Emerging Markets
Some investors have thrown in the towel on investing in Chinese equities, instead deploying capital in EM ex-China – or at least contemplating doing so. This report examines the merits of investing in EM ex-China stocks and concludes that EM – whether including or excluding China - will continue underperforming DM equities.
The trajectory of China’s infrastructure investment in 2023H2 will be like what occurred in 2021H2. Growth will likely drop from the current nominal 10% to 0-2% in the next six months. China will continue promoting environmentally friendly infrastructure projects that may prevent a contraction in infrastructure investment in 2023H2.
History suggests that a “soft landing” is highly unlikely after such an aggressive Fed tightening cycle. The rally could continue for a little longer but, on the 12-month horizon, market risks are very skewed to the downside.
In Section I, we audit the market’s “soft landing” narrative in response to a meaningful challenge to our cautious stance from recent financial market developments. We acknowledge that US economic growth was stronger in the first half of the year than many investors expected, but we are unmoved by the recent uptick in “soft landing” hopes. A “soft landing” outcome very likely necessitates interest rate cuts before recessionary dynamics emerge, and it is far from clear that rate cuts or (especially) an easy monetary policy stance are likely to materialize over the coming year. As such, we continue to believe that conservative portfolio positioning is appropriate. In Section II, we discuss some simple approaches that we use when valuing the major asset classes that we cover. We conclude that global ex-US equities and ex-US developed market currencies are the main assets that can be considered “cheap” today.
Among the critical materials needed for the global energy transition, Li is expected to see the largest increase in demand from 2022 to 2050. Li supply is not constrained, but continued investment in mining and refining will be required to meet increasing demand. We expect strong Li-ion battery demand in the major economies of the world – the EU, US and China – will keep a bid under Li, and allow growing supply to find a home. At tonight’s close we are getting long the LIT ETF, consistent with our view.
Stay cautious on Chinese stocks. Equity investors should use any rebound in onshore stock prices to downgrade A-shares from overweight to neutral within global and EM equity portfolios. Remain underweight Chinese investable/offshore stocks. Onshore bond yields will drop to all-time lows. Continue receiving 10-year swap rates. The currency will continue depreciating versus the US dollar in the coming months.
