2022 Q2 Report of RC

In the second quarter of 2022, under the influence of factors such as the continuous fermentation of the Russia-Ukraine conflict, repeated interest rate hikes by the Federal Reserve and repeated epidemics, global inflationary pressures continued to rise; commodity prices fluctuated at a high level; global asset markets fluctuated violently; and the performance of major assets was seriously differentiated. With the US’s interest rates having fully exceeded China’s, China's room for monetary policies has been further squeezed, and the debt crisis in emerging economies has become prominent. In the third quarter, the uncertainty of geo-political conflicts will still exist, and the global economic growth rate will be dragged down by many uncertain factors, with persistently high inflation, slowing economic growth and significant global "stagflation" risk. The macroeconomic situation at home and abroad and the global capital market will also become more complicated. Being farsighted and prudent, 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.

This year, the Federal Reserve has raised interest rates four times. RC comprehensively predicts the impacts on asset allocation and enterprises’ strategic layout

In view of the high global inflation resilience, the developed economies represented by the United States and Europe have entered the rate hike cycle one after another, and the persistently high inflation will force the central banks of the United States and Europe to accelerate the pace of monetary tightening. The European Central Bank decided to end net asset purchases under its asset purchase program (APP) from July 1, and planned to raise interest rates by 25 basis points (bp) in July, and will possibly accelerate the pace of rate hike in the second half of the year. The Federal Reserve raised interest rates by 150 bp to 2.25% - 2.5% this June and July, the largest rate hike since 1994. In July, the core CPI of the United States went up by 5.9% year-on-year, at a slightly lower rate but remaining at a historic high. Looking forward to the second half of the year, RC expects that the general direction of rate hike by developed economies will not change. The extent of rate hike will depend on developed economies’ trade-off and balance between inflation control and economic growth promotion. The rate hike cycle of the western countries represented by the United States will drive the global financial cycle switch and impact global asset pricing. The tightening of financial market liquidity and the rising interest rate of the U.S. bonds will restrict the market valuation. On the other hand, with the impact of overseas monetary tightening on the real economy beginning to accelerate, problems such as weak economic growth in short-term overseas markets are further highlighted in the context of liquidity tightening; the EU’s overall demand is weakening; and the US economy is expected to undergo the "technical recession", and the interest rate hike is expected to enter a certain cooling range.

Figure 1: Since the beginning of the year, the CPIs of the United States, Japan and the EU have risen sharply.

Data source: RC Family Office

Figure 2: The US has an inflation level at a historic high, and a low PMI.

Data source: RC Family Office

1.There will be structural opportunities of investments in the U.S. stocks, which will transmit to A shares.

It is expected that the Federal Reserve will slow down interest rate hikes in the second half of the year, which will significantly boost risky assets such as stocks and bulk commodities. Since the beginning of this year, the decline of the US stocks has reached the level of moderate economic recession, while the magnitude of this US economic recession may be mild. In the second half of the year, the US stocks have room for restoration. RC expects that US stocks, especially Nasdaq index, will usher in structural opportunities. According to RC’s research, the U.S. stocks generally showed signs of improvement about three months after the Federal Reserve began to raise interest rates and half a year before it stopped raising interest rates. As of July 1, the PE-TTM of the NASDAQ index was 26 times, in the historical position of the 15th percentile since 2012, and with a low valuation. Since this June, the U.S. stocks have rebounded from the low valuation, and the Nasdaq index has obviously outperformed the S&P 500, with an increase being about 4.51% higher than the S&P 500. RC expects that this trend will continue until the obvious economic recession begins in the United States, and there will be structural opportunities for the U.S. stocks, especially the Nasdaq index, in the next 3-5 months.

Figure 3: About half a year before the Fed stopped raising interest rates, the U.S. stocks usually started to improve.

Data source: RC Family Office

Figure 4: In recent years, the style switching between US stocks and the A shares is highly synchronized.

Data source: RC Family Office

RC suggests: The current trading of the U.S. stocks is still gaming between valuation restoration and profit slowdown. In the next 3-5 months, the U.S. economy will have a high probability of hovering at the level of "technical recession", which will not trigger a substantial recession. The benefit of the Fed's interest rate hike slowdown to liquidity will offset the unfavorable expectation of economic growth slowdown, which will prompt the staged rebound of the U.S. stocks, which will be conducive to the rise of growth stocks. In recent years, the trend of style switching between A-shares and the U.S. stocks has been increasingly linked, which will transmit to A-shares to a certain degree. There will be valuable opportunities of investments in A-shares with low valuations.

