What Is Next For The Chinese RMB? What Is Next For The Chinese RMB? Chart 31 What Is Next For The Chinese RMB? What Is Next For The Chinese RMB? Stay Put On Chinese Equities Odds are rising that Chinese platform companies will likely be delisted from the US as we have argued for some time. Hence, international investors will continue dampening US-listed Chinese stocks. The outlook for China’s economic recovery and profits is downbeat. This will weigh on non-TMT stocks and A shares. Within the Chinese equity universe, we continue to recommend the long A-shares / short Investable stocks strategy, a position we initiated on March 4, 2021. Chart 32 Stay Put On Chinese Equities Stay Put On Chinese Equities Chart 33 Stay Put On Chinese Equities Stay Put On Chinese Equities Chart 34 Stay Put On Chinese Equities Stay Put On Chinese Equities Chart 35 Stay Put On Chinese Equities Stay Put On Chinese Equities Messages For Stocks From Corporate Bonds Historically, rising US and EM corporate bond yields led to a selloff in US and EM share prices, respectively. Corporate bond yields are the cost of capital that matters for equities. Unless US and EM corporate bond yields start falling on a sustainable basis, their share prices will struggle. Corporate bond yields could increase because of either rising US Treasury yields or widening credit spreads. Chart 36 Messages For Stocks From Corporate Bonds Messages For Stocks From Corporate Bonds Chart 37 Messages For Stocks From Corporate Bonds Messages For Stocks From Corporate Bonds EM Currencies And Fixed-Income: An Unfinished Adjustment The profiles of EM FX and credit spreads suggest that their adjustment might not be complete. We expect further EM currency depreciation and renewed EM credit spread widening. EM domestic bond yields have risen significantly and offer value. However, if and as US TIPS yields rise and/or EM currencies continue to depreciate, local bond yields are unlikely to fall. To recommend buying EM local bonds aggressively, we need to change our view on the US dollar. Chart 38 EM Currencies And Fixed-Income: An Unfinished Adjustment EM Currencies And Fixed-Income: An Unfinished Adjustment Chart 39 EM Currencies And Fixed-Income: An Unfinished Adjustment EM Currencies And Fixed-Income: An Unfinished Adjustment Chart 40 EM Currencies And Fixed-Income: An Unfinished Adjustment EM Currencies And Fixed-Income: An Unfinished Adjustment Chart 41 EM Currencies And Fixed-Income: An Unfinished Adjustment EM Currencies And Fixed-Income: An Unfinished Adjustment   Footnotes Strategic Themes (18 Months And Beyond) Equities Cyclical Recommendations (6-18 Months) Cyclical Recommendations (6-18 Months)