Reference URL: http://mp.weixin.qq.com/s/9ChGYQk6VSfYDChPV6JaVA
It is hard to fathom a raging bull market amid tightening liquidity. China’s real interest rate has fallen to new lows that used to portend interest rate or RRR hike. It has been the real culprit behind the bubble in bond, property and commodities, as well as fast depreciating CNY. While inflation expectation is rising, growth may not eventuate, as investment will likely fall with property curbs. As such, the Chinese economy is stuck between mild cyclical reflation and outright stagflation. It will continue to traverse an L-shaped trajectory, as it has been since 2012. For now, more restrictive property curbs are chosen instead to deal with surging property prices. Consensus believes that such moves will push funds from property to equities. But in the past, after each property curb, disappointing market performance, or even plunge ensued – as seen in September 2007, January 2010 and April 2011. Consensus has failed to recognize that property transactions are indeed monetary multipliers, and can accelerate money velocity. As such, the curbs on property transactions will cut liquidity, and become a drag to market performance. If interest rates were to be kept stable to sooth the volatility during deleveraging, then CNY will have to bear the brunt of economic adjustment. If capital control is instigated to slowdown onshore CNY depreciation, then on/off-shore exchange rates will divert, obliging market interventions such as cutting offshore RMB supply and raising offshore RMB borrowing costs. But that higher interest rate offshore will eventually roil the other asset prices, such as equities. Something somewhere will have to bend sometime – it is a high-wire act. While bonds will likely underperform equities, how far equities can rise will depend on how fast equity valuation expands relative to bond yield’s rise. In general, in a tightening liquidity environment, valuation multiple will compress. Contrary to bullish consensus, our EYBY model estimates the likely trading range in 2017 for the Shanghai Composite to be 3300 +/- 500, suggesting perhaps a better year than 2016 (the same model estimated 2900 +/- 400 for 2016 exactly twelve months ago) - but with wider return dispersion to reflect rising volatility. Further, 2/3 of the estimates are lower than the current index level of ~3300. As such, we remain guarded. With the expanded connect scheme and a depreciating CNY, southbound flows should help offset outflows from HK due to a strengthening Dollar to an extent. 2017 is destined to be a year of epic changes and volatility. We should focus on convexity trades with option-like payoff and think in probabilistic scenarios, instead of being overly engrossed by the perpetual futile debate of bull vs. bear. We see a strengthening Dollar, rising inflation and long bond yield, as well as a weakening CNY. In the first half, there should be opportunities in financials, materials, energy, industrials, tech and consumer discretionary. ------------------------------ “To light a candle is to cast a shadow.” – Ursula K. Le Guin
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