Hong Kong SAR

Dear clients, The Foreign Exchange Strategy will take a summer break next week. We will resume our publication on September 4th. Best regards, Chester Ntonifor, Vice President Foreign Exchange Strategy Feature The economy of Hong Kong SAR1 has been held under siege by two tectonic forces. With the highest share of exports-to-GDP in the world, and at very close proximity to China, the epicenter of the pandemic shock, economic growth has been knocked down hard. The second shock to Hong Kong’s economy has been political instability. The extradition bill that was proposed in February 2019, followed by the enactment of the national security law this past June, has been accompanied by cascading street-wide protests and social unrest. The spirit of the bill is that crimes committed in Hong Kong can be trialed in China. The US has moved to impose sanctions on Hong Kong, as it no longer sees the city-state as autonomous, the latest of which is revoking its extradition treaty with the former colony. Some commentators have defined this as the end of the one country, two systems socio-economic model that has been in place since the handover from British rule in 1997. From a currency perspective, these shocks put in question the sustainability of the Hong Kong dollar (HKD) peg. Historically, currency pegs more often than not fail, especially in the midst of both geopolitical and economic turmoil. This was the story of the Asian Financial crisis in the late 1990s, and the Mexican peso crisis earlier that decade. Is the Hong Kong dollar destined for the same fate? If so, what are the potential adjustments in the exchange rate? Finally, what indicators can investors look to as a guide for any pending adjustment? A Historical Perspective Chart 137 Years Of Stability 37 Years Of Stability 37 Years Of Stability The HKD is no stranger to shifting exchange-rate regimes. Over the last 170 years, it has been linked to the Chinese yuan, backed by silver, pegged to the British pound, free-floating, and, since 1983, tied to the US dollar. Therefore, a bet on the unsustainability of the peg is historically justified. That said, the stability of the peg to the US dollar has survived 37 years of economic volatility, suggesting the Hong Kong Monetary Authority (HKMA) has been able to successfully navigate a post-Bretton Woods currency era (Chart 1).   Beginning as a bi-metallic monetary regime in the early 19th century, the HKD was initially linked to gold and silver prices, akin to the commodity–monetary standard that dominated that era. When Britain colonized Hong Kong in 1841, and as new trade alliances developed, the drawbacks of the bi-metallic monetary standard became apparent. As bilateral trade boomed, adjustments to imbalances (surpluses or deficits) could not occur through the exchange rate since it was fixed. Therefore, they had to occur through the real economy. This led to very volatile and destabilizing domestic prices. The stability of the peg to the US dollar has survived 37 years of economic volatility. Most Anglo-Saxon countries finally converted from bi-metallic exchange rates to the gold standard in the late 1800s, and strong ties to China dictated that Hong Kong naturally adopted the silver dollar in 1863. However, the silver system had the same drawbacks as the bi-metallic standard. Specifically, when your money supply is fixed, any increase in output leads to “few dollars chasing many goods.” This is synonymous with falling prices, just as “many dollars chasing few goods” is synonymous with rising inflation. The petri dish for this phenomenon was the post-World War I construction boom. A fixed money supply under the gold (and silver) standard meant rapidly falling prices globally. By the late 1920s, most countries had overvalued exchange rates relative to gold (and silver), that exerted powerful deflationary forces on their domestic economies. This forced most Western governments to debase fiat money vis-à-vis gold to stop price deflation. Correspondingly, China had to abandon the silver standard in November 1935, with Hong Kong shortly following suit. At the time of debasement, the United Kingdom was the leading economic power. As a colony, it made sense for the Hong Kong government to link the HKD to the British pound. The established rate was GBP/HKD 16, giving birth to the currency board system (Chart 2). Meanwhile, as a trading hub, a peg with an international currency made sense. The problems there were two-fold. First, the pound was still gold-linked. And second, Britain’s subsequent decline in economic power was accompanied by a series of sudden and dramatic devaluations in the pound, which was hugely disruptive to Hong Kong’s financial system. By 1972, the British government decided to float the pound, which effectively ended the GBP/HKD peg. Chart 2A History Of The HKD Peg A History Of The HKD Peg A History Of The HKD Peg In July 1972, the authorities made the decision to peg the Hong Kong dollar to the US dollar at USD/HKD 5.65, which was another policy mistake. The switch made sense given the rising economic power of the US, as well as rising trade links (Chart 3). However, the dollar was also under a crisis of confidence following the Nixon devaluation in 1971. In February 1973, the HKD was freely floated. Chart 3The Peg Is Usually Against The Dominant Economic Power The Peg Is Usually Against The Dominant Economic Power The Peg Is Usually Against The Dominant Economic Power Counter-intuitively, the free-floating era for HKD was arguably the most volatile for its domestic economy. For one, discipline in monetary policy was gone. Money and credit growth exploded, inflation hit double-digits, home prices soared and the trade balance massively deteriorated. Political instability was also rife, given the uncertainty surrounding the end of British claims on the island. As the dialogue included China’s reclaim of political control over Hong Kong, there was uncertainty over the rule of law. This cocktail of political and economic uncertainty led to a 33% depreciation in the HKD between mid-1980 and October 1983. Panicked policymakers returned to the US dollar peg. Paul Volcker, then Federal Reserve chairperson, was establishing himself as the world’s most credible central banker, having dropped US inflation from almost 15% in 1980 to below 3% by 1983. Economic and financial links with the US also justified a peg. In August of 1983, the authorities announced a USD/HKD fixed rate of 7.80, which has remained in place since. The Current Peg: Advantages And Disadvantages Chart 4Fiscal Prudence In Hong Kong Fiscal Prudence In Hong Kong Fiscal Prudence In Hong Kong The advantage of the HKD peg is that the choice of the nominal anchor, the US dollar, renders it credible. First, the US dollar is an international reserve currency dominating international trade, which helps to facilitate settlements while instilling confidence among transacting participants. As a financial hub, this is crucial for Hong Kong. Meanwhile, such an anchor imposes fiscal discipline, since government deficits cannot be monetized by money printing. In the case where the government tries to be profligate, the rise in inflation will lower real rates and lead to capital outflows. This will force the HKMA to sell US dollars and absorb local currency. In the extreme case, the central bank can run out of reserves, causing the peg to collapse. Indeed, over the past several years, government debt in Hong Kong has been close to nil (Chart 4). The drawback of a fixed exchange rate regime is that a country or a region relinquishes control over independent monetary policy. In the case of Hong Kong, this means that interest rates are determined by the actions of the US Fed. Such a marriage was justified when the business cycles between the two economies were in sync, but in times of economic divergences, the fixed exchange rate leads to economic volatility. Chart 5Currency Peg And Internal Devaluation Currency Peg And Internal Devaluation Currency Peg And Internal Devaluation Chart 6Hong Kong Interest Rates In The Late 90's Hong Kong Interest Rates In The Late 90's Hong Kong Interest Rates In The Late 90's This divergence was clearly evident in the 1990s, as falling interest rates in the US supercharged a housing and stock market bubble in Hong Kong. When the Asian crisis finally came around in 1997, the lack of exchange-rate flexibility led to a vicious internal devaluation (Chart 5). A prolonged period of high unemployment and stagnant wages was needed for Hong Kong to finally improve its competitiveness. Most importantly, in 1998, in the depths of the Asian financial crisis, the peg attracted a concerted attack from speculators who believed a devaluation of the Hong Kong dollar alongside other regional currencies was inevitable. Their assault inflicted considerable pain, driving short-term HKD interest rates (Chart 6) and wiping out over a quarter of the local stock market in a matter of weeks. At the time, the Hong Kong government was successful in fending off the speculative attacks by intervening massively in both the foreign exchange and equity markets. Is An Adjustment Pending? If So, When?      Chart 7USD/HKD And Interest Rate Spreads USD/HKD And Interest Rate Spreads USD/HKD And Interest Rate Spreads As the above narrative suggests, the HKD is no stranger to socio-economic shocks and speculative attacks, and it has, more recently, weathered them pretty well. The more immediate question is whether the shift in the political landscape could be potent enough to crack the peg this time around. While plausible, it is unlikely for a few reasons. First, the HKD continues to trade on the stronger side of the peg as US interest rates have collapsed, wiping off any positive carry that would have catalyzed outflows. Fluctuations in the USD/HKD within the 7.75-7.85-band track the Libor-Hibor spread pretty closely (Chart 7). A currency board has unlimited ability to defend the strong side of the peg, since it can print currency and absorb foreign reserves (print HKDs and use these to buy USDs in this case). On the weak side, these foreign exchange reserves are drawn down. Therefore, any threat to the peg should be preceded by consistent trading on the weaker side, questioning the HKMA’s ability to keep selling FX reserves to defend the peg. Fluctuations in the USD/HKD within the 7.75-7.85-band track the Libor-Hibor spread pretty closely. Second, the Hong Kong peg remains extremely credible, since the entire monetary base is backed over two times by FX reserves (Chart 8). Even as a percentage of broad money supply, Hong Kong reserves are ample and very high by historical standards (Chart 8, bottom panel). Meanwhile, since 1983, the currency board system has undergone a number of reforms and modifications, allowing it to adapt to the changing macro environment. This represents a powerful insurance policy for the HKMA’s ability to defend the currency peg, significantly enhancing the system’s credibility. Chart 8Ample Foreign Exchange Reserves Ample Foreign Exchange Reserves Ample Foreign Exchange Reserves Chart 9Hong Kong Runs Recurring Surpluses Hong Kong Runs Recurring Surpluses Hong Kong Runs Recurring Surpluses Third, ever since the peg was instituted, Hong Kong has mostly run budget surpluses. As a result, government debt in Hong Kong is almost non-existent, as we illustrate above. This has removed any incentive to monetize spending, which remains an open argument in the US, Japan or even the euro area. One of our favored metrics on the health of a currency is the basic balance, and on this basis, Hong Kong scores much more favorably than the US. While Hong Kong has transitioned from being a goods exporter to that of services, it remains extremely competitive, with a healthy current account surplus of 5% of GDP (Chart 9). These recurring surpluses have propelled Hong Kong to one of the biggest creditors in the world, with a net international investment position that is a whopping 430% of GDP and rising (Chart 10).   