Issue 05
2020.08.12
Fiscal Policies -
The Key Driving Force in the H2
Mr. Hou Zhenhai
Straits Financial (China) Chief Strategist
Review of Last Views:
This year, the release of global government liquidity is unprecedented. However, the real economy has been worse than in previous cycles, which means that excess liquidity will be more inclined to investment and speculation in the capital market.
Under the global asset shortage, the stock market and commodity market as a whole may still be bullish.
It is difficult for A-shares to continue to rise sharply, because the policy emphasizes on guiding funds to "close up gap between virtual and real". Therefore, A shares may fluctuate at a higher level.
Our view on Domestic China commodities are that prices may drop following the bullish rise of A-shares.
Webinar Review | Asset Shortage amidst Overflowing Liquidity
Main Points:
Our view is that fiscal policies will become the key driving force in the 2nd half.
The Covid-19 trends in the US and EU countries are not optimistic. The number of new infections and new deaths has rebounded, and the positive rate of specimen tested also rose recently. Therefore, we are doubtful for an early US reopening in the 2nd half.
The fast rebounding domestic demand in the US during the past two months are contributed to the large scale direct fiscal money payments to the households from the government. This resulted in the average income per capita in the US rising in Q2, with millions still out of jobs.
Therefore, the key is whether the US can promote another round of stimulus in Q3 as the pandemic may not be controlled soon, especially on how much money can be given to the households. If the Democrats and Republicans cannot reach a new round of fiscal stimulus, even the Trump administration can use an executive order to cut some taxes, the absent of direct payment to the households will lead to a downside risk for the US economic recovery. Meanwhile, as household individuals uses part of residual money to invest, this may also cause a downside risk to the US stock market.
A late July Politburo meeting in China indicated that the loose credit policy will be steadily withdrawn in the 2nd half. The meeting, for the first time this year, did not mention "RRR & Interest rate cuts or refinancing". Instead, it emphasize on "precise direct" money into real economy, rather than property and capital markets.
Short to Mid-term Focus: the chance of consolidation in the global markets is increasing. The market has excessive high expectations on further stimulus package. The speculative short dollar positions have rapidly reached a high level, which as a contrarian indicator, shows a potential adjustment in risk asset prices including stocks and commodities. Though it may not bode for the coming of another bear market, our view is for investors to hedge their long positions, possibly by using stock puts or US dollar calls. We expect the Shanghai Composite Index to consolidate between 3000 and 3500 due to the adjustment of domestic policy and disturbances from US-China disputes, and it may not be able to break to the upside soon.
The Chinese domestic commodity market is still in a bull market sentiment. We expect, with a steady withdrawal of loose credit policy, domestic commodity prices may face more pressure when the most active future contracts expire in Q3 and transfer to 2021Q1 contracts.
I．Fiscal policy will be the core factor to determine the global market trend in the 2nd half
Since 2020, the world's major central banks have all adopted unprecedented easing policies, including RRR and interest rate cuts as well as QEs on a large scale. Among them, the Fed expanded its balance sheet by nearly US$3 trillion, the ECB by 1.7 trillion euro, and the BOJ by nearly 80 trillion yen. It can be said that these enormous liquidity injections is the major driving force to boost the global asset prices after the Covid-19 broke out. Especially in June to July, when the global market saw a rare situation where stocks, bonds, gold and other commodities all rose at the same time. But in Q3, the room for further monetary easing of the central banks have been significantly reduced. Firstly, ZIRPs are now all over the developed countries, and the Fed explicitly refuses to adopt a negative policy rate. Secondly, the Fed has slowed down its balance sheet expansion significantly. Therefore, we believe that fiscal policy in the 2nd half of the year will replace monetary policy as the core factor driving the global market trend. And the highly disputed new round of fiscal stimulus in the US could be an important inflection point on that transition.
So why is the fiscal policy so important now?