At present, the US dollar index is at its highest level since 2005, and in the 92nd percentile since 1987. In the next quarter, it is expected that the weakening of the US economic fundamentals will constrain the US dollar index to some extent. However, the US dollar plays a significant role in hedging thanks to its dominant position in the global financial system. Under the background of globally high inflation and the ongoing Russian-Ukrainian war, the global economy will be dragged down by various uncertain factors. It is expected that with the rising global risk aversion, cross-border funds will continue to flow back to the US, and the US dollar will remain strong in the next quarter. This means that major currencies such as EUR, JPY and CNY will be relatively weak. In response to the high inflation in the Eurozone, the European Central Bank began to turn hawkish, but its monetary policy tightening was still lower than that of the Federal Reserve due to concerns about the economic downturn. RC predicts that the EUR will remain sluggish in the second half of the year. Japan has not followed the European or American developed economies in the interest rate hike, and JPY will perform poorly due to the dislocation of the financial cycles between the United States and Japan. As for CNY, the rebound of the epidemic in the second quarter and the interest rate hike by the Federal Reserve exerted significant downward pressure on CNY. The USD/CNY exchange rate changed from 6.3 on April 15 to 6.78 on June 15, while the strong export will boost the CNY exchange rate to some extent. RC expects the CNY depreciation pressure to ease with the domestic economy stabilizing and rebounding, the U.S. economy entering a "technical recession" period and the Federal Reserve's interest rate hike slowing down. However, due to the possibility of interest rate cut by the central bank in the second half of the year and the difficulty in sustaining strong exports, there is more room for two-way fluctuation of CNY; therefore, import and export enterprises need to customize sound exchange risk management with professional financial tools.

Figure 5: The global economic slowdown pushes the US dollar index to remain strong.

Data source: RC Family Office

Figure 6: Since the beginning of April, the US dollar index has been rising, and CNY has depreciated sharply.

Data source: RC Family Office

In the first half of the year, the mixed influence of bullish and bearish factors caused the crude oil prices to fluctuate continuously. Since mid-March, the Russian-Ukrainian conflict has continuously pushed up the prices of basic raw materials such as crude oil. Recently, with the hawkish attitude of the Federal Reserve temporarily coming to an end and the market's expectation of economic recession becoming stronger, the oil price has recorded a historic decline. The currently small peak of summer travel, resumption of work and production, and other favorable factors in the developed countries can strongly support the demand side. The price has repeatedly reached USD 90/barrel, and has generally remained in an oscillation range.

Crude oil trading will enter an off-season in August. The crude oil reserves in OECD countries have been on the rise, and the previously inventory shrinkage has been reversed. However, the "oil substitution" caused by Europe’s natural gas shortage and the increase in oil demand from China's economic recovery will support oil prices. RC expects Brent crude oil prices to drop slightly and maintain a volatile trend. Crude oil is an important raw material for industrial production, and the fluctuation of crude oil prices will lead to the fluctuation of enterprise costs. Therefore, enterprises need to hedge crude oil and other bulk commodities to maintain the stability of production and operation.

Figure 7: Historical trend of crude oil prices, recent price bottoming, and remaining oscillating.

Data source: RC Family Office

4.Emerging economies have big debt crises, and thus it is necessary to exercise caution in the allocation of assets in emerging markets.

Recently, the several rate hikes by the Federal Reserve have caused the currencies of emerging market economies to generally depreciate: Since the beginning of April, the currencies of Sri Lanka, Turkey, Argentina, South Africa and Brazil have depreciated by 21.3%, 22.5%, 19.2%, 14.5% and 10.4% respectively. Among them, emerging market countries with high foreign debts and insufficient foreign exchange reserves are seriously affected by currency depreciation, and their own funds are not enough to repay their debts; therefore, it is difficult for them to bear the costs of borrowing new ones and repaying old ones, and the overall sovereign debt risk increases sharply. At the end of 2021, the world's new sovereign debts reached USD 10 trillion, of which 80% came from emerging markets. Internationally, a country's solvency is generally measured by foreign debt/GDP and foreign debt/foreign exchange reserve. As at March 2022, the foreign debt percentages of Turkey, Argentina, Ukraine and Chile were 55.3%, 55.8%, 63.7% and 74.9% respectively, among which the foreign debts of Turkey and Argentina are more than 7 times their foreign exchange reserves, representing serious debt problems. With currency depreciation in addition to high foreign debts, the debt risks faced by emerging economies continue to increase. It is necessary to be wary that Sri Lanka's bankruptcy may be just the beginning.