Chart 10Hong Kong Is A Net Creditor To The World The Hong Kong Dollar Peg And Socio-Economic Debate The Hong Kong Dollar Peg And Socio-Economic Debate Fourth, over the past few years, productivity in Hong Kong has outpaced that of the US and most of its trading partners (Chart 11). This has lifted the fair value of the currency tremendously. This means it is more like that when the peg adjusts, the outcome will be HKD appreciation. On a real effective exchange rate basis, the HKD is not that overvalued compared to the US dollar, after accounting for the massive increase in relative productivity (Chart 12). It is notable that during the Asian financial crisis, currencies like the Thai bhat were massively overvalued, which is why the adjustment was back down toward fair value. Chart 11Hong Kong Is Highly Productive Hong Kong Is Highly Productive Hong Kong Is Highly Productive Chart 12Trade-Weighted HKD Is Slightly Expensive Trade-Weighted HKD Is Slightly Expensive Trade-Weighted HKD Is Slightly Expensive Fifth, there is a strong incentive for both Beijing and Hong Kong to defend the peg, because the relevance of Hong Kong is no longer as a shipping port, but as a financial center. The peg reduces volatility, as transactions are essentially dollarized. The relevance of Hong Kong in Asia can be seen by looking at the market capitalization of the Hang Seng index compared to that of the Topix index in Tokyo or the Shanghai Composite index. Any escalation in the US-China trade war, especially in the technology sphere, will only lead to more listings on the Hong Kong stock exchange. Equity flows through the HK-Shanghai and HK-Shenzhen stock connect program are rising, suggesting the market still considers Hong Kong an important intermediary in doing business with China (Chart 13).  On the political front, the most potent risk is that the US Treasury moves to unilaterally limit access to US dollars by Hong Kong banks. While this was discussed by President Trump’s top advisers, it was also dismissed as unwise due to the potential shock to the global financial system. Meanwhile, with massive swap lines with the Fed, Hong Kong’s international banks can always draw on US liquidity. Tariffs on Hong Kong goods are another option, but this again will not really deal a severe blow to the peg, since Hong Kong mainly re-exports, with very little in the way of domestic goods exports (Chart 14). Chart 13Hong Kong Is An Important Financial Center Hong Kong Is An Important Financial Center Hong Kong Is An Important Financial Center Chart 14Hong Kong Is Partially Insulated From Tariffs Hong Kong Is Partially Insulated From Tariffs Hong Kong Is Partially Insulated From Tariffs   Property Market Blues The property market is the one area in Hong Kong where a sanguine view is difficult to paint. Hong Kong is one of the most unaffordable cities on the planet, and high income inequality has been a reason behind resident angst. The gini coefficient, a measure of inequality in a society, is more elevated in Hong Kong compared to Singapore, China or even South Africa. After years of loose monetary policy, property prices in Hong Kong have completely decoupled from fundamentals. Housing is even more unaffordable now than it was back in 1997, and domestic leverage is very high. With such a high debt stock, even a gradual uptick in interest rates will have a significant impact on the debt service burden (Chart 15). Stocks and real estate prices are positively correlated, suggesting deleveraging pressures will likely be quite high if both unravel (Chart 16). Chart 15High Debt Service Burden##br## In Hong Kong High Debt Service Burden In Hong Kong High Debt Service Burden In Hong Kong Chart 16Hong Kong Stocks Are Tied To The Property Market Hong Kong Stocks Are Tied To The Property Market Hong Kong Stocks Are Tied To The Property Market However, there are offsetting factors. First, it is unlikely that interest rates in Hong Kong (or anywhere in the developed world for that matter) will rise anytime soon. COVID-19 has provided “carte blanche” in terms of global stimulus. More importantly, the US is at the forefront of this campaign, meaning interest rates in Hong Kong will remain low for a while. Second, in recent history, Hong Kong has proven that it has the resilience to handle volatility in the property markets. During the Asian crisis, property prices fell by 60%, yet no bank went bust. Share prices also collapsed but are much higher today, suggesting the drop was a buying opportunity. And with such a low government debt burden, any systemic threat to banks will nudge the authorities to bail out important companies and sectors. In terms of asset markets, the performance of the Hang Seng index relative to the S&P 500 is purely a function of interest rates. The US stock market is dominated by technology and healthcare that do well when interest rates fall, while banks and real estate dominate the Hong Kong market. So rising rates hurt the US stock market much more than Hong Kong (Chart 17). Meanwhile, the recent turmoil has made Hong Kong assets very cheap relative to its sister-city, Singapore (Chart 18). This suggests that a lot of the potential equity outflows have already occurred, based on today’s situation. Chart 17Interest Rates And The Hong Kong Stock Market Interest Rates And The Hong Kong Stock Market Interest Rates And The Hong Kong Stock Market Chart 18Hong Kong Has Cheapened Relative To Singapore Hong Kong Has Cheapened Relative To Singapore Hong Kong Has Cheapened Relative To Singapore The Future Of The Peg A peg to the Chinese RMB makes sense. The Hong Kong economy is now heavily tied to the Chinese economy, with over 50% of exports going to China (previously mentioned Chart 3). However, that will sound the death knell for Hong Kong’s status as a financial center, since the US dollar remains very much a reserve currency. There is also a risk that if Beijing uses RMB depreciation as a weapon in a blown-out confrontation with the US in the coming years, it will threaten the sustainability of the HKD peg, since it could inflate asset bubbles. What is more likely is that the option of re-pegging to the RMB comes many years down the road, when the yuan has become a fully convertible currency. The recent turmoil has made Hong Kong assets very cheap relative to its sister-city, Singapore. There is the option to assume another currency board akin to Singapore. This option makes sense, since this would give the HKMA scope to link to cheaper currencies, such as the yen and euro. Such an overhaul will require significant technical expertise and political will from both Beijing and Hong Kong. It is not very clear what the cost/benefit outcome would be of this initiative, but it is worth considering since the RMB itself is managed against other currencies. Finally, there is always the option to fully float the peg, but this is likely to increase volatility. As well, for policymakers, it makes sense to continue pegging the exchange rate to the US dollar as it depreciates against major currencies, since it ends up easing financial conditions for Hong Kong concerns.   Chester Ntonifor Foreign Exchange Strategist chestern@bcaresearch.com Footnotes 1 Special Administrative Region of the People's Republic of China  Trades & Forecasts Forecast Summary Core Portfolio Tactical Trades Limit Orders Closed Trades

Dear Client, In lieu of our regular report next week, I will present our view on China’s economic recovery, geopolitical risks, and implications on financial markets in two live webcasts. The webcasts will take place next Wednesday, July 15 at 10:00AM EDT (English) and at 9:00PM EDT (Mandarin). Best regards, Jing Sima, China Strategist Highlights China’s economic recovery continues through June, but the pace of its demand-side recovery has been more muted compared to the V-shaped rebound in 2009. The intensity of the PBoC’s monetary easing may start to taper in H2, but the central bank is likely to stay on the easing course and keep liquidity conditions ample. Bank lending to the corporate sector should increase further in H2. Chinese stocks rallied through last week’s enactment of the new national security law for Hong Kong and the subsequently announced sanctions from the US government. The existing US sanctions should have limited impact on Hong Kong and mainland China’s economies and financial markets. We remain positive on Chinese stocks despite the recent rallies in China’s equity markets. Feature June’s official and Caixin manufacturing PMIs indicate that China’s economic recovery continues at a steady rate, with the production side of the economy picking up slightly faster than the demand side. The drag on China’s economic recovery from lackluster demand growth should be temporary. Unlike in 2015 when policy uncertainties hindered the recovery in both economic activity and stock prices, the Chinese government has been determined to support its economy and job market in the current cycle. The massive stimulus implemented since March has tremendously boosted activities in China’s construction sector. While households and the corporate sector remain reluctant to spend and to invest, their marginal propensity to spend usually catches up with credit growth with about a 6-9-month lag (Chart 1). The sharp pickup in credit growth should meaningfully support China’s economic rebound, while a better global growth outlook in H2 should also provide some modest tailwinds. On June 30, the PBoC announced a 0.25 percentage point cut to its relending rates for small and rural enterprises and to its general rediscount rate. While the scale of rate cuts in H2 will unlikely match that of Q1, China’s monetary and fiscal policy support will remain in place through the rest of the year. Chinese investable and domestic equities were some of the best performers among global asset classes in June, whereas they were the third-worst the month prior (Chart 2). In the first week of July, both Chinese investable and domestic stocks rallied even further. As we noted in our last week’s report,1 China’s stronger economic outlook, less uncertainty related to its domestic COVID-19 containment, and policy support should provide more room for Chinese stocks to trend upwards. Last week’s passing of the new national security