In the year 2023, a stark divergence in market performance has emerged between the US stock market and China's A-share marketLed by major tech giants, the US market has displayed a bullish sentiment, buoyed by robust growth and investor confidenceHowever, the A-share market in China, while remaining active, has struggled with weaker performance in its main indicesAs we delve deeper into the second half of the year, global investors are keenly observing the trajectories of these two significant marketsWill the momentum of the tech-driven bull market in the US continue, or will China's A-share market start to reveal its intrinsic investment value?

Recently, a number of major global asset management firms have shared their insights regarding the outlook for key markets in the latter half of the yearSome institutional investors have suggested that the US economy is still at risk of recession, with corporate profits on the decline

In this context, US stocks may lack sufficient fundamental support, possibly necessitating a downward adjustment in valuationComparatively, the valuation levels in China's A-share market remain historically low, and with strong policy support and ongoing economic recovery, the attractiveness of the Chinese equity market is poised for significant enhancement.

The probability of a US recession stands at 30%

Policy interest rates are likely to remain elevated for the long term

On July 6, Credit Suisse published their global economic outlook for the second half of 2023, highlighting the views of Chen Dong, the head of Asia macroeconomic research at Credit SuisseHe posited that due to the tightening of monetary policy, a recession in the US might be postponed, but not completely avoided, with the potential for a downturn in the latter half of the year

Chen noted, “One reason the US has not yet entered a recession is that the effects of tightening monetary policy have yet to fully propagate through to the real economy, particularly in the real estate sector, where we have not observed a pronounced tightening effect.”

Chen further pointed out that the US has just come through a banking crisis, with three regional banks having failed, whose total assets surpassed $550 billion—greater than the scale of bank failures during the 2008 financial crisisAlthough the Federal Reserve and other regulatory bodies acted swiftly to prevent the situation from worsening, regional banks tightening credit standards and shrinking their balance sheets will still indirectly affect the real economy.

Additionally, wholesale inventories in the US are currently at historical highs relative to sales, suggesting that further inventory reduction is on the horizon

Such actions could impose downward pressure not only on domestic US manufacturing but also on global manufacturing.

Aligning with Chen’s perspective, Preston Caldwell, the head of US economic research at Morningstar, has assessed that the probability of a US recession is significant, estimating approximately a 30% chance of a downturn occurring in the next 12 monthsHe anticipates that the Federal Reserve may raise the federal funds rate once more in July; thereafter, a trend of interest rate cuts could commence in February 2024. Morningstar predicts that aggressive reductions in the federal funds rate will take place during 2024 and 2025.

However, during a recent “2023 Mid-Year Global Investment Outlook” conference organized by the global asset management giant Invesco, Keith Бог, a strategist for the Asia Pacific region (excluding Japan), shared that the likelihood of the Federal Reserve implementing another 50 basis points hike within the year is low

alefox

He suggested that the Fed may adopt a hawkish tone simply to indicate its stance, as it does not wish for financial conditions to ease too rapidlyA more plausible scenario would be an additional 25 basis points hike before the year concludes, potentially happening this monthLooking back, once the Fed makes a clear statement signifying an end to its tightening policy, or concludes its rate hike cycle, the market typically sees a strong rebound; I believe this could be the scenario in the US moving forward.

As for the long-term outlook on Federal Reserve monetary policy, Chen indicated that US policy interest rates are likely to remain elevated for an extended duration, not transitioning into a lowering cycle immediately“Over the long term, inflation rates could systematically exceed those of the past decade, and investors may face a relatively low-growth yet high-inflation environment that could persist.”

Three factors supporting the outlook

China’s economy continues to recover

In contrast, China’s economic recovery during the first half of the year has not met expectations

Nonetheless, global asset management giants maintain that the recovery will persist into the latter half, with its intensity and pacing hinged on the robustness of policy support.

Chen elaborated that looking at household consumption, China’s retail sales figures remain significantly below pre-pandemic levels, displaying a marked disparity from the peaks seen in 2021. Thus, there is ample room for growth on the consumption side of the economy as household savings have escalated, indicative of a lack of confidence in the current economic climateChen emphasized that the government must augment its short-term stimulus efforts (especially in the real estate sector) to shift this cautious sentiment; only then can the economy be reignited.

