2022 Q1 Report of RC

See below for RC Family Office's Report for Q1 2022.

In the first quarter of 2022, the Chinese and foreign capital markets had an overall poor performance, except the bulk commodities market, which was due to three factors: “the Federal Reserve’s entering an interest rate hike cycle, the worsening Russia-Ukraine conflict, and the impact of China’s epidemic situation”. In the second quarter, with the continuous influence of these three factors, the macroeconomic situations in China and overseas will remain severe, and the Chinese and foreign capital markets will become more complicated. RC will make analysis and prediction of crisis prevention, strategic adjustment and asset allocation from the perspectives of Chinese enterprises, investors and Chinese and foreign institutional clients.

The strong recovery of the US economy is reflected by both the high inflationary pressure on the US and the continuous improvement of the employment market in the US. Meanwhile, the tight supply chain, labor shortage, geopolitics and other issues have caused the inflation rate to be at an all-time high. Therefore, the Fed has suspended its loose monetary policy and switched to raising the interest rates and reducing its balance sheet. This March, the Fed started the interest rate increase by 25 bp to 0.25~0.5%; judging from the recent speeches of major central bank officials, the rate hike may be even faster. Besides, Powell hinted that FOMC would start shrinking the balance sheet in May, in a way similar to the last shrinking but faster.

Figure 1 The inflation rate in the US was at a historical high.

Data source: RC Family Office

RC’s comprehensive forecast of impacts on the global asset markets.   

1.The US stocks will experience adjustments under pressure on the whole, and the Nasdaq Composite Index will undergo an adjustment to a greater extent than the Dow Jones Industrial Average (DJIA).

By studying the four interest rate hike cycles since the 1990s, RC has found that after the first rate increase by the Fed, the US stock market would go through some adjustments, with the Nasdaq Composite Index usually declining to a greater extent than the DJIA, but would be back on the upward trend after a certain period. Therefore, it is expected that the Fed’s interest rate increase this time will bring about a certain degree of adjustment of the US stocks in the medium term, but the US stocks will return to their fundamentals in the long run. The US economy is anticipated to remain relatively prosperous for some time to come, which will drive the US stocks to resume the upward trend after the adjustment.

Figure 2 After the Fed raised interest rates for the first time, the US stocks were under pressure in the medium term but returned to the upward trend supported by fundamentals in the long term.

Data source: RC Family Office

2.Crude oil prices will continue to rise.

As crude oil is essential for many commodities, the Fed usually raises the interest rates for the first time when the US economy is prosperous and most economies in the world are expanding. At such a stage, the demand for crude oil is strong, so the crude oil price can maintain the upward trend.

Figure 3 After the Fed raised the interest rates for the first time, crude oil prices continued to rise.

Data source: RC Family Office

3.The risk of capital outflow will be high, so caution should be exercised about asset allocation in the emerging markets.

When the US enters the interest rate hike cycle, the emerging markets will generally experience crises under the joint impacts of multiple external factors (such as the Fed’s interest rate hike, USD appreciation and capital outflow) and internal factors (such as irrational industrial structure, foreign trade and serious fiscal deficit).

After the US started the interest rate hike cycle in 2022, the US economy is forecast to grow at a higher rate than other developed economies, supporting USD to remain strong. According to the IMF and the World Bank, Malaysia, Hungary, Chile, Argentina, Turkey and other emerging economies have the highest vulnerability index values, which indicates that they will face huger risks.

Figure 4 The Fed’s interest rate hike coupled with a stronger US dollar index tends to trigger crises in emerging markets.

Data source: RC Family Office

RC’s advice: It is necessary to guard against debt or currency crises in several emerging market countries with high vulnerability index values because such countries are facing the risk of capital outflow when the Federal Reserve has entered the interest rate hike cycle and the Russia-Ukraine conflict has caused the global economic stagflation.

4.The relationship between A-shares and US stocks is growing. The Fed’s interest rate hike is predicted to have a greater impact on growth A-shares.

With the wider opening-up of China’s financial market, foreign investments in A-shares account for an increasing proportion; A-shares and US stocks, especially GEM/Shanghai Composite Index and NASDAQ/S&P 500, have increasingly converging trends and mode switching. In view of the aforementioned impact of the Fed’s interest rate hike on US stocks, the Fed’s interest rate hike is expected to also affect A-shares, especially growth A-shares.