Figure 8: Exchange rate fluctuation range from early April to early August, 2022

Data source: RC Family Office

Figure 9: Major emerging economies’ foreign debt risks

Data source: RC Family Office

RC suggests: Some developing countries including emerging economies are facing increasing sovereign debt default risks. Therefore, RC suggests that investors and enterprises related to emerging market countries in investment, management and other fields should guard against exchange rate fluctuations, receivables default and other risks, and suggests that customers should build customized hedging schemes according to the involved emerging market countries’ business contexts and investment targets to hedge against possible future losses.

Stagflation risk rises in Europe RC predicts that sovereign debt risks in Europe will increase.

With the continuous Russian-Ukrainian war, the Russian-Ukrainian geopolitical risks continue; with the dependence of the EU's overall energy on Russia being as high as 20%, further unlinkage between the EU and Russia in energy will increase the stagflation pressure in Europe, and the European Central Bank may continue to raise interest rates in the future, which will not only suppress the already weak economy but also aggravate the debt risks faced by high-debt countries in Europe. This means that even if interest rate are hiked, EUR will be unlikely to be boosted. From the perspective of "stagnation", since this May, manufacturing PMI in the Eurozone has dropped from 57.7% to 49.8%, and services PMI in the Eurozone has dropped from 56.1% to 51.2%. PMI has nearly fallen back to the historic low. The restriction of energy supply may greatly affect the replenishment for European industrial production, and the European GDP growth rate may remain low. From the perspective of "inflation", the upward trend of energy prices is the main source of inflationary pressure in Europe, and may be further transmitted and spread to the downstream.

Figure 10: Inflationary pressure is high in Europe, and the risk of PMI decline is close to the historic low.

Data source: RC Family Office

This May, Germany experienced its first trade deficit in more than 30 years, and developed countries such as Spain, Italy and the UK also experienced enlarged trade deficits. The reason behind this was the high cost of energy product import caused by the rising supply-side prices. Since 2015, Europe has undergone the gradual decline of natural gas production, and become more dependent on the outside in energy demand, with the external dependence as high as 60%. In July 2022, the maintenance of Russia's Nord Stream-1 pipeline greatly reduced the external energy supply to the EU. With the conflict between Russia and Ukraine having not eased yet and with the increase of heating demand in Europe in winter, a new round of energy supply test is about to begin. Being in short supply of energy, Europe may again encounter the crisis of energy cut-off and high prices, which will aggravate the risk of economic recession and further drive the risk of stagflation. This July, HICP increased by 8.9% year-on-year, and the inflation level once again set a new record since the establishment of the Eurozone. Among them, HICP energy increased by 39.7% year-on-year. Europe has been facing high inflationary pressure.

Figure 11: Europe's inflation level set a new record.

Data source: RC Family Office

After the European debt crisis, the governments of the southern European countries has further increased leverage ratio. The main contradiction lies in the unresolved problems such as "the wealth gap, the high government debt ratio, and the deep linkage between the banking system and the government". The European Central Bank has raised interest rates by 50 bp for the first time since 2011, saying goodbye to the era of negative interest rates; and raised the refinancing rate, overnight deposit rate and overnight loan rate all by 25 bp. The issuance of national debts by PIIGS (Portugal, Italy, Ireland, Greece and Spain) countries is highly dependent on the liquidity empowerment by the European Central Bank. With the suspension of quantitative easing, the pressure of national debt issuance will increase significantly, further raising the financing costs of the EU countries. RC expects that the European Central Bank's entering the rate hike cycle and the increase in the US federal benchmark interest rate will be transmitted through the global bond arbitrage transactions, which will further drive the increase of the European regional government bond yields. In response to the debt pressure, the European Central Bank will continue to maintain flexible reinvestment at maturity, while adding TPI protection tools to prevent debt risks, but the risks have not been completely eliminated.

Figure 12: The European Central Bank's policy interest rate has remained low all the year round.

Data source: RC Family Office

RC suggests: In this year's global interest rate hikes, more than 80 central banks have raised interest rates. Under the background of stagflation, Europe is faced with the double dilemma of "higher leverage ratio and tighter monetary policy". At present, the government leverage ratios of the debt-stressed countries in Europe are significantly higher than that during the European debt crisis. If the continuous fermentation of the Russia-Ukraine crisis leads to further decoupling of energy between the EU and Russia, it will aggravate the high energy prices. The rate hike by the European Central Bank may continue to increase, and Europe may be subject to a tighter monetary policy. The European economy will face three constraints: "slowing external demand, energy shortage and debt risk". RC believes that the risk of future debt defaults in Europe should not be underestimated, and it is necessary to pay close attention to the debt repayment pressure of some EU member states. If there arise external factors such as rating agencies' downgrading of sovereign ratings in previous years, the EU may fall into the mire of debt crisis again. RC suggests that enterprises and investors involved in the European business should exercise more caution about European debt and related asset allocation under the guidance of professional teams in the context of economic fluctuations.