Andy Rothman, an investment strategist at Matthews Asia who resided in Shanghai and Beijing for 19 years, recently visited these cities and noted that a consumer-led recovery in China is underway and likely sustainable

He remarked on the resilience of Chinese entrepreneurs and pragmatic government policies overcoming short-term challenges posed by sluggish manufacturing, low private sector investment, and elevated youth unemployment“Currently, China’s economy is in the early stages of a consumer-led gradual recovery, which is likely to be sustained through loose policies and significant household savings.”

Rothman identified several elements likely to bolster the gradual recovery of this consumer-led economy: first, there is consumer purchasing power, evidenced by a 3.8% year-on-year increase in inflation-adjusted income for the first quarter, marking the quickest quarterly growth since Q2 of 2022. Since 2020, Chinese households have adopted a savings mode, with mainland investors holding around 95% of shares in the domestic stock market, which has been instrumental in driving consumer spending recovery alongside the stock market rebound.

Secondly, there is a strong likelihood that the People's Bank of China will pursue a continued accommodative policy, while other global regions may adopt tightening measures.

Thirdly, the resilience of Chinese enterprises and consumers, paired with a pragmatic government approach, is noteworthy

Rothman pointed out that since his first visit to China in 1980, per capita income has surged 148-fold, the literacy rate among adults has climbed from 66% to 97%, and the number of university graduates has risen from 150,000 to 11 million, while home ownership rates have soared from nearly zero to around 90%. Over the past decade, China has experienced an annual growth in real per capita income of 6.2%, a stark contrast to the US's 1.4% and the UK’s 1%.

While Rothman expresses optimism regarding China's economic prospects, he underscores three primary challenges facing the recovery: A soft performance in industrial output and private sector investment in the first four months of the year, disappointing housing starts, and sluggish automobile salesThese factors have contributed to a rise in the urban youth unemployment rate for ages 16-24, increasing from 18% in February to 20% in April

He hopes regulators will incentivize state institutions and state-owned enterprises to hire more young individuals to alleviate this issue.

Potential for downward adjustment in US stock valuations

Positive outlook for China's electric vehicles and high-end manufacturing sectors

This year, growth stocks in the US have surged to the forefront of the global marketIn response, Jia Wenjian, head of multi-asset investment and management at Credit Suisse Asia, has commented that US corporate earnings reached their peak mid-last year and have been on a downtrend ever sinceHe anticipates that corporate profits will continue to decline in the latter half, implying that US stocks lack fundamental backingFurthermore, historical data spanning from 1988 suggests that the average long-term P/E ratio in the US hovers around 15 times—below the current figure of 19 times

Given this scenario, if US corporate earnings are unlikely to grow substantially, a downward shift in price-to-earnings multiples is probable.

Wenjian candidly indicated that he views investment opportunities in Chinese stocks more favorably, primarily due to their exceptionally low valuations“The MSCI China Index currently trades at around 9.8 times earnings, which is not only depressed compared to its historical averages but also lower than other emerging markets and substantially beneath developed countries' markets.”

From this valuation perspective, Wenjian believes that China’s market is nearing its bottomHe remarked that should positive policies emerge in the second half of the year and corporate profits rebound, it would provide substantial support to the overall Chinese stock market’s positive trajectoryIn the backdrop of a slowing global economy and comparatively accommodative fiscal and monetary policies in China, its market remains appealing.

Focusing on investment prospects in the A-share market for the remainder of the year, Zhao Yaoting is placing particular emphasis on areas benefiting from policy support, such as the high-end manufacturing sector, including electric vehicles

He noted that the thriving AI sector has been a significant performer; however, its prosperity hinges on the profitability of AI-related enterprises“In the US, returns in AI are seeing double-digit growth in rate-sensitive indices, reflecting both a serious underestimation by stock investors of potential monetary policy shifts and the undeniable boom within the AI sectorUltimately, the prosperity of AI will depend on the profitability of related enterprisesAs for the broader technology sector, I believe there is a likelihood of significant effects due to generative AI’s capacity to enhance commercial efficiency and activitiesWhile such impacts may not parallel the transformative influence of the rise of Internet in the 90s, they are likely to be profound across emerging trends like the metaverse.”

Zhao further highlighted that the robust performance of the AI sector in the US is largely attributable to its companies' capabilities in both hardware (e.g., semiconductor chips) and software, contrasting with China’s focus primarily on software