Figure 5 A-shares and US stocks have increasingly converging trends and mode switching.

Data source: RC Family Office

5.With the USD short-term interest rate rising rapidly, Chinese-funded real estate companies will facing sharply increasing risk of USD-denominated debts.

Facing strict regulation of China’s real estate industry and increasing liquidity pressure last year, some real estate enterprises have defaulted on overseas USD-denominated loans. After the Fed entered the interest rate hike cycle this year, the resulting rapid rise in the USD short-term interest rate and widening of corporate credit spreads will be unconducive to the overseas refinancing for real estate companies.

In addition, 2022 is the peak of the maturity of USD-denominated debts of real estate companies, so it should be noted that the Fed’s interest rate raise will increase the default risk of a small number of real estate companies.

Figure 6 The year 2022 is the peak of maturity of USD-denominated debts of Chinese-funded real estate companies.

Data source: RC Family Office

RC predicts that the overall plunging of the global stock indexes triggered by the Russia-Ukraine conflict will cause global investors’ concerns about stagflation.

On the early morning of February 24th (Moscow time), Russian President Vladimir Putin announced that Russia would launch a special military operation in the eastern Ukraine. Then Russian troops began to attack Ukraine, and the Russia-Ukraine conflict has intensified. This led to panic in the global capital market, resulting in sharp drops in major global stock market indexes.

Figure 7 Since the Russia-Ukraine conflict, major stock indexes in the world have plunged.

Data source: RC Family Office

RC anticipates that global investors will be concerned about stagflation.   

Historically, every time a war broke out in a resource-rich country, the whole world seemed to undergo a period of “stagflation” characterized by economic growth decline and high inflation. Judging from this perspective, although the war situation is unpredictable, its influence on economic “stagnation” and “inflation” is established.

Figure 8 Every time a war broke out in a resource-rich country, the global economy suffered from stagflation.

Data source: RC Family Office

There is still great uncertainty about the future trend of the Russia-Ukraine conflict. However, the impacts on the global economy and financial market have begun to appear, and the risks of stagflation have been continuously exposed. Specifically, the risk of stagflation will spread through two channels of the supply chain: first, bulk commodity shortage and inflation; second, the lower efficiency of the supply chain.

1.The Russia-Ukraine conflict will lead to bulk commodity shortage and inflation, so corporate clients are advised to do well in hedging.

Although Russia and Ukraine account for only about 2% of the world’s total GDP and do not make up a large proportion in the global trade (for example, the two countries accounted for only 2.2% and 1.5% of global imports and exports in 2020 respectively, and their financial ties with other countries were limited), they not only export energy such as oil and natural gas, but also export important agricultural products and metal raw materials. For example, the two countries account for 30% of the world’s wheat exports, and Russia is a main supplier of palladium for automotive catalytic converters and nickel for steel production and battery manufacturing, accounting for 25% and 14% of the global exports respectively.

Figure 9 Russia and Ukraine are exporters of key food and mineral resources.

Data source: OECD

The Russia-Ukraine conflict will seriously affect the production of goods in the two countries. For example, the war has caused Ukraine to miss the best period of spring sowing. According to Reuters, the Minister of Agriculture of Ukraine said that the area sown with Ukraine’s 2022 spring grain crops was expected to be reduced by more than half compared with the same period of last year, which means that even if the war ends now, Ukraine, “the granary of Europe”, may be unable to guarantee sufficient grain exports, which may lead to a global “grain crisis”. In other fields, Ukraine’s transportation capacity and normal production activities may also be continuously suppressed. Electronic special gases (such as neon, krypton and tritium) and nonferrous metals (such as palladium, nickel, aluminum and copper) are important products exported by Ukraine in large quantities. If the production cannot be quickly resumed, the tight supply of such products may not be immediately relieved. This will bring a sharp rise in the prices of related bulk commodities.