China's economic performance is weak.RC predicts that domestic policies will be gradually loosening while being stable.The economy will be generally recovering.

China’s GDP in the second quarter increased by 0.4% year-on-year, which was significantly lower than the growth rate of 4.8% in the first quarter. In the first half of the year, China’s economic growth rate was 2.5%, far from the target economic growth rate of 5.5%. The main reason was that the short-term impact of the epidemic was severe, causing huge disturbance to both macroeconomic supply and demand. At present, the epidemic has passed the peak of the second wave of outbreaks and has become stable. However, the impact has not been eliminated, and domestic demand is still weak. In terms of consumption, residents' consumption has not yet been restored. The central bank’s survey results show that residents highly prefer to save money and have lower desire for consumption and investment. In terms of investment, real estate is still in an important position in the national economy. The "foreclosure wave" in the second quarter shows that the real estate industry is exposed to large-scale risks, so that the real estate investment has begun to shrink. The real economy is expected to be weak. It has been more than one month since the State Council issued a package of policies to stabilize growth. However, manufacturing PMI is still lower than the threshold, which indicates that market players are still not optimistic about economic expectations. Overall, the economy is still facing the "triple constraints": demand contraction, supply impact and weakening expectation, with the weak domestic demand being prominent.

RC predicts: in the third quarter, the focus will be to stabilize growth, and the macro-policy will be neutral but a bit loose.

Recently, the State Council has introduced a package of economic measures to stabilize the economy. The Politburo meeting held on July 28 called for consolidating the trend of economic recovery in the second half of the year, keeping the economy running within a reasonable range, and striving to achieve the best results. The long-term positive trend of China's economy has not changed. RC reckons that the focus of the government's work in the second half of the year will be to stabilize growth, and the macro-policy will remain neutral but a bit loose. On the premise of keeping the epidemic stable, the spontaneous recovery of the economy and the gradual exertion of the policies to stabilize growth can cause the economy to slowly warm up.

China’s current economic growth rate is still far from the target of 5.5% set at the beginning of the year. The unemployment rate of people aged 16-24 has reached a new high for three consecutive months, reaching 19.3% in June, exceeding the high level during the epidemic-hit 2020. With the impact of the high unemployment rate on income, the consumer demand is restrained, and the pressure on SMEs, which employ the majority of employees, has obviously increased. Since March, SME PMI and services PMI have been continuously in a contraction range, hovering at the threshold. In addition, consumption has been significantly constrained by the impact of epidemic control on offline consumption scenarios, the continuous decline of the real estate market, the sluggish related consumption and the insufficient supply of automobiles. Specifically, since the second quarter, the monthly consumption of household appliances, furniture, building decoration materials, etc. has decreased by about 10% year-on-year.

To stabilize growth will be the focus in the second half of the year. Easing policies are needed due to the insufficient driver of economic growth. In terms of fiscal policy, at the end of June, the Ministry of Finance said that it would prioritize stability, strive for progress while maintaining stability, and keep the economic operation within a reasonable range. In terms of monetary policy, the monetary policy implementation report for the second quarter proposed to firmly support the stabilization of the economy on the whole. The sharp rise in inflation and the sharp depreciation of CNY will be the two main risks that will lead to the tightening of macro-policy in the second half of the year. RC believes that the current inflation and exchange rate levels are inadequate to trigger policy tightening. The inflation rate was 2.7% in July, and still controllable although it rose to a certain degree. In terms of exchange rate, the European and American developed economies’ entering the interest rate hike cycle has caused certain pressure on CNY depreciation. However, China's long-term positive economic fundamentals have not changed, and the trade surplus of goods will continue to support the CNY exchange rate in the short term. Therefore, there is no basis for sustained unilateral depreciation of CNY.

Figure 17: China's inflation level is controllable.

Data source: RC Family Office

Fiscal policy is essential to stabilize growth, and expected to be strengthened in due course in the second half of the year. In the first half of the year, the proactive fiscal policy promoted the fight against and relief from the epidemic, eased market players’ operation pressure, and made great contributions to stabilizing the economy on the whole by multiple means including: reducing taxes and fees on a large scale, speeding up the issuance and use of special bonds, and increasing transfer payments to local levels. RC expects that the accelerated implementation of the published policies and the introduction of new policies in the second half of the year will continue to help stabilize the economy.