law for Hong Kong and the subsequently announced sanctions from the US government, in our view, should have limited impact on investors’ sentiment for now. Chart 1China's Household And Corporate Marginal Propensities Lag The Credit Impulse By 6-9 Months China's Household And Corporate Marginal Propensities Lag The Credit Impulse By 6-9 Months China's Household And Corporate Marginal Propensities Lag The Credit Impulse By 6-9 Months Chart 2Chinese Equities Are Taking Flight China Macro And Market Review China Macro And Market Review   Tables 1 and 2 present key developments in China’s economic and financial market performance in the past month, and we highlight several of these developments below: Table 1China Macro Data Summary China Macro And Market Review China Macro And Market Review Table 2China Financial Market Performance Summary China Macro And Market Review China Macro And Market Review China’s June official manufacturing PMI ticked up to 50.9 from 50.6 in the previous month. The Caixin manufacturing PMI came in at 51.2, beating the expectation of 50.5 and compared to 50.7 in May. Both suggest that China’s manufacturing sector continues to expand, however the pace of its demand-side recovery has been more muted compared to the V-shaped rebound in 2009 (Chart 3). Although the import and export subcomponents have fared better in June from the low levels in April and May, their readings in June were still below the 50 boom-bust line (Chart 4). Headwinds remain strong for global trade as the US and many of emerging economies are still struggling with the pandemic. Even without re-imposing lockdowns, the resurge in the number of new cases in the US may result in a drag on consumption and global trade. The IMF projects a 12% contraction in global trade in 2020. While the external demand may improve in H2, positive contribution to China's GDP growth from the net exports will be limited this year. Chart 3Current Recovery Lies Somewhere Between 2009 And 2015 Current Recovery Lies Somewhere Between 2009 And 2015 Current Recovery Lies Somewhere Between 2009 And 2015 Chart 4Demand-Side Recovery Remains Muted Demand-Side Recovery Remains Muted Demand-Side Recovery Remains Muted   The employment situation in the manufacturing sector has worsened since May, and has returned to contraction following a brief improvement in March and April (Chart 5). An estimated 8.7 million new graduates in 2020,2 a historical high number, will hit the job market in July and August. As such, China’s labor market will likely remain under significant pressure. Even though employment usually lags economic recoveries, depressed expectations on the job market will refrain policymakers from prematurely withdrawing stimulus measures. Small and micro enterprises are an important part of China’s private sector, which provides 80% of jobs in China. The manufacturing PMI of small enterprises fell below the 50 boom-bust line in June, reflecting a persistent weakness in this part of China’s economy. The recent relending and rediscount rate cuts suggest that the PBoC is committed to stay on the easing course. The intensity of monetary easing may start to taper in H2, but the central bank is likely to keep liquidity conditions ample and encourage banks to accelerate lending to the corporate sector. The contraction in Chinese producer prices deepened to -3.7% (year-over-year) in May. However, we think PPI deflation is likely to bottom in Q3. Both the purchasing and producer price subcomponents of the manufacturing PMI ticked up sharply in June, while the drawdown in industrial product inventory relative to new orders has accelerated (Chart 6). The ongoing accommodative policy should provide powerful tailwinds to both economic activity and the PPI in H2. The improvement in the PPI will help to boost industrial profits growth, which turned positive in May (year-over-year) for the first time this year. We expect year-to-date industrial profits to end the calendar year with a modest positive growth rate.  Chart 5Labor Market Pressure Intensifies Labor Market Pressure Intensifies Labor Market Pressure Intensifies Chart 6PPI Deflation Nears Its Bottom PPI Deflation Nears Its Bottom PPI Deflation Nears Its Bottom   China’s property market indicators have notably trended up in May, with year-over-year growth in housing demand normalizing to its pre-pandemic level (Chart 7A & Chart 7B). As the demand in housing rebounded faster than the supply, housing prices have correspondingly turned the corner in May after trending down for 6 consecutive months. Chart 7AHousing Prices Ticked Up Slightly Following A Sharp Fall In Q1 Housing Prices Ticked Up Slightly Following A Sharp Fall In Q1 Housing Prices Ticked Up Slightly Following A Sharp Fall In Q1 Chart 7BStrong Rebound In Property Investments Strong Rebound In Property Investments Strong Rebound In Property Investments   Chart 7B shows that housing investments and land purchases have also recovered to near their pre-pandemic levels. Financing restrictions for property developers that were put in place since 2018 have been loosened in H1, which helped to boost real estate investments. We expect the property sector financing conditions to remain accommodative through the rest of this year. Moreover, there is a possibility that the PBoC will lower the 5-year MLF (medium lending facility) rate in Q3. As downward pressures on China's labor market and household income growth intensify, the government is likely to lower the mortgage rate to ease payment constraints on households. Chart 8Chinese Stocks Rallied Through Frictions Over Hong Kong Chinese Stocks Rallied Through Frictions Over Hong Kong Chinese Stocks Rallied Through Frictions Over Hong Kong Despite the passing of China’s new and controversial national security law for Hong Kong on June 30 and the subsequently announced sanctions from the US government, stock prices in both China’s onshore and offshore markets rallied (Chart 8). While we agree the US may impose further and more concrete sanctions on China during the months leading up to the November US presidential election, our preliminary assessment points to a limited economic cost on China from the existing US sanctions. The removal of Hong Kong’s special trade status will subject Hong Kong’s export goods to the same tariffs the US levies on Chinese exports. But the raised tariffs will barely make a dent in Hong Kong or mainland China’s export status quo. Hong Kong’s economy consists mainly of the financial, logistical and services sectors. The manufacturing sector only accounts for 1% of its overall economy. Chart 9 shows that Hong Kong’s exports to the US only accounted for around 1% of its total exports and 1.3% of its GDP in 2019. More importantly, of the $5 billion goods Hong Kong exports to the US, only 10% is actually produced in Hong Kong. Most of Hong Kong's exports to the US are goods produced in China that are re-exported through Hong Kong, which are already subject to the same tariffs as the goods China exports to the US directly.3 On the other hand, US exports to Hong Kong accounts for 2% of its total exports, with a trade surplus of about $30 billion in the past two years (Chart 9, bottom panel). The US trade surplus with Hong Kong has drastically reduced since the US-China trade war broke out in 2018, suggesting that the US has already imposed restrictions on its export goods to mainland China through Hong Kong. Moreover, the large trade surplus with Hong Kong as well as China’s commitment to the Phase One trade deal may be part of the reason President Trump is unwilling to impose more substantial sanctions on China right now. The US senate and house have also passed a bill which, if signed and implemented by President Trump, will allow the US government to levy any foreign financial institutions for knowingly conducting business with individuals who are involved in jeopardizing Hong Kong’s autonomy. Chinese banks with operations in the US will be mostly exposed to such sanctions. However, Chinese banks are largely domestic-focused with very low reliance on foreign-currency funding (Chart 10). Hence, the direct impact of a deteriorating operating environment in the US will be limited on Chinese banks. Chart 9Trade Sanctions On Hong Kong Exports Have A Minimum Impact On Its Local Economy Trade Sanctions On Hong Kong Exports Have A Minimum Impact On Its Local Economy Trade Sanctions On Hong Kong Exports Have A Minimum Impact On Its Local Economy Chart 10Chinese Banking Sector Stock Performance Is Largely Driven By Domestic Policy Factors Chinese Banking Sector Stock Performance Is Largely Driven By Domestic Policy Factors Chinese Banking Sector Stock Performance Is Largely Driven By Domestic Policy Factors   Qingyun Xu, CFA Senior Analyst qingyunx@bcaresearch.com Jing Sima China Strategist jings@bcaresearch.com   Footnotes 1 Please see China Investment Strategy Weekly Report "Upgrading Chinese Stocks To Overweight," dated July 1, 2020, available at cis.bcaresearch.com 2 iiMediaReport, Analysis report on current situation and development trend of Chinese employment entrepreneurship market in 2020. 3 Please see Nicholas Lardy, “Trump’s latest move on Hong Kong is bluster”. Peterson Institute For International Economies, dated June 1, 2020.   Cyclical Investment Stance Equity Sector Recommendations

An analysis on Hong Kong is available below. Highlights The correction in EM risk assets and currencies will be larger than during the SARS outbreak. A number of market indicators that are pertinent for EM assets are sending a disconcerting message. The trouble is that they have relapsed from already low levels. We are closing our long position in EM stocks to manage risk and continue recommending underweighting EM equities and credit versus their DM counterparts. Stay short EM currencies versus the US dollar. A new trade: Go short Hong Kong banks / long Taiwanese banks. Feature Chart I-1Global Equity Correction: SARS- And Coronavirus-Episodes Global Equity Correction: SARS- And Coronavirus-Episodes Global Equity Correction: SARS- And Coronavirus-Episodes It is tempting to compare the potential impact of the current coronavirus outbreak on the global economy and financial markets with that of SARS in the spring of 2003. The correction in global equities due to the SARS outbreak lasted only a couple of days during April 2003, and global share prices sold off by only 2.5% (Chart I-1). During that period, the EM equity index dropped by 4% and emerging Asian bourses by 8% in US dollar terms (Chart I-2). Presently, the drawdowns in global stocks and EM share prices have been 2.5% and 4%, respectively. Thus, the magnitude of the current correction is on a par with what occurred during the 2003 SARS outbreak (Charts I-1 and I-2). Further, in 2003, share prices bottomed when the number of registered new SARS infections – on a rolling fortnight basis – declined (Chart I-3). This was true both worldwide and in the case of Hong Kong. Chart I-2EM And Asian Stock Corrections: SARS- And Coronavirus-Episodes EM And Asian Stock Corrections: SARS- And Coronavirus-Episodes EM And Asian Stock Corrections: SARS- And Coronavirus-Episodes