RC’s advice: Corporate clients are advised to make risk plans for bulk commodity hedging because although the evolution of the Russia-Ukraine conflict is difficult to predict, the market generally expects that this will cause global stagflation, resulting in violent fluctuation of bulk commodity prices at high levels and great difficulties to brick-and-mortar enterprises in raw material cost control.

2.The Russia-Ukraine conflict will lead to a lower supply chain efficiency or further inflation.

Since the outbreak of the Russia-Ukraine conflict, a number of internationally renowned shipping companies have announced the suspension of freight services in Russia. Britain, Canada and some EU countries have announced the prohibition of Russian ships from entering their ports. The risk of port logistics paralysis and non-delivery or delayed delivery is gradually expanding. Consequently, the prices of shipping and air freight has risen sharply. According to the Seafarer Workforce Report 2021 released by the International Chamber of Shipping (ICS), 198,123 seafarers (10.5%) are Russian and 76,442 seafarers (4%) are Ukrainian. In terms of air transportation, Russia has closed its airspace to 36 countries, which means the rising cost of aviation fuel, the soaring freight on international routes and the decreased transportation efficiency. In addition to the rising transportation cost, the removal of seven banks from the SWIFT system will reduce the efficiency of delivery and settlement in cross-border trade.

According to RC’s analysis, all the four wars and conflicts in energy-rich countries since 1970 caused the global economic stagflation. Therefore, it is expected that before the situation of the Russia-Ukraine conflict is clear, bulk commodity prices will stay high, and the market will remain pessimistic about the global economy.

Figure 10 The Russia-Ukraine conflict will cause the market to worry about global economic stagflation.

Data source: OECD

Due to the worsening local epidemic situations, China’s economy grew at a high rate at the beginning and then at a lower rate in the first quarter.

At the beginning of 2022, China’s economy gradually picked up with the synergy of the policies for pursuing steady growth; the economic data of January to February obviously exceeded expectations, and in particular, the production and consumption data were striking. Since March, the local epidemic situations have intensified, which has seriously affected the economic vitality and consumption recovery, so that the Manufacturing PMI showed an anti-seasonal sharp drop in March.

Figure 11 PMI experienced an anti-seasonal sharp drop in March 2022 due to the epidemic situation.

Data source: RC Family Office

RC’s prediction: After the epidemic is effectively controlled, the government will concentrate on pursuing steady growth.

Although China’s economy faces increasing downward pressure due to the impact of the epidemic in March, the government work report emphasized the target of 5.5% real growth of China’s GDP in 2022 and the overall requirement for economic work “take economic stability as the top priority and pursue progress while ensuring stability”. At the special meeting of the Financial Stability and Development Commission of the State Council on March 16th and the executive meeting of the State Council on March 29th, it was made clear again that this year’s growth target would not be adjusted, showing China’s determination to “pursue steady growth”. For this reason, China’s economy is forecast to gradually pick up with the support of relevant policies after the epidemic is effectively controlled later.

1.Macro environment: Fiscal efforts will be sped up in an all-round way, and the monetary structure will be generally loose.

In terms of fiscal policy, as pursuing steady growth has become more important in the context of internal and external new downward pressure, the second quarter will see the accelerated fiscal efforts to support the economy and the further earlier issuance of special bonds. In view of the greater impacts of scattered epidemic outbreaks and global bulk commodity price increases on low-income groups and downstream enterprises, fiscal measures will remain strong to support the “three guarantees (guarantee salary payments, business operations and people’s basic livelihood)” and policies to stabilize the market players, such as tax refund and tax relief, will be implemented at a faster pace.

The monetary policy will remains sound but slightly loose, but high overseas inflation will intensify the asynchrony of the Sino-US monetary cycle, and the interest rate spread between China and the US will continue to converge or even go upside down, restricting China’s monetary easing room. A stronger structural policy is foreseen to remain dominant in the second quarter. However, the requirement reserve ratio (RRR) cut and the interest rate cut can also be expected if the economic growth deviates from the 5.5% growth target beyond expectation.

2.The risk of RMB depreciation will rise, so import enterprises and enterprises with high USD-denominated debts need to effectively manage the exchange risk.