1. This is because the pandemic trends in the US and some EU countries are not optimistic in the 2nd half. The recent data in the US showed that the "2nd wave" of Covid-19 infection has appeared in July, with the daily new infections over 50,000. Moreover, with the fast-increasing infections, the daily new deaths also began to increase during the mid-July (Figure 1). Meanwhile, in some European countries, such as Spain, there was also a "2nd wave" of infections (Figure 2). Besides, according to the data from the US Center for Disease Control and Prevention (CDC), the positive rate of specimen tested in the US has begun to rise slowly in the past four weeks. These data imply that the economic and employment recoveries in the US and EU during the 2nd half may have further slowdown risks.
Source: Bloomberg, CEIC, Wind
Source: Bloomberg, CEIC, Wind
Source: US CDC
2. However, during June and July when the pandemic situations were still quite severe, the overall economic recoveries in the US and EU, esp. the household consumption demand, is significantly better than expected. For example, the new order sub-index of US Service PMI, which indicates the US domestic service demand, shot up from the lowest reading of 32 in April to 67.7 in July, setting the fastest rebound ever recorded in history. However, the employment sub-index in the same Service PMI just rebounded from 30 to 42.1, still in a below 50 recessionary territory. Although employment is usually a lagging indicator, such a huge divergence is still unprecedented (Figure 3). This shows that the US household income also deviated from the employment situation. We know that under normal circumstances, these two data are highly correlated. However, this year, the US government has adopted an unprecedented fiscal policy to send paychecks directly to the households, as a result, although nearly 30 million people lost their jobs in the US this year, the overall personal income has not decreased, but increased instead. From Figure 4, we can see that before the outbreak of the pandemic, the per capita income of an American resident was about USD 4,800 per month. In fact, after the pandemic outbreak made tens of millions of people lose their jobs, the average monthly income of an American resident increased to over USD 5,000 per month in Q2. Naturally, the wage income should drop when millions of people are unemployed. However, the huge fiscal subsidies from the US government have exceeded the wage loss of most Americans. Especially for the low-income Americans, where they actually gotten more money in the past three jobless months than before the pandemic, thanks to a one-time paycheck of USD 1,200 peradult and additional USD 600 per week of federal unemployment benefits. These direct fiscal payments to the households have become the most important driver for the rebound of domestic demand in the US over the past two months without any containment on the pandemic. However, by the end of July, the previous fiscal stimulus plan in the US has basically ran its course, and there is a heated debate now between the two parties on how to launch a new round offiscal stimulus plan.
Source: Bloomberg, CEIC, Wind
Source: Bloomberg, CEIC, Wind
Therefore, if the pandemic cannot be effectively controlled, which seems more likely now; the scale of further fiscal stimulus plans in the US and European countries for the second half of the year, will largely determine the pace of economic recovery, and the future trend of asset prices. Especially so, based on the amount of money directly given to the households. In the near future, if the US democrats and republicans fail to agree on a new round offiscal stimulus, the Trump Administration may have to resort to a president executive order to give further fiscal support to the economy. This is possible as the net debt financing from the US Treasury department has amounted to USD 3.3 trillion this year. Among that, 2.3 trillion has been spent. Therefore, there are still nearly 1.7 trillion available on the balance sheet of US Treasury department (Figure 5), which gives room for the Trump administration to provide tax holiday to some corporates and individuals. However, without the direct fiscal payments to individuals, the US economy may have more downside risks in Q3 when a full resumption of work cannot be realized without an alleviation of the pandemic in the country.
Source: Bloomberg, CEIC, Wind
Considering the current valuation of global financial market, if there is no further large-scale fiscal stimulus in the second half of the year, we think that asset prices will also face a greater risk of falling. Because a significant "fiscal cliff" effect will occur without a renewal of fiscal stimulus. It will make the real household income decrease significantly in the US and EU countries. This, if happens, may lead the overall consumption and economic activities to fall into recession again.
Moreover, as many people cannot spend all the money from the stimulus due to "shelter-in-house", these extra savings have flowed into capital markets, especially the stock market, and become an important funding source to drive up stock prices since Q2. This effect is particularly more evident in the US. Therefore, if the stimulus ends, even for several weeks, it may dry up the retail money supply to the capital markets, especially the US stock market and lead to a market sell-off.