Chart I-3Number Of New Cases And Share Prices: Global And Hong Kong Number Of New Cases And Share Prices: Global And Hong Kong Number Of New Cases And Share Prices: Global And Hong Kong However, such simplistic comparisons between SARS in 2003 and the current coronavirus outbreak are uninformative. There are striking economic differences between these two episodes. The impact on both the Chinese and global economies will be larger today compared with the effects of SARS. This is true even if the spread of the coronavirus is contained soon and the number of infections and deaths peaks earlier and at much lower levels compared to the SARS outbreak. The rationale behind the meaningful impact on Chinese and global growth is two-fold: The safety measures undertaken by the Chinese authorities, including the extension of the Lunar New Year holiday period and imposition of limits on travel – are much greater than their response in 2003. These efforts might contain the spread of the virus and save human lives, but they will likely dampen economic activity in the near term. The importance of the Chinese economy in the world and hence its impact have grown immensely since early 2003. Overall, the current correction in EM risk assets and currencies will be larger than the one during the SARS outbreak. China’s Share Of The Global Economy: Today Versus 2003 Table I-1China’s Importance Now And In 2003 Coronavirus Versus SARS: Mind The Economic Differences Coronavirus Versus SARS: Mind The Economic Differences China’s economy is much more important to global aggregate demand and growth today than it was in 2003 (Table I-1). Specifically: China’s GDP at purchasing power parity accounts for 19.3% of world GDP compared to 8.3% in 2002 before the SARS outbreak occurred. In nominal US dollar terms, the mainland currently accounts for 17% of global GDP versus 4.3% in 2002. We use 2002 because the SARS outbreak occurred in early 2003, so China’s share of world GDP in 2002 is the more accurate measure of the country’s importance in early 2003. Chinese imports of goods and services make up 13.5% of global trade at present, significantly greater than their 4.5% share in 2002. The mainland’s share of consumption of various industrial metals has surged, from between 10-20% in 2002 to 50-60% presently (Table I-1). For copper, it has soared from 18% in 2002 to its current share of 53%. China’s iron ore imports have risen from 21% of the global total in 2002 to 64% presently. The nation’s oil consumption presently accounts for 13.5% compared with 6.6% in 2002. Total semiconductor sales in China currently constitute 34.6% of global semiconductor sales versus 5% in 2002. Personal computer sales in China make up 20% of worldwide sales compared with 2.4% in 2002. Mobile phones sales in China constituted 11% of worldwide sales in 2002. Today, smartphone sales account for 29% of global sales. Finally, in the past 12 months, passenger car sales in China were 21.5 million units, or 34.5% of the global total. In 2002, China’s share in global passenger auto demand was only 7.3%. Other relevant differences between China’s economy then and now include: Chart I-4China's Leverage In 2003 And Now China's Leverage In 2003 And Now China's Leverage In 2003 And Now First, leverage among companies and households was low in 2002 compared with the current debt bubble. Aggregate local currency indebtedness of companies, households and the various levels of government stood at 120% of GDP in 2002, compared with 260% currently (Chart I-4). Even a temporary reduction in cash flows of enterprises due to shutdowns and a plunge in demand will weigh on their ability to service debt. This could in turn temporarily curtail their appetite for new investments and hiring. Second, by 2003 China had just completed a major overhaul of its state-owned enterprises (SOEs) and banks. As a result, the nation was in the early stages of a structural economic boom driven by higher productivity growth. Presently, neither SOE reforms nor deleveraging are meaningfully advanced (Chart I-4, bottom panel). Consequently, China is still in a structural decline in terms of productivity growth. Third, China entered the World Trade Organization in late 2001, and by early 2003 it was enjoying an FDI inflow boom and was on the verge of rapidly increasing its market share in global trade (Chart I-5). Presently, both multinational and Chinese producers are moving their production and supply chains out of China in response to US trade protectionism. Chart I-5China's Global Export Market Share In 2003 And Now China's Global Export Market Share In 2003 And Now China's Global Export Market Share In 2003 And Now Finally, enterprises and organizations were not forced to shut down because of the SARS virus in the spring of 2003. Consequently, the hit to economic activity in the spring of 2003 was mild, as shown in Chart I-6A and I-6B. In contrast, the government today has extended the Chinese New Year holidays by a few days, and some companies will be operating on a part-time basis for a couple of weeks. It is impossible to forecast the evolution of the outbreak, but the odds are that a hit to economic activity in China due to the coronavirus outbreak is likely to be worse than during the SARS episode. Chart I-6AChina: Cyclical Variables During SARS Outbreak China: Cyclical Variables During SARS Outbreak China: Cyclical Variables During SARS Outbreak Chart I-6BChina: Cyclical Variables During SARS Outbreak China: Cyclical Variables During SARS Outbreak China: Cyclical Variables During SARS Outbreak On a positive note, the Chinese authorities will certainly augment their stimulus, especially fiscal spending, to counteract the negative impact of the shutdowns on the economy. However, it remains to be seen how long it will take for these stimulus efforts to filter through the economy and offset the drag from poor sentiment. Market Signals Are Disconcerting There are several financial market signals that are often important in terms of gauging primary trends in EM risk assets and currencies: Chart I-7Industrial Metal Prices Are Back To Their Cyclical Lows Industrial Metal Prices Are Back To Their Cyclical Lows Industrial Metal Prices Are Back To Their Cyclical Lows Base metal prices in general and copper prices in particular have relapsed to their cyclical lows (Chart I-7). In short, industrial metal prices are not confirming a durable recovery in global manufacturing and China/EM domestic demand. Industrial metal prices are leveraged to China’s growth as well as closely correlated with EM ex-China currencies (Chart I-8). This is a bearish signpost for EM exchange rates. Notably, Korea’s bond yields are drifting lower, casting doubt on the sustainability of the nation’s export growth (Chart I-9). The latter is a good barometer of global trade. EM assets are very sensitive to global trade and as such remain at risk. EM small-cap stocks have failed to enter a cyclical bull market, despite investor enthusiasm for EM financial markets following the US-China Phase One trade agreement. Their much-muted rebound is not confirming a broad-based recovery in EM/China growth and improvement in EM domestic fundamentals. Chart I-8EM Currencies: Rebound Has Faded EM Currencies: Rebound Has Faded EM Currencies: Rebound Has Faded Chart I-9Korean Bond Yields And Global Manufacturing Korean Bond Yields And Global Manufacturing Korean Bond Yields And Global Manufacturing Chart I-10EM Risks Are Tilted To The Downside EM Risks Are Tilted To The Downside EM Risks Are Tilted To The Downside Similarly, the rebound in our Risk-On/Safe-Haven currency ratio has faded and this indicator has rolled over (Chart I-10). It correlates well with EM share prices, and presently heralds further downside in the latter.  The disconcerting message from these market indicators is that they – unlike the S&P 500 - are not correcting from very overbought levels, but have relapsed and are gapping down from already low levels. Economic data from China and Asia in the coming months will be weak due to coronavirus-related disruptions. Therefore, investors cannot rely on economic data to gauge the direction of the business cycle, Instead, market signals and market-based indicators might become the predominant tools for gauging financial markets directions.     Investment Strategy Last week we recommended investors consider going long EM volatility. The levels of EM and DM currencies’ implied volatility were at all-time lows (Chart I-11). We are reiterating this recommendation. Notably, the previous historical lows in EM and DM currencies’ implied volatility occurred just before major bear markets in EM share prices (Chart I-11). Hence, the odds of a major drawdown in EM share prices are considerable. We gave the benefit of the doubt to the market action and went long EM stocks on December 19, 2019. Given the latest market action, indicators and uncertainty over the Chinese/Asian business cycle, we are closing the open position in EM equities. This trade has been flat since its initiation. The EM equity index in US dollar terms is hovering above major technical support lines (Chart I-12). If this level is decisively broken, the downside could be substantial. Alternatively, if EM share prices find support around these levels, it would signal a budding major bull market. We will monitor market action and indicators and adjust our strategy accordingly. Chart I-11A Record Low Vol = A Major Top In Risk Assets A Record Low Vol = A Major Top In Risk Assets A Record Low Vol = A Major Top In Risk Assets Chart I-12EM Stocks: Will Long-Term Technical Support Hold? EM Stocks: Will Long-Term Technical Support Hold? EM Stocks: Will Long-Term Technical Support Hold? Although we upgraded our view on the absolute performance of EM stocks in December, we have continued recommending underweighting EM versus DM. In recent weeks, we have been arguing that we will upgrade EM stocks and credit from underweight to overweight relative to their DM peers if EM share prices and currencies demonstrate resilience amid a correction in global risk assets. So far, they have not been resilient – EM equities have sold off more than their DM peers (Chart I-13) and the weakness in EM currencies has been broad-based. For now, investors should continue underweighting EM equities and credit versus their DM counterparts. The odds of a breakdown in EM currencies are rising. Investors should continue shorting a basket of EM currencies versus the US dollar. Our favored shorts are BRL, CLP, COP, IDR, MYR, PHP, KRW and ZAR. Finally, EM local currency bond yields as well as sovereign and corporate credit spreads are either at record lows or at extremely low levels (Chart I-14). EM sovereign credit spreads appear elevated because the index includes de-facto defaulted sovereigns like Argentina, Venezuela, and others. EM currency trends hold the key for these asset classes. If EM currencies break down, as we expect, EM domestic bond yields will rise, and sovereign and credit spreads will widen. Chart I-13EM Equities Versus DM: New Lows Ahead? EM Equities Versus DM: New Lows Ahead? EM Equities Versus DM: New Lows