Login Open account
Singapore
Equity Monthly: China holds the key to 2019 Equity Monthly: China holds the key to 2019 Equity Monthly: China holds the key to 2019

Equity Monthly: China holds the key to 2019

Equities 7 minutes to read
Peter Garnry

Head of Saxo Strats

Summary:  That markets can be wildly unpredictable things was brought into sharp focus by the December washout. Looking ahead to the new year, the outlook remains murky, but China, for all its woes, could provide the seeds of redemption.

Last month’s Equity Monthly proved to be incorrect on our short-term forecast. In this business, driven by a high degree of randomness, we do expect wrong predictions in almost half of all cases, so nothing unusual about the December prognosis. But the 9% decline in the S&P 500 in December, making it the second worst  since 1928, was a stark reminder of the intense moves on the downside. 
These events are what makes you humble. Let’s just recap our thesis for December:

Over the weekend, investors got another dose of positive news as Trump and Xi agreed to a “ceasefire” in the ongoing trade war. I had only put a 25% probability on this event in my recent presentation and judging from the market reaction overnight, the market in general had not priced it in. Based on recent events, we expect global equities to rise by 5-7%, so with today’s 2.5% move in global equities almost a third has already been achieved. (Equity Monthly: Were the Fed and the G20 enough?, 4 December 2018)

Literally the days after our forecast things went into a whirl. Equities were brutally slaughtered as global investors fled into secure assets such as government bonds. Growth forecasts for 2019 were coming down and the Federal Open Market Committee's decision to make a relatively hawkish rate hike was too much for the markets. The sell-off intensified.

While being wrong on our short-term call, we did stick to our overall view held throughout all of 2018. That we are late stage in the cycle and that the risk-reward ratio in global equities is getting worse and worse. US investors can lock in almost 2-3% return over the next year with almost zero price risk compared to betting on equities which may return 5-7% but with 30% variance. 

The broader question is whether recent events set equity markets up for a rosy 2019. We remain sceptical of this projection despite our current short-term positive outlook. The global economy is late stage and financial conditions have tightened above the historical average. Equity valuations are not outrageous, but they are not cheap either. Our biggest worry is still credit markets that look very vulnerable due to the significant increase in corporate bonds. (Equity Monthly: Were the Fed and the G20 enough?, 4 December 2018)

Markets do not deliver an event like December for nothing. Things are changing and every investor should be worried about 2019. Our tactical asset allocation model Stronghold, which we offer to our most valued clients, has mostly cut risk in 2018 and in December the USD portfolio reduced equity exposure to zero only leaving high yield bonds as its meaningful risky asset.

In our 21 December 2018 equity update we showed simulations of US equities whenever the VIX is in its 9th decile [24.1 – 28.6]. The message was clear. The near-term future will be extremely volatile. Our simulations show that there is likely a 10% probability for US equities being down 16% or more, or up 21% or more within the next three months. At the time of our analysis this translates into the S&P 500 at index level 2,992 or 2,074 by late March. The question is whether investors are prepared. Those with significant equity exposure are running portfolios with very high risk at this point. Our recommendation remains to be overall defensive in terms of asset allocation and stay defensive within the equity exposure component (so minimum volatility stocks).
Source: Bloomberg and Saxo Bank
Valuations are getting cheap, but it’s a poor timing tool

This morning we ran our global equity market valuation model to see where things landed after December. The z-score measured on an equal-weighted index of nine valuation metrics show that global equities are now at minus 0.36 which is the lowest level since February 2016. Is this a buying opportunity? Valuation models have never been good timing tools so investors should be careful making buying arguments off valuation cheapness.

When fear and reduced growth expectations kick into gear the valuations always go down sharply. If 2019 turns out to be the transition year into a recession (the probability that the US economy is in a recession is somewhere around 10% according to the recession models we track) then the valuation multiple will continue to be under pressure. 
It’s all about China in 2019

The new year has started off with more negative sentiment. Most notably in Asia with Hang Seng Index futures down 3.4% as the Caixin China PMI Manufacturing index slipped below 50 (49.7 vs est. 50.2) indicating negative momentum remains in the Chinese private sector. I admit that I have been part of the positive China rebound story for Q1 but with incoming information I’m revising down my optimism. It looks increasingly as if the China’s government has underestimated the impact from the trade war with the US.

