Chinese Equities: Are We There Yet?

A relatively weak environment for financial markets this week late in January 2023, as participants digested a lower volume of economic data ahead of the impending earnings season. China was the first major economy to release important macro data, with the December GDP and retail sales data surprising strongly to the upside. The economy grew by 2.9% for the year; ahead of estimates of 1.8%, while retail sales contracted by 1.8% versus predictions of an 8.6% decline, demonstrating the pent-up demand unleashed following the relaxation of Zero-COVID measures. This helped fuel a rally in the domestic equity market but at slower pace than seen in prior sessions, highlighting that perhaps some positivity had been priced into markets already.

The UK released inflation and retail sales this week and a second month of lower trending inflation helped UK gilt yields tighten, as the peak inflation argument gained traction. CPI came in at 10.5% for the year to December; the main contributors for the easing (from the peak of 11.1% in October) came from transportation costs, namely motor fuels. Declining, but still very high inflation, impacted December retail sales as they fell by 5.8% year on year, below market forecasts of -4.1%. This was the biggest December decline since records began, reflecting the cost of living crisis impacting the volume of goods purchased during the Christmas period.

Even though December’s Japanese inflation print came in at 4%, which was 20 basis points higher than November, one of the only remaining central banks in the developed world that have yet to embark on a tightening cycle concluded their two day meeting this week with no changes to monetary policy, causing some volatility in the FX markets. Investors had been expecting the Bank of Japan to start messaging that it would begin to exit its long held easing policy in the wake of the global inflation shock, but were left disappointed when governor Kuroda dismissed the idea of exiting easy monetary policy in the near term.

This caused a large spike in the Yen as it sold off, but the currency subsequently recovered. It also gave cover to bond bulls, as the general rally in bonds that began earlier in the week continued with the Japanese yield curve tightening relative prior to the meeting. Finally, another catalyst for the rally in bonds was the weaker than expected US macro data released this week. On Tuesday, the New York Empire manufacturing survey reported a January reading of -32.9, well below the prior month and consensus forecasts and the US consumer suffered similarly but to a lesser extent to the UK one, when their retail sales declined by 1.1% for December, below forecasts and slightly worsening from November. However, positive news came from the Philadelphia Fed business conditions survey for January, where the +4.9 reading was much improved from the prior -0.9 print in December.

With the peak in inflation prints from last week, combined with some weakening macro data, investors are pricing in cuts to interest rates later on this year, which is contrary to the messaging from the Federal Reserve. How this resolves will dictate the direction of risk assets, as they weigh the impact of monetary tightening on company earnings and the prospects of a soft or hard landing for the economy.

The insurance industry is struggling to adapt to a new normal in which losses fueled by climate change are now regularly exceeding $100bn a year. Data compiled by Munich Re. showed that insured losses from natural disasters hit circa $120bn in 2022, most of which was weather related. Hurricane Ian, which devastated Florida in September, was responsible for about fifty percent. Including uninsured losses, the total cost of storms, droughts, earthquakes and fires last year was $270bn. “There is no denying that climate change is driving losses from natural catastrophes,” Ernst Rauch, chief climate scientist at Munich Re, said in an interview. “Insured losses of more than $100bn a year are the new normal”. That’s a major departure from industry norms of less than two decades. Before 2005, the year Hurricane Katrina ripped through New Orleans, insured losses had never exceeded an annual $50bn, adjusting for inflation, according to Munich Re’s records.

Important macro releases for next week include leading indicators, with PMI numbers from various countries as well as consumer sentiment and inflation expectations data from the US. The earnings season also continues, with analysts combing through financial reports to determine the impact of inflation and interest rates to business models.