Ahead? Chart I-14Too Much Complacency In EM Local Bonds And Credit Markets Too Much Complacency In EM Local Bonds And Credit Markets Too Much Complacency In EM Local Bonds And Credit Markets     Arthur Budaghyan Chief Emerging Markets Strategist arthurb@bcaresearch.com           Hong Kong: Into Uncharted Waters The Hong Kong economy is in recession and its equity prices – stocks domiciled in Hong Kong and included in the MSCI Hong Kong equity index – have underperformed considerably. Is it time to turn positive on Hong Kong equities? We continue to recommend underweighting Hong Kong-domiciled stocks, because the heavyweight sectors – financials and property – remain at risk. The basis is that Hong Kong’s interest rates will likely creep higher as capital outflows persist. Higher borrowing costs will weigh on this highly leveraged economy. Capital Flows And Interest Rates The currency board system mandates the Hong Kong Monetary Authority (HKMA) to maintain a pegged exchange rate with the US dollar. With an open capital account and a fixed exchange rate, the HKMA has little control over interest rates. Chart II-1Banks Excess Reserves AT HKMA And Interest Rates Banks Excess Reserves AT HKMA And Interest Rates Banks Excess Reserves AT HKMA And Interest Rates Capital outflows exert depreciation pressure on the currency, forcing the monetary authorities to sell their foreign currency reserves to defend the exchange rate peg. This drains commercial banks’ excess reserves at the central bank, thereby tightening interbank liquidity and lifting interest rates (Chart II-1). In brief, interbank rates need to rise to inhibit capital flight. For now, we expect the heightened socio-political uncertainty in Hong Kong to linger. This will hurt economic growth, thereby depressing economic sentiment and return on capital. In turn, this will continue to spur capital outflows. The latter will exert upward pressure on interest rates. Overall, this could unleash a feedback loop of deteriorating growth conditions, capital outflows and higher interest rates. While it is doubtful that Hong Kong will experience a full-blown crisis, the most likely scenario is a slow leakage of capital out of the city and gradually rising interest rates. A mirror image of capital outflows from Hong Kong is foreign capital inflows in Singapore. In particular, foreigners’ Singapore dollar deposits rose by S$6.8 billion from May to November 2019, and foreign currency deposits in Singaporean banks increased by S$9 billion during the same period (Chart II-2). Chart II-2Non-Residents Deposits In Singapore Confirm Capital Flight Out Of HK Non-Residents Deposits In Singapore Confirm Capital Flight Out Of HK Non-Residents Deposits In Singapore Confirm Capital Flight Out Of HK Real Estate Blues Hong Kong’s property market is under stress from both falling income/cash flow and slowly rising interest rates. Odds are that various segments of the Hong Kong property market – especially the retail, commercial and high-end residential – have entered an extended downturn. The protests and the coronavirus outbreak have all but halted tourism, especially from the mainland. Mainland Chinese visitors accounted for 75% of total arrivals a year ago, and their spending accounted for over 10% of personal consumption expenditures in Hong Kong. Tourists from the mainland are not expected to return soon due to both Hong Kong’s protests and the travel limitations due to the coronavirus outbreak. Hong Kong’s domestic demand is also anemic, and will stay so given poor business sentiment and a weakening labor market. In a nutshell, the value of retail sales in November plunged by a record 23.6% from a year earlier (Chart II-3). Contracting consumption has resulted in sharply rising vacancies and pushed retail property rents and prices off the cliff for the first time since 2008 (Chart II-4). Retail sector rents and prices have on average deflated by 10% from last year. Consistently, high-street rents have also fallen by about 18% in 2019. In short, rising vacancy rates of retail properties herald further rent decline. Chart II-3HK: Retail Sales Have Collapsed HK: Retail Sales Have Collapsed HK: Retail Sales Have Collapsed Chart II-4HK Retail Properties: Vacancy, Rents And Prices HK Retail Properties: Vacancy, Rents And Prices HK Retail Properties: Vacancy, Rents And Prices Hong Kong’s office market is also at risk, with vacancy rates climbing (Chart II-5). Office property prices have dropped by 8%, and prime grade A property prices have plunged a whopping 20% from a year earlier (Chart II-5, bottom panel). Multinational companies and financial firms have been relocating to reduce their rental costs. In the third quarter of this year, office vacancies in the center of Hong Kong reached 7.4%, their highest in 14 years. With respect to Hong Kong‘s residential market, it is a mixed bag. On average, home prices have so far declined by only 3% from their peak in 2019. (Chart II-6, top panel). That said, luxury residential prices have already plunged by 27% from a year ago (Chart II-6, second panel).  The residential sector’s resilience in the middle- and low-ends can be explained by strong end-user demand and lack of speculative purchases over the past three years due to the government’s anti-speculative measures. For example, the number of residential transactions involving stamp duties – a proxy for foreign purchases – has fallen sharply since Q4 2016 due to tougher regulations. Chart II-5HK Offices: Vacancy, Rents And Prices HK Offices: Vacancy, Rents And Prices HK Offices: Vacancy, Rents And Prices Chart II-6HK Residential Vacancy, Rents And Prices HK Residential Vacancy, Rents And Prices HK Residential Vacancy, Rents And Prices Chart II-7HK: Retail Yields And Interest Rates HK: Retail Yields And Interest Rates HK: Retail Yields And Interest Rates Even only marginally higher interest rates will be sufficient to hurt real estate. Rental yields on all types of properties are very low and close to borrowing costs (Chart II-7). There is not much of a valuation buffer if borrowing costs rise or rents deflate. In a nutshell, the high-end property market as well as commercial real estate are vulnerable. Importantly, the Hong Kong authorities cannot use lower interest rates to help the economy, leaving fiscal policy as the sole tool. The government has accumulated enormous fiscal surpluses, and it will ramp up spending to stimulate the economy. The authorities have so far announced three tiny fiscal stimulus packages amounting to only 0.8% of GDP in aggregate. This is clearly insufficient to jump start the business cycle amid lingering headwinds. Nevertheless, government expenditures account for only 10% of GDP, and any reasonable jump in spending in the coming months will not be sufficient to preclude a downtrend in the broader economy. Banks Holds The Key Chart II-8HK-Domiciled Banks: Profit Outlook Is Downbeat HK-Domiciled Banks: Profit Outlook Is Downbeat HK-Domiciled Banks: Profit Outlook Is Downbeat Hong Kong-domiciled bank share prices are at risk from a deceleration in loan growth, rising non-performing loans (NPLs) and a drop in their net interest rate margins (Chart II-8). Banks’ domestic loans are concentrated in real estate: About 55% of domestic loans consist of lending to property developers and mortgages. Such a high concentration of real estate lending makes Hong Kong banks vulnerable to a property market correction. If banks begin tightening lending standards, the game will be over. At the moment, bankers might be relaxed as they are comparing the current episode with short-lived corrections in the property market and the economy in 2008, 2013 and 2015. However, odds are that this downturn will be more severe. As the economic stress heightens, banks might begin tightening lending standards. In such a case, property prices and construction activity will sink, feeding back into the economy. Notably, this process seems to have started, as evidenced by bank tightening of credit standards for small businesses (Chart II-9). Importantly, the debt service ratio for Hong Kong’s nonfinancial sectors is among the highest in the world (Chart II-10). Provided all outstanding mortgages are floating-rate, any rise in interest rates will increase borrowing costs. Coupled with shrinking nominal incomes, debtors – both households and companies – will struggle to service their debt. Chart II-9HK Banks Have Been Tightening Credit For Small Businesses HK Banks Have Been Tightening Credit For Small Businesses HK Banks Have Been Tightening Credit For Small Businesses Chart II-10HK Private Sector: Debt-Service Ratio Is the Highest HK Private Sector: Debt-Service Ratio Is the Highest HK Private Sector: Debt-Service Ratio Is the Highest Investment conclusions We continue to reiterate our underweight position in Hong Kong equities within emerging markets, global and Asian equity portfolios (Chart II-11). The Hong Kong currency peg will be maintained for now, even at the cost of rising interest rates and debt deflation in the real economy. We discussed the Hong Kong exchange rate outlook in a special report last June,  and the main points of that analysis remain valid. The HKMA has an enormous amount of foreign exchange reserves to defend the currency peg. However, the cost of defending the exchange rate will be higher interest rates. The latter will hurt Hong Kong’s highly leveraged economy in general and its property market in particular. As a bet on property market travails, we continue to recommend being short Hong Kong property stocks and long Singapore real estate equities (Chart II-12). The macro justification for this trade is the ability of Singapore to drop interest rates and tolerate currency depreciation, and Hong Kong’s inability to do so. Finally, as a new trade, we recommend shorting Hong Kong-domiciled banks relative to Taiwanese banks. As discussed, Hong Kong banks are exposed to rising borrowing costs, weakening real estate and rising NPLs. Chart II-11Continue Underweighting HK Stocks Continue Underweighting HK Stocks Continue Underweighting HK Stocks Chart II-12Stay Short HK Property / Long Singapore Property Stocks Stay Short HK Property / Long Singapore Property Stocks Stay Short HK Property / Long Singapore Property Stocks We chose Taiwanese banks because they are defensive in nature – i.e., they will likely be a low-beta play within the Asia equity universe.   Lin Xiang, CFA Research Analyst linx@bcaresearch.com   Footnotes Equities Recommendations Currencies, Credit And Fixed-Income Recommendations