While China has more fire power on the fiscal side our biggest worry is that the credit transmission is broken (as it is in both Japan and Europe) due to excessive debt levels reducing the transmission effect. The chart below shows the four largest banks in China on market cap to total assets. If the credit transmission was intact then this ratio would normally increase in a positive business cycle. The reason is that in a positive business cycle banks extend loans as good margin and credit risk are decreasing, which increases the market value of both existing and new assets on banks’ balance sheets. However, in China we observe investors not buying into banks proportional to their asset expansion. This is not a positive sign in our opinion.
China has the keys to turn around sentiment. Some sort of deal with the US will calm markets and restore some confidence. But regardless of a deal with the US the most important action is more stimulus and especially via fiscal measures (tax cuts and more government investments). If China delivers on both fronts then things may be very different by Q2.

Quarterly Outlook 2024 Q2

2024: The wasted year

01 / 05

Macro: It’s all about elections and keeping status quo

Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.

Read article

FX: The rate cut race shifts into high gear

As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.

Read article

Equities: The AI and obesity rally is defying gravity

Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.

Read article

Fixed income: Keep calm, seize the moment

With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.

Read article

Commodities: Is the correction over?

Commodities poised for rebound. The "Year of the Metal" boosts gold and silver, copper awaits rate cuts. Grains may recover, natural gas stabilises. Gold targets $2,300-$2,500/oz, copper's breakout could signal growth.

Read article

  • Macro: It’s all about elections and keeping status quo

    Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.

    Read article

  • FX: The rate cut race shifts into high gear

    As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.

    Read article

  • Equities: The AI and obesity rally is defying gravity

    Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.

    Read article

  • Fixed income: Keep calm, seize the moment

    With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.

    Read article

  • Commodities: Is the correction over?

    Commodities poised for rebound. The "Year of the Metal" boosts gold and silver, copper awaits rate cuts. Grains may recover, natural gas stabilises. Gold targets $2,300-$2,500/oz, copper's breakout could signal growth.

    Read article

Disclaimer

 The Saxo Group entities each provide execution-only service, and access to analysis permitting a person to view and/or use content available on or via the website is not intended to and does not change or expand on this. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Inspiration Disclaimer and (v) Notices applying to Trade Inspiration, Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular, no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
Full disclaimer (https://www.home.saxo/en-sg/legal/disclaimer/saxo-disclaimer)

None of the information contained here constitutes an offer to purchase or sell a financial instrument, or to make any investments. Saxo Markets does not take into account your personal investment objectives or financial situation and makes no representation and assumes no liability as to the accuracy or completeness of the information nor for any loss arising from any investment made in reliance of this presentation. Any opinions made are subject to change and may be personal to the author. These may not necessarily reflect the opinion of Saxo Markets or its affiliates.

Saxo Markets
88 Market Street
CapitaSpring #31-01
Singapore 048948

Contact Saxo

Select region

Singapore
Singapore
Products & pricing
Asset Management
Platforms
Accounts & service
General
Other
Legal

Losses can exceed deposits on margin products. Please ensure you understand the risks.

Saxo Capital Markets Pte Ltd ('Saxo Markets') is a company authorised and regulated by the Monetary Authority of Singapore (MAS) [Co. Reg. No.: 200601141M ] and is a wholly owned subsidiary of Saxo Bank A/S, headquartered in Denmark. Please refer to our General Business Terms & Risk Warning to consider whether acquiring or continuing to hold financial products is suitable for you, prior to opening an account and investing in a financial product.

Trading in financial instruments carries various risks, and is not suitable for all investors. Please seek expert advice, and always ensure that you fully understand these risks before trading. Trading in leveraged products such as Margin FX products may result in your losses exceeding your initial deposits. Saxo Markets does not provide financial advice, any information available on this website is ‘general’ in nature and for informational purposes only. Saxo Markets does not take into account an individual’s needs, objectives or financial situation.

The Saxo trading platform has received numerous awards and recognition. For details of these awards and information on awards visit www.home.saxo/en-sg/about-us/awards.

The information or the products and services referred to on this website may be accessed worldwide, however is only intended for distribution to and use by recipients located in countries where such use does not constitute a violation of applicable legislation or regulations. Products and Services offered on this website are not intended for residents of the United States, Malaysia and Japan. Please click here to view our full disclaimer.

This advertisement has not been reviewed by the Monetary Authority of Singapore.

Apple and the Apple logo are trademarks of Apple Inc, registered in the US and other countries and regions. App Store is a service mark of Apple Inc. Google Play and the Google Play logo are trademarks of Google LLC.