Written by 4:00 am Europe Economy

stock market outlook: What will be the impact of China’s reopening on commodities and oil? Luke Browne answers

“While the start of the year and the macro data that we are seeing are encouraging for investors, we should not get carried away. There is a lot to watch; there is a lot of volatility and we have to be nimble about choosing which asset allocations we want to have in our portfolios through time,” says Luke Browne, Head-Asset Allocation, APAC, Manulife Investment Management.

How did you see the start of the year for equities? Gold had a runaway rally and some rebound in commodities as well but equities were subdued at least for the first few days?
Yes, the start of 2023 has surprised many and as you say, different asset classes had different pockets of positive performance but from the equity side, we are starting to see that US markets have had a pretty strong stance. Europe and Asia clearly have been the outperformers and within the Asian complex, China, Hong Kong and India are particularly stronger.

This is all part of the macro backdrop and what the market is trying to digest over the part of Fed rates, the prospects of a global economy and particularly what is happening with inflation.

There seems to be a lot of excitement in Asia on China’s turnaround or reopening trade. Hong Kong has rallied, Taiwan is rallying, India was slightly quiet at the start but we had a great time last year. Do you see fund flows coming to Asia and the Emerging Market pack this year?
Yes, this is one of the questions that we have wrestled with in our investment calls and we need to look at it through a number of different lenses.

So, China with the relaxation of Covid restrictions is clearly a tailwind for Asia markets generally. Now for India specifically, we have come off an incredibly strong 2022. We have seen all-time highs in Indian equities and there is a bit of a pause there, some consolidation before we could potentially see a leg up. In terms of allocations and certainly with the conversations we are having with our global client base, there is a lot more excitement over the opportunities that Asia is showing across the investment complex.

Yes equities are performing well, but in a credit space with the additional work that the Chinese government has done to stabilise property, it has led to some outsize gains there. Now in terms of the flows that we are seeing and the EM complex more broadly, there is a lot of interest in how EMs might perform relative to other investment opportunities. Two things are critical here. One is the power from the strength of the US dollar and the second is how the China reopening potentially impacts the global inflation complex. If China’s economy grows strongly and above estimates that are coming out from the market, I would be cautious that it might lead to increased inflationary pressure on a cost push basis.

I guess my central message would be that whilst the start of the year is encouraging and the macro data that we are seeing is encouraging for investors, we should not get carried away. There is a lot to watch; there is a lot of volatility and we have to be nimble about choosing which asset allocations we want to have in our portfolios through time.

Were you looking at the macro data coming out of the US – the inflation data and the trajectory? Do you think the Fed will overdo the tightening and let the soft recession sink in a bit before going on a pause or smaller hikes? What are your thoughts because that will determine the trajectory of a lot of equity markets worldwide this year?
You are absolutely right and I like to think if it is two edges and with respect to the Fed so how high and for how long so the market at the moment is pricing in terminal rates around 5%-5.25% by the Fed and so perhaps how long they are going to retain rates at that sort of demand destruction level. Tighter financial conditions is what is going to play out over the next six months.

Now with the data that came out yesterday from the US and the inflation numbers would be broadly in line with the employment figures which suggested that the economy remains robust and that might give an indication that the resilience of the US economy could help a softer landing. The trajectory of GDP could be less extreme to the downside than the prediction a while ago.

Now what might the Fed do? I think they now have an opportunity to dial back a little bit on the aggressive rises that we have seen. So we will become accustomed to perhaps a 25 bps rate hike in February rather than the 50 bps rate hike. If that is the case, the market is likely to try to look through that data into the second half of the year in particular, looking for inflation numbers to roll over further and move from the tightening cycle that we have seen globally, perhaps into the green shoots of an easing cycle by the end of 2023 and beyond and over lends itself to some positive environments, Let us not forget that the markets look to the future not just now and one can see markets moving in a way that will get slightly ahead of the path of central banks’ tightening policies.

Goldman Sachs just made a remark a few days back that Europe may not go into recession anytime soon and in fact may post a little bit of growth. Also what are your thoughts on the ramifications of China reopening on commodities and oil?
Europe is dominated by geopolitical risks, the war between Russia and Ukraine and how that is going to evolve and obviously the knock-on effect it has on European growth potential. One of the catalysts or tailwinds that have been in the market for European growth over the start of the year has been a pretty mild winter so far. That has allowed gas inventories to be built and stay at a level that was higher than what some were predicting, leading to natural gas prices being lower than the extremes that we had seen at the backend of last year.

Now that is all very positive. However, it only takes a cold snap and some excess demand coming from Asia for a reversal in LPG prices. I think that we need to very cautiously look at the data coming out of Europe to make sure that any rollover that we see does not impact the potential for growth and move away from this.

Are we talking mild recession potential for small growth into something more extreme? If we were to get resolution, that would be an enormous catalyst for European markets across the spectrum of asset classes which we want to take advantage of but it is not something that personally I would have high conviction in at this time. I want to see more data, more outlook from the ECB on what their plans are.

Now the second part of your question was around commodities. I have touched a little bit on that and particularly the reopening of China. What we have to be cognisant of is the consumption that China has of commodities, energy, raw materials and the impact across the global supply chains. Should China accelerate in its reopening, accelerate growth and potentially introduce further stimulus to their economy – and let us not forget that they have far more dry powder than some other economies across the globe – that could be an aggressive reopening. Then there will be concerns that it would undo some of the work that is being done from central banks in terms of tightening financial conditions and we might end up with additional inflationary pressures coming into the global economy.

Do you see this year the DXY slip below the 100 mark as well? If that happens, it would bode well for the emerging market pack, including India?
Absolutely right. This was one of the conversations that we had in London and in Q4 of last year when we started thinking about what are the high conviction, client conviction trades that we might have for the coming 12 months. Dollar weakness was certainly one that was on our notepad. Now we have obviously seen a very strong bull market represented by DXY for quite some time. We did see some declines over the back end of 2022. We are probably in a period of stabilisation, being more range-bound for the time being.

But yes, I still have conviction that we are probably going to see dollar weakness through 2023 and that could be extremely encouraging for emerging economies. It could be extremely encouraging for commodity sensitive economies such as India. We need to moderate this slightly and say what is the other side of the coin and what might derail our conviction in that trade . I think that if there is increased volatility in the markets, we would get a flight to safety and that would be a tailwind for US dollar strength.

Furthermore if there are restrictions in the availability of US dollars globally, more people would be looking for dollars and that could put US dollar strength back on the table. So one has to watch carefully but yes, it is one of the things that I would be looking to really make me want to position more aggressively into those dollar and commodity sensitive economies in the emerging markets.

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