Highlights Investors should remain overweight global stocks relative to bonds over the next 12 months and begin shifting equity exposure towards non-US markets. Bond yields will rise next year as global growth picks up, while the dollar will sell off. The extent to which bond yields increase over the long term depends on whether inflation eventually stages a comeback. Today’s high debt levels could turn out to be deflationary if they curtail spending by overstretched households, firms, and governments. However, high debt levels could also prompt central banks to engineer higher inflation in order to reduce the real burden of debt obligations. Which of these two effects will win out depends on whether central banks are able to gain traction over the economy. This ultimately boils down to whether the neutral rate of interest is positive or negative in nominal terms. While there is little that policymakers can do to alter certain drivers of the neutral rate such as the trend rate of economic growth, they do have control over other drivers such as the stance of fiscal policy. Ironically, a structural shift towards easier fiscal policy could lead to a decline in government debt-to-GDP ratios if higher inflation, together with central bankers' reluctance to raise nominal rates, pushes real rates down far enough. This suggests that the endgame for today’s high debt levels is likely to be overheated economies and rising inflation.   Stay Bullish On Stocks But Shift Towards Non-US Equities We returned to a cyclically bullish stance on global equities following the stock market selloff late last year, having temporarily moved to the sidelines in June 2018. We have remained overweight global equities throughout 2019. Two weeks ago, we increased our pro-cyclical bias by upgrading non-US stocks within our recommended equity allocation at the expense of their US peers. Our decision to upgrade non-US equities stems from the conviction that global growth has turned the corner. Manufacturing has been at the heart of the global slowdown. As we have often pointed out, manufacturing cycles tend to last about three years – 18 months of weaker growth followed by 18 months of stronger growth (Chart 1). The current slowdown began in the first half of 2018, and right on cue, the recent data has begun to improve. The global manufacturing PMI has moved off its lows, with significant gains seen in the new orders-to-inventories component. Global growth expectations in the ZEW survey have rebounded. US durable goods orders surprised on the upside in October. The regional Fed manufacturing surveys have also brightened, suggesting upside for the ISM next week (Chart 2). Chart 1A Fairly Regular Three-Year Manufacturing Cycle A Fairly Regular Three-Year Manufacturing Cycle A Fairly Regular Three-Year Manufacturing Cycle Chart 2Some Manufacturing Green Shoots Some Manufacturing Green Shoots Some Manufacturing Green Shoots     Unlike in 2016, China has not allowed a major reacceleration in credit growth this year. Instead, fiscal policy has been loosened significantly. The official general government deficit has increased from around 3% of GDP in mid-2018 to 6.5% of GDP at present. The augmented budget deficit – which includes spending through local government financing vehicles and other off-balance sheet expenditures – is on track to reach nearly 13% of GDP in 2019. This is a bigger deficit than during the depths of the Great Recession (Chart 3). As a result of all this fiscal easing, the combined Chinese credit/fiscal impulse has continued to move up. It leads global growth by about nine months (Chart 4). Chart 3China Has Been Stimulating, Fiscally China Has Been Stimulating, Fiscally China Has Been Stimulating, Fiscally Chart 4Chinese Stimulus Should Boost Global Growth Chinese Stimulus Should Boost Global Growth Chinese Stimulus Should Boost Global Growth The dollar tends to weaken when global growth strengthens (Chart 5). The combination of stronger global growth and a softer dollar will disproportionately benefit cyclical equity sectors. Financials will also gain thanks to steeper yield curves (Chart 6). The sector weights of non-US stock markets tend to be more tilted towards deep cyclicals and financials. As a consequence, non-US stocks typically outperform when global growth picks up (Chart 7). Chart 5The Dollar Is A Countercyclical Currency The Dollar Is A Countercyclical Currency The Dollar Is A Countercyclical Currency Chart 6Steeper Yield Curves Will Benefit Financials Steeper Yield Curves Will Benefit Financials Steeper Yield Curves Will Benefit Financials In addition, valuations favor stocks outside the US. Non-US equities currently trade at 13.8-times forward earnings, compared to 18.1-times for the US. The valuation gap is even greater if one looks at price-to-book, price-to-sales, and other measures (Chart 8). Chart 7Non-US Equities Usually Outperform When Global Growth Improves Non-US Equities Usually Outperform When Global Growth Improves Non-US Equities Usually Outperform When Global Growth Improves Chart 8US Stocks Are Relatively More Expensive US Stocks Are Relatively More Expensive US Stocks Are Relatively More Expensive Trade War Remains A Key Risk The US-China trade war remains a key risk to our bullish equity view. President Trump continues to send conflicting signals about the status of the talks. He complained last week that Beijing is not “stepping up” in finalizing a phase 1 agreement, adding that China wants a deal “much more than I do.” This Wednesday he struck a more optimistic tone, saying that negotiators were in the “final throes” of deal. However, he made this statement on the same day that he decided to sign the Hong Kong Human Rights and Democracy Act into law, a decision that was bound to antagonize China. According to our BCA geopolitical team, Trump had little choice but to sign the bill. The Senate approved it unanimously, while the House voted for it 417-1. Failure to sign it would have resulted in an embarrassing veto by the Senate. The key point is that the new law does not force Trump to take any immediate actions against China. This suggests that the trade talks will continue. In fact, from China's point of view, Congress’ desire to pass a Hong Kong bill may provide a timely reminder that getting a deal done with Trump now may be preferable to waiting until after the election and potentially facing someone like Elizabeth Warren who is likely to make human rights a key element of any deal to roll back tariffs. Waiting For Inflation If global growth accelerates next year, history suggests that bond yields will rise (Chart 9). Looking further out, the extent to which bond yields will continue to increase depends on whether inflation ultimately stages a comeback. Right now, most of our forward-looking inflationary indicators remain well contained (Chart 10). However, this could change if falling unemployment eventually triggers a price-wage spiral. Chart 9Stronger Economic Growth Will Put Upward Pressure On Government Bond Yields Stronger Economic Growth Will Put Upward Pressure On Government Bond Yields Stronger Economic Growth Will Put Upward Pressure On Government Bond Yields Chart 10An Inflation Breakout Is Not Imminent An Inflation Breakout Is Not Imminent An Inflation Breakout Is Not Imminent     Many investors are skeptical that such a price-wage spiral could ever emerge. They argue that automation, globalization, weak trade unions, and demographic changes make an inflationary outburst rather implausible. We have addressed these arguments in the past1 and will not delve into them in this report. Instead, we will focus on one argument that also gets a fair bit of attention, which is that high debt levels will prove to be deflationary. Are High Debt Levels Inflationary Or Deflationary? Total debt levels in developed economies are no lower today than they were during the Great Recession. While private debt has fallen, public debt has risen by roughly the same magnitude, leaving the overall debt-to-GDP ratio unchanged (Chart 11). Meanwhile, debt levels in emerging markets have risen substantially. A common rebuttal to any suggestion that inflation might rise over the medium-to-longer term is that high debt levels around the world will cause households, firms, and governments to pare back spending. While this may be true, it could also be argued that high debt levels could prompt central banks to engineer higher inflation in order to reduce the real burden of debt obligations. So which effect will win out? Given the choice, it is likely that most policymakers would opt for higher inflation. This is partly because high unemployment and fiscal austerity are politically toxic. It is also because falling prices make it very difficult to reduce real debt burdens. The experience of the Great Depression bears this out: Private debt declined by 25% in absolute terms between 1929 and 1933. However, due to the collapse in nominal GDP, the ratio of debt-to-GDP actually increased more in the first half of the 1930s than during the Roaring Twenties (Chart 12). Chart 11Global Debt Levels Remain High Global Debt Levels Remain High Global Debt Levels Remain High Chart 12The Experience Of The Great Depression Shows Deleveraging Is Impossible Without Growth The Debt Supercycle Endgame: Deflation Or Inflation? The Debt Supercycle Endgame: Deflation Or Inflation?   Means, Motive And Opportunity Chart 13A Kinked Relationship: It Takes Time For Inflation To Break Out The Debt Supercycle Endgame: Deflation Or Inflation? The Debt Supercycle Endgame: Deflation Or Inflation? There is a big difference between wanting to engineer higher inflation and being able to do so. The distinction between success and failure ultimately boils down to a seemingly technical question: Is the neutral rate of interest – the interest rate consistent with full employment and stable inflation – positive or negative in nominal terms? When the neutral rate is above zero, central banks can gain traction over the economy. Even if the neutral rate is only slightly positive, a zero rate would be enough to keep monetary policy in expansionary territory. When monetary policy is accommodative, the unemployment rate will tend to drop. Eventually the “kink” in the Phillips curve will be reached, resulting in higher inflation (Chart 13). In contrast, when the neutral rate is firmly below zero, monetary policy loses traction over the economy. Since there is a limit to how deeply negative policy rates can go before people decide to hold cash, the central bank could find itself out of ammunition. This could set off a vicious circle where high unemployment causes inflation to drift lower, leading to an increase in real rates. Rising real rates will then further curb spending, causing inflation to fall even more. Drivers Of The Neutral Rate Two of the more important determinants of the neutral rate of interest are the growth rate of the economy and the national savings rate. If either the savings rate rises or economic growth slows, the stock of fixed capital will tend to pile up in relation to GDP, leading to a higher capital-to-output ratio.2 As Chart 14 shows, this has already happened in Europe and Japan. An increase in the capital-to-GDP ratio will drag down the rate of return on capital. A lower interest rate will be necessary to ensure that the capital stock is fully utilized. Chart 14Capital Stock-To-Output Ratios Have Risen The Debt Supercycle Endgame: Deflation Or Inflation? The Debt Supercycle Endgame: Deflation Or Inflation? Realistically, there is not much that policymakers can do to raise trend GDP growth. While looser immigration policy would allow for a faster expansion of labor force growth, this is politically contentious. Increasing productivity