II. The Loose Credit Policy in China may be withdrawn steadily in the 2nd half
With the control of Covid-19 and gradual economic recovery in China, its loose credit policy is expected to be withdrawn steadily in the second half of the year. In its press release of the Politburo meeting held on July 30, regarding the macro economic policy in the 2nd half, the Politburo meeting did not mention "touse RRR & interest rate cuts as well as refinancing" for the first time this year, and adjusted its policy objective from "maintaining sufficient liquidity" to "maintaining reasonable growth of money supply and total social financing". On the whole, a steady exit of the loose credit policy should be the current policy stance. At the same time, the announcement of this Politburo meeting, for the first time, required that monetary policy should be "precise oriented". This refers to another policy emphasis in the 2nd half to drive money to the real economy, especially the manufacturing industries and small & medium firms. At the same time, to curb the excessive liquidities flowing to the property and capital markets. Therefore, in line with this policy stance, the Chinese central government has recently reiterated repeatedly its policy guidance of "properties are to reside, not to invest". Many local governments have also begin to discuss new measures to curb speculative purchases in real estate market.
Data in recent months showed that the new house prices have risen since March, and already reached a new historic high (Figure 6). Therefore, the policy makers have to put more focus on controlling debt-leverage and preventing more money from flowing into speculative markets instead of real economy.
Source: Bloomberg, CEIC, Wind
Therefore, what may happen in China during the 2nd half is likely to be a combination of slow economic recovery and steady withdrawal of stimulus policies. We believe that this is relatively neutral to the overall capital market, including Chinese stocks and domestic commodity markets.
III. Short to mid-term focus
We believe that the risk in global markets is increasing, as the market has high expectations for a new round of stimulus and policy easing in the US, reflected in resilient strength of the US stock market and a fast decline of US dollar. Recently, speculative short dollar positions in CFTC have risen rapidly, already reaching the highest level in two years, entering a territory of excessive bearish (Figure7), which is more often a contrarian indicator. Therefore, if the new round of US fiscal stimulus fails to pass the amount of USD 1.5 trillion, or even an agreement cannot be reached, a wave of US dollar rebound may occur and it will reduce the market risk appetite. In that case, we expect a consolidation of stock and commodity prices. Although, at present, this may not guarantee another bear market for these risky assets, we suggest investors to consider certain tools, such as equity puts or dollar calls, to hedge their long position exposures.
Source: Bloomberg, CEIC, Wind
China domestic A-shares will comparatively be less affected by that. But, with the steady withdrawal of domestic credit loosening, as well as the sentiment disturbance caused by incidents in US and China relationship before the election, we believe that A-shares will have quite limited upside in Q3, and it is more likely that the Shanghai Composite Index will consolidate between 3000-3500. While the overall index may not move strongly, we think individual thematic sectors will still have room to perform.
Benefited from a gradual demand recovery and the rising cost driven by upstream supply constraints, the domestic commodity market as a whole is still in a bull market trend. However, with a steady withdrawal of loose credit, domestic commodity prices may face more pressure when the most active future contracts expire in Q3 and transfer to 2021 Q1 contracts.
Mr. Hou Zhenhai
Straits Financial (China) Chief Strategist
1998 – 2004, Chief Representative Assistant of GKN Group in China.
2006, obtained MBA degree from Wisconsin School of Business at University of Wisconsin–Madison.
2006 – 2007, served at the Wisconsin Foundation.
August 2007 – July 2013, served at China International Capital Corporation (CICC) as the leader of the overseas strategy team and A-share strategy team. He is also the main report writer and contributor. Mr. Hou and his team received many honors including the top team for the New Fortune Sell-side Strategy Research in 2008, and the top team for the Asia Money China Strategy Research in Hong Kong in 2009 and 2012, etc.
September 2013 – December 2019, served at Discovering Group and was responsible for the Group’s macro strategy research. During the period, the company has accumulated absolute returns that far exceed the market level.
【Straits Chief Commentary】
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