With the divergence between China and the US in the monetary policy, the spread between China and the US has been narrowing this year. Emphasizing “mainly centering on China’s own issues”, China’s monetary policy will continue to focus on pursuing steady growth, coupled with the narrowing spread between China and the US. With the spread shrinking, the pressure and scale of foreign capital outflow may be higher than that in the first quarter. With the gradual drop of the high prosperity of trade items in the second quarter, the negative impact of capital outflow pressure on RMB will be amplified and the risk of RMB depreciation is on the rise.

Figure 12 The divergence between China and the US in the monetary policy keeps narrowing the spread.

Data source: RC Family Office

RC’s advice: Import enterprises and enterprises with high USD-denominated debts are advised to customize exchange risk management plans according to their own conditions because they will face higher exchange risks when the divergence between China and the US in the monetary policy and the impact of China’s epidemic situation on China’s economy continuously increase the pressure on RMB depreciation (RMB depreciation will be beneficial to export enterprises and enterprises with overseas incomes making up relatively large proportions).

3.The risks in the global equity market will be high in the short and medium terms, and there will be structural opportunities in A shares.

In the first quarter of this year, China’s stock market declined significantly. A shares have a high yield compared with bonds. After the epidemic is under control, the government will concentrate on pursuing steady growth. Therefore, there will be structural opportunities in the A-share market with a high yield when the policies for “pursuing steady growth” and the “loose monetary policy” continuously show their effectiveness.

Figure 13 A shares are currently safe with a high yield compared with bonds.

Data source: RC Family Office

RC’s advice:Investors are advised to effectively manage the high risks in the global equity market in the short and medium terms. The US stock market will be under pressure as a whole in the short and medium terms now that the Fed’s interest rate hike cycle and the Russia-Ukraine conflict have led to the expectation of global stagflation. Therefore, investors are advised to make position management and risk hedging plans. China’s A-share market has been continuously dropping under the pressure brought by the Fed’s interest rate hike cycle, the increasing bulk commodity prices caused by the Russia-Ukraine conflict and the aggravation of China’s local epidemic situations. Although expected to face notable downside risks in the short and medium terms, the A-share market as a whole has entered a safe area with a high yield. RC believes that after China’s epidemic situation is effectively controlled later, the government will concentrate on pursuing steady growth; so there will be structural opportunities in A-shares, and Chinese and foreign investors can make professional capital allocation plans.

Due to the positioning “Houses are for living in and not for speculation”, the performance of the real estate industry remains unsatisfactory.

Although real estate enterprises have seen an improved credit financing situation since January and the government work report reaffirmed “implement city-specific policies” to stabilize the expectation of the real estate market, residents remain unenthusiastic about purchasing residential property because this round of real estate market downturn is caused by multiple factors such as the positioning “Houses are for living in and not for speculation”, the economic downturn and real estate enterprises’ credit standing. At the end of March, the three-year average growth rate of commodity house transaction area in 30 large and medium-sized cities dropped to -23.6%, showing a further decline.

Figure 14 The real estate industry was still unsatisfactory.

Data source: RC Family Office

RC believes that the short-term focus in the real estate market is still to maintain stability, so investors are advised to explore new models in the long term.

In the current economic downturn, it is essential to maintain the stable operation of the real estate market in the short run. China’s central government and some local governments have introduced easing policies, and the room for city-specific policies is constantly opening up. In the light of the positioning “Houses are for living in and not for speculation”, the real estate industry will undergo marginally eased regulation, and there will be stronger financial support for real estate enterprises’ reasonable financing needs and residents’ reasonable housing needs.

In the medium to long term, the real estate industry will need to update its development mode because China’s population is about to peak and has been at a stage of moderate aging, and China’s urbanization has entered the middle or late stage with limited room and potential for further improvement. Recently, the central government explicitly proposed for the first time to explore a new development model for the real estate industry, that is, to improve the housing market and security system; specifically, to promote a virtuous circle and healthy development of the real estate industry by speeding up the formation of a housing system with high-end needs met in the market and low-end needs secured, switching from “emphasizing house purchasing but taking house rental lightly” to “encouraging both house rental and house purchasing”, and attaching equal importance to building new houses and making good use of existing houses.

Figure 15 China’s urbanization is coming to an end

Data source: World Bank.

……Prepared by: the research team   of RC Family Office