growth is also easier said than done. Fiscal Policy And The Neutral Rate In contrast, policymakers already have a ready-made mechanism for lowering the savings rate: fiscal policy. The fiscal balance is a component of national savings. If the government runs a larger budget deficit in order to finance tax cuts or higher transfer payments to households, national savings will decline and aggregate demand will rise. Is the endgame for today’s high debt levels deflation or inflation? The answer is inflation. Since one can think of the neutral rate as the interest rate that brings aggregate demand in line with the economy’s supply-side potential, anything that raises demand will also lift the neutral rate. Once the neutral rate has risen above the zero bound, monetary policy will gain traction again. This implies that central banks should never run out of ammunition in countries whose governments can issue debt in their own currencies. While higher inflation stemming from fiscal stimulus will erode the real value of private sector debt obligations, won’t the impact on total debt be offset by the increase in public debt? Not necessarily. True, larger budget deficits will raise the stock of government debt. However, nominal GDP will also rise on account of higher inflation. Standard debt sustainability equations state that the government debt-to-GDP ratio could actually fall if higher inflation pushes real policy rates down far enough. As discussed in Box 1, such an outcome is quite likely when inflation accelerates in response to an overheated economy, but the central bank nevertheless refrains from raising nominal rates. The Final Verdict We are finally ready to answer the question posed in the title of this report: Is the endgame for today’s high debt levels deflation or inflation? The answer is inflation. People with a 30-year fixed rate mortgage will always favor inflation over deflation. And there are more voters who owe mortgage debt than own mortgage debt. Chart 15Germany's Competitive Advantage Over The Rest Of The Euro Area Is Deteriorating Germany's Competitive Advantage Over The Rest Of The Euro Area Is Deteriorating Germany's Competitive Advantage Over The Rest Of The Euro Area Is Deteriorating Politics is moving in a more populist direction. Whether it is left-wing populism of the Elizabeth Warren/Jeremy Corbyn variety or right-wing populism of the Donald Trump/Matteo Salvini variety, the result is usually bigger budget deficits and higher inflation. Even in those countries where populism has been slow to take hold, there may be pragmatic reasons for loosening fiscal policy. For example, Germany’s trade surplus with the rest of the euro area has fallen in half since 2007, largely because German unit labor costs have increased more than elsewhere (Chart 15). As Germany loses its ability to ship excess production to the rest of the world, it may end up having to rely more on easier fiscal policy to bolster demand. Of course, the path to higher inflation is paved with interest rates that stay lower for much longer than the economy needs to reach full employment. This means we are entering a period where first the US economy, and then many other economies, will start to overheat, and yet central banks will still refrain from tightening monetary policy until inflation rises well above their comfort zones. Such an environment will be positive for stocks for as long as it lasts, even if it eventually produces a mighty hangover.   Peter Berezin Chief Global Strategist peterb@bcaresearch.com   Box 1 When Does A Large Budget Deficit Lead To A Lower Government Debt-to-GDP Ratio?   The Debt Supercycle Endgame: Deflation Or Inflation? The Debt Supercycle Endgame: Deflation Or Inflation? Footnotes 1    Please see Global Investment Strategy Special Report, “1970s-Style Inflation: Could It Happen Again? (Part 2),” dated August 24, 2018. 2   This point can be seen through the lens of the widely used Solow growth model. In steady state, the desired level of investment in the model is given by the formula: I=(a/r)(n+g+d)Y where a denotes the output elasticity of capital, r is the real rate of interest, n is labor force growth, g is productivity growth, d is the depreciation rate, and Y is GDP. Savings is assumed to be a constant fraction of income, S=sY. Equating savings with investment yields: r=(a/s)(n+g+d). A decrease in the growth rate of the economy (n+g) shifts the investment schedule downward, leading to a lower equilibrium rate of interest. This initially makes investing in fixed capital more attractive than buying bonds. Over time, however, the marginal return on capital will fall as the capital stock expands in relation to GDP.    Strategy & Market Trends MacroQuant Model And Current Subjective Scores The Debt Supercycle Endgame: Deflation Or Inflation? The Debt Supercycle Endgame: Deflation Or Inflation? Strategic Recommendations Closed Trades

Highlights Economic data suggest the current business cycle in China has not yet reached a bottom. Stimulus measures have not been forceful enough to fully offset a slowing domestic economy and weakening global demand. With possibly more U.S. tariffs to come, intensifying political unrest in Hong Kong and a currency set to depreciate further, the potential downside risks outweigh any potential upside over the near term. Investors who are already positioned in favor of Chinese equities should stay long. We are still early in a credit expansionary cycle, and we expect further economic weakness to pave the way for more policy support in China. However, we recommend investors who are not yet invested in Chinese assets to remain on the sidelines until clearer signs of materially stronger stimulus emerge. Feature Chart 1A Breakdown In Chinese Stocks A Breakdown In Chinese Stocks A Breakdown In Chinese Stocks Financial market volatility surged in the first half of the month following U.S. President Donald Trump’s recent tweet, vowing to impose a 10% tariff on the remaining $300 billion of U.S. imports of Chinese goods by September 1st. By the end of last week, prices of China investable stocks relative to global equities had nearly wiped out all their 2019 year-to-date gains. (Chart 1) The extent of the decline has left some investors wondering whether the time has come to bottom-fish Chinese assets. In our view, the answer is no. In this week’s report we detail five reasons why the near-term outlook for China-related assets remains negative. We remain bullish on Chinese stocks over the cyclical (i.e. 6-12 month) horizon and recommend investors who are already positioned in favor of China-related assets stay long. However, we also recommend investors who are not yet invested to remain on the sidelines until surer signs of materially stronger stimulus emerge. As we go to press, the U.S. Trade Representative Office announced that the Trump administration would delay imposing the 10% tariff on a series of consumer goods imported from China — including laptops and cell phones — until December.1 Stocks in the U.S. surged on the news. Today’s rally in the equity market highlights our view, that short-term market performance can be dominated and distorted by news on the trade front. However, market rallies based on headline news will not sustain without the support of economic fundamentals. Reason #1: Chinese Economic Growth Has Not Yet Bottomed In a previous China Investment Strategy report,2  we presented some simple arithmetic to help investors formulate their outlook on the Chinese economy. We argued that in a full-tariff scenario, investors should focus on the likely outcome of one of the two following possibilities: Scenario 1 (Bullish): Effects of Stimulus – Impact of Tariff Shock > 0 Scenario 2 (Bearish): Effects of Stimulus – Impact of Tariff Shock ≤ 0 In scenario 1, the impact of China’s reflationary efforts more than offsets the negative shock to aggregate demand from the sharp decline in exports to the U.S. Scenario 2 denotes an outcome where China’s reflationary response is not larger than the magnitude of the shock. For now, we remain in scenario 2 due to Chinese policymakers’ continual reluctance to allow the economy to re-leverage. The magnitude of the credit impulse so far has been “half measured” relative to previous cycles.3  More than seven months into the current credit expansionary cycle, Chinese economic data have not yet exhibited a clear bottom. As a result, more than seven months into the current credit expansionary cycle, Chinese economic data have not yet exhibited a clear bottom, with the main pillars supporting China’s “old economy” still in the doldrums (Chart 2 and Chart 3). Chart 2No Clear Bottom, Yet No Clear Bottom, Yet No Clear Bottom, Yet Chart 3Key Economic Drivers Struggling To Trend Higher Key Economic Drivers Struggling To Trend Higher Key Economic Drivers Struggling To Trend Higher   In addition to a weakening domestic economy, China’s external sector has been weighed down by U.S. import tariffs as well as slowing global demand. (Chart 4).  The possibility of adding a 10% tariff by year end on the remaining $300 billion of Chinese goods exports to the U.S. may trigger another tariff “front-running” episode in the 3rd quarter. However, Chart 5 and Chart 6 highlight that any front-running would be against the backdrop of sluggish global demand. Therefore, not only the upside in Chinese export growth will be very limited in the subsequent months following the front-running, but export growth is also likely to fall deeper into contraction. Chart 4Domestic Demand More Concerning Than Exports Domestic Demand More Concerning Than Exports Domestic Demand More Concerning Than Exports Chart 5Pickup In Global Demand Not Yet Visible Pickup In Global Demand Not Yet Visible Pickup In Global Demand Not Yet Visible Chart 6Bottoming In Global Manufacturing Also Delayed Bottoming In Global Manufacturing Also Delayed Bottoming In Global Manufacturing Also Delayed Reason # 2: A-Shares Are Not Yet Signaling A Sizeable Policy Response Chart 7 In previous China Investment Strategy reports, we have written at length about how Chinese policymakers are reluctant to undo their financial deleveraging efforts and push for more stimulus. After incorporating July credit data, our credit impulse, at a very subdued 26% of nominal GDP, was in fact a pullback from June’s credit growth number (Chart 7). This confirms our view that the current stimulus is clearly falling short compared to the 2015-2016 credit expansionary cycle. It underscores Chinese policymakers’ commitment to keep their foot off the stimulus pedal. What’s more, the recent performance of China’s domestic financial markets has been consistent with a half-measured credit response, and is not yet signaling a meaningful change in China’s policy stance. The A-share market since last summer has been trading off of the likely policy response to the trade war. Chart 8Market Not Signaling Significant Policy Shift Market Not Signaling Significant Policy Shift Market Not Signaling Significant Policy Shift Chart 8 (top panel) shows that the A-share market has closely tracked China’s domestic credit growth over the past year. Given