On the quantitative aspect of monetary policy, the central bank reiterates that liquidity should be maintained at a reasonable and sufficient level, and that strong stimulus policies should be resolutely discarded. It is expected that in the second half of the year, the central bank will support the real economy through structural policies, with no significant change in the total-amount policy. On the price aspect of monetary policy, the People's Bank of China lowered the 5-year LPR by 15 basis points in May, and then lowered the MLF by 10 basis points in August, indicating that the central bank currently cares more about economic growth than inflation and exchange rate. The 7-day inter-bank bond pledged repo rate has dropped to about 1.6%, hitting a two-year low. RC expects that the People's Bank of China will continue to maintain a low interest rate environment to support the real economy and stabilize the real estate market.

Figure 18: The benchmark interest rate remains low.

Data source: RC Family Office

RC suggests: There will be structural opportunities for A-shares under the action of the gradual economic recovery and the stable but a bit loose monetary policy. Specifically, RC suggests that clients should set a "basket" portfolio plan from the perspective of global economic dynamics, screen the equity investment targets at different levels, make differentiated adjustments of the investment strategies for equity assets according to customized investment models, and steadily increase their returns on the premise of hedging risks as much as possible. Close attention may be paid to the following areas: First, infrastructure and consumption, which are the main starting points for steady growth, including traditional infrastructure and new infrastructure (wind power, PV, energy storage, etc.); second, major consumption commodities, such as automobiles, new energy vehicle industry chain, food and beverage, and household appliances; third, the main thread of the cycle dominated by the contradiction between supply and demand, such as energy security (petroleum, petrochemical and coal), resource security (lithium, copper and rare earth) and food security (planting and agrochemical products); fourth, the military sector with the tightening of geopolitical situations.

Risk events occur frequently RC suggests that investors should enhance the identification of "investment traps"

Affected by the "foreclosure wave", home buyers’ mentality is quietly changing. Last March was the last high growth point for commodity houses. Due to the rapid rise of house prices and the low year-on-year base, the sales areas of commodity houses under construction and those having been completed increased by 42.4% and 11.1% respectively. After that, the sales area of newly-built commodity houses began to decline; in particular, the sales area of commodity houses under construction declined all the way, dropped by 24.3% year-on-year this June and continuing to fall significantly.

Figure 19: The risk of non-completion of residential houses increases, and the acceptance of houses under construction is low.

Data source: RC Family Office

RC believes: "foreclosure wave" reflects multiple risks in the real estate industry. The real estate industry has a long chain. For individual investors, the current demand in the real estate industry is generally weak, and there is still some downward pressure on housing prices in third-and fourth-tier cities. It is suggested that caution should be exercised about real estate investment in third-and fourth-tier cities. For the real estate-related enterprises, the existing debts should be tracked well in terms of risks, and the funds should be withdrawn from risky enterprises’ projects in the window of "long duration", and high-quality developers should be selected for cooperation. The trend of high-end residential and affordable housing should be catered to. Upstream and downstream enterprises need to pay close attention to the default risks of Chinese-issued US dollar bonds of domestic housing enterprises. The large-scale default of Chinese-issued US dollar bonds in the early stage has caused the market to downgrade the rating of Chinese-funded housing enterprises. Chinese-funded housing enterprises have been facing increasing difficulties and costs of overseas refinancing, and increasing difficulties in repayment of old loans; and the default risks of Chinese-funded US dollar bonds have increased. The chain reaction caused by debt default will cause losses to other stakeholders of housing enterprises. RC suggests that investors and affiliated enterprises should make arrangements in advance.

In the second quarter, the bubble bursts of rural banks in Henan and Anhui provinces attracted much attention and exerted wide impacts. This not only causes direct losses to depositors, but also damages the recognition of financial institutions, especially small and medium-sized banks. The reason for the incident was that Henan New Fortune Group manipulated five rural banks in Henan and Anhui, illegally absorbing and occupying people’s funds through internal and external collusion and the use of third-party platforms and fund brokers, tampering with the original business data, and covering up illegal acts.

RC suggests:Investors should pay attention to investment traps such as soliciting deposits at high interest rates. The implementation of the new asset management regulations has gone beyond the rigid payments. There are no financial products with high returns and low risks in the market. High returns mean high risks, and "securing the principal and providing high returns" is financial fraud from the perspective of regulatory compliance. Financial management products are often nested in layers, and it is a prerequisite for investors to improve their financial literacy or choose professionals to help them to thoroughly understand the underlying assets of products.