this, we believe that the A-share market is reacting more to the likely policy response to the trade war, in contrast to the investable market which rises and falls in near-lockstep with trade-related news (middle panel). The fact that A-share stocks have been trending sideways underscores that China’s domestic equity market continues to expect “half measured” stimulus. This week’s sharp decline in China’s 10-year government bond yield is in part related to escalating political unrest in Hong Kong (bottom panel), and in our view does not yet signal any major change in the PBOC’s stance. Finally, our corporate earnings recession probability model provides another perspective on the equity market implications of the current path of stimulus. If the current size of stimulus holds through the end of 2019, our model suggests that the probability of an outright contraction in corporate earnings lasting through year end remains quite elevated, at close to 50% (first X in Chart 9). The July Politburo statement signaled a greater willingness to stimulate the economy; as a result, we are penciling in a slightly more optimistic scenario on forthcoming credit growth through the remainder of the year, by adding 300 billion yuan of debt-to-bond swaps4 and 800 billion yuan of extra infrastructure spending5 to our baseline estimate for the rest of 2019. However, this would only add a credit impulse equivalent of 1 percentage point of nominal GDP and would only marginally reduce the probability of an earnings recession to 40% (second X in Chart 9). A 40% chance of an earnings recession is well above “normal” levels that would be consistent with a durable uptrend in stock prices, and in previous cycles, Chinese stock prices picked up only after business cycles and corporate earnings had bottomed (Chart 10). In sum, the current pace of credit growth, signals from the domestic equity market, and our earnings recession model all suggest that it is too early to bottom fish Chinese stocks. Chart 9A "Measured" Pickup in Stimulus Will Not Be A Game Changer A "Measured" Pickup in Stimulus Will Not Be A Game Changer A "Measured" Pickup in Stimulus Will Not Be A Game Changer Chart 10Too Early To Bottom Fish Too Early To Bottom Fish Too Early To Bottom Fish Reason #3: The Trade War Is Far From Over Our Geopolitical Strategy team maintains that the U.S. and China have only a 40% chance of concluding a trade agreement by November 2020, and that any trade truce is likely to be shallow.6 We agree with this assessment, which has clear negative near-term implications for Chinese investable stocks, even if temporary rallies such as what took place yesterday periodically occur. Since the onset of the trade war, Chinese investable stocks appear to have traded nearly entirely in reaction to trade-related events. Hence, until global investors are given proof that much stronger stimulus can and will offset the impact of the trade war on corporate earnings, Chinese stocks are likely to continue to underperform their global peers. Reason #4: The Hong Kong Crisis Is A Near-Term Risk Another near-term catalyst for financial market turbulence in China is the worsening situation in Hong Kong. For now, we hold the view that a full-blown crisis (i.e. China intervening with military force) can be avoided, but we are not ruling out the possibility of a severe escalation or its potential impact on market sentiment towards Chinese assets.  On the surface, China investable stocks (the MSCI China Index, the predominantly investable index that now includes some mainland A-shares) are not directly linked to businesses in Hong Kong: Out of the top 10 constituents of the MSCI China Index, which account for roughly 50% of the index’s market capitalization, seven are headquartered in mainland China and do not appear to have significant revenue exposure to Hong Kong. By contrast, at least 30% of Hang Seng Index-listed companies have business operations in Hong Kong. The remaining three companies in the top 10 MSCI China Index are Tencent (the largest component of the index, with a weight of approximately 15%), Ping An Insurance (4% weight), and China Mobile (3% weight) – all of which registered large losses in the past week. Both Tencent and Ping An Insurance are headquartered in Shenzhen, a southeastern China metropolis that links Hong Kong to mainland China. China Mobile appears to have the most revenue exposure to Hong Kong of any top constituent through its CMHK subsidiary, which is the largest telecommunications provider in Hong Kong. It is true that there has been little evidence so far that Chinese investable stocks have been more impacted by the escalation in political unrest in Hong Kong than by the escalation in the trade war. Indeed, the fact that the two escalations were overlapping this past week makes it difficult to isolate their effects. But if unrest in Hong Kong spirals out of control, it could result in mainland China intervening. According to an analysis done by BCA’s Geopolitical Strategy team,6 the deployment of mainland troops would likely lead to casualties and could trigger sanctions from western countries. The 1989 Tiananmen Square incident shows that such an event could lead to a non-negligible hit to domestic demand and foreign exports under sanctions. Should this to occur, the near-term idiosyncratic risk to Chinese stocks in both onshore and offshore markets will be significant. Reason #5: Further RMB Depreciation May Weigh On Stock Prices Whether due to manipulation or market forces, last week’s depreciation in the Chinese currency (RMB) was economically justified and long overdue. Chart 11RMB Depreciation Long Overdue RMB Depreciation Long Overdue RMB Depreciation Long Overdue Chart 11 shows the close relationship between the U.S.-China one-year swap rate differential and the USD/CNY exchange rate. The true source of the correlation shown in the chart remains somewhat of a mystery, given that Chinese capital controls, particularly following the 2015 devaluation episode, prevent the arbitrage activities that link rate differentials and exchange rates in economies with fully open capital accounts. However, Chart 11 clearly shows that China’s currency would have already weakened by now if it was fully market-driven, and we do not believe that the People’s Bank of China will be inclined to tighten monetary policy in order to reverse the recent devaluation. Hence, the path of least resistance for the CNY is further depreciation.  If the threatened 10% tariff on all remaining U.S. imports from China is imposed this year, our back-of-the-envelope calculation based on Chart 12 suggests that a market-driven “equilibrium” USD/CNY exchange rate should be at around 7.6. We have high conviction, based on previous RMB devaluation episodes, that China’s central bank will not allow its currency to depreciate in a manner that invites speculation of meaningful further weakness – meaning we are not likely to see a straight-lined or rapid depreciation down to the 7.6 mark. Chart 12Market Driven 'Equilibrium' Provides Some Guidance On The Exchange Rate Market Driven 'Equilibrium' Provides Some Guidance On The Exchange Rate Market Driven 'Equilibrium' Provides Some Guidance On The Exchange Rate A “managed” currency depreciation is in and of itself stimulative for the Chinese economy. At the same time, aggressive market intervention via the PBoC burning through its foreign exchange reserves is also unlikely: A “managed” currency depreciation is in and of itself stimulative for the economy. It improves Chinese export goods’ price competitiveness and helps mitigate some of the pain caused by increased tariffs. Therefore it is in the PBoC’s every interest to allow such depreciation. However, no matter how “orderly” RMB depreciation may be, the fact that the PBoC has signaled it is no longer defending a “line in the sand” exchange-rate mark is likely to trigger another round of “race to the bottom” currency devaluation from other regional, export-dependent economies.7 A weaker RMB and emerging market currencies will also contribute to USD strength. A strong dollar has been negatively correlated with global risky assets, implying that for a time, a weaker RMB will be a risk-off event for risky assets and thus presumably for Chinese and EM equity relative performance. Investment Implications Our analysis above highlights that the near-term outlook for Chinese stocks is fraught with risk, and it is for this reason that we recommended an underweight tactical position in Chinese stocks for the remainder of the year in our July 24 Weekly Report.8 However, by next summer (the tail-end of our cyclical investment horizon), it is our judgement that one of two things will have likely occurred: The trade war with the U.S. will have abated or been called off, and investors will have determined that a “half-strength” credit cycle is likely enough to stabilize Chinese domestic demand and the earnings outlook. In this scenario, Chinese stocks are likely to rise US$ terms over the coming year, relative to global stocks. The trade war with the U.S. will have continued, and Chinese policymakers will have acted on the need to stimulate aggressively further in order to stabilize domestic demand. In combination with an ultimately stimulative (although near-term negative) decline in the RMB, the relative performance of Chinese stocks versus the global benchmark will likely be higher in hedged currency terms. Because of the near-term risks to the outlook, we agree that investors who are not yet invested should remain on the sidelines until surer signs of materially stronger stimulus emerge. But investors who are already positioned in favor of Chinese equities should stay long, and should bet on the latter scenario: rising relative Chinese equity performance in local currency terms, alongside a falling CNY-USD / appreciating USD-CNY exchange rate.   Jing Sima  China Strategist JingS@bcaresearch.com   Footnotes 1      “US to delay some tariffs on Chinese goods”, Financial Times, August 13, 2019. 2      Please see China Investment Strategy Weekly Report, “Simple Arithmetic”, dated May 15, 2019, available at cis.bcaresearch.com. 3      Please see China Investment Strategy Weekly Reports, “Threading A Stimulus Needle (Part 1): A Reluctant PBoC”, dated July 10, 2019, and “Threading A Stimulus Needle (Part 2): Will Proactive Fiscal Policy Lose Steam?”, dated July 24, 2019, available at cis.bcaresearch.com. 4      The remaining of 14 trillion debt-to-bond swap program rounds up to 315 billion yuan. 5      The relaxed financing requirement for infrastructure projects can add 800 billion yuan. 6      Please see Geopolitical Strategy Weekly Report, “The Rattling Of Sabers”, dated August 9, 2019, available at gps.bcaresearch. 7      Please see Emerging Markets Strategy Weekly Report, “The RMB: Depreciation Time?”, dated May 23, 2019, available at ems.bcaresearch.com. 8      Please see China Investment Strategy Weekly Report, Threading A Stimulus Needle (Part 2): Will Proactive Fiscal Policy Lose Steam?”, dated July 24, 2019, available at cis.bcaresearch.com. Cyclical Investment Stance Equity Sector Recommendations