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The China/Fed gazing over the past two months does give us a chance to step back and assess if the risk selling has been justified. Has it created a value opportunity or is there more risk to come?
The questions to ask
Is there a fundamental deterioration in the global backdrop?
I don’t believe so, as the move has been due to phantom Fed fund rate rises and speculation, as opposed to fact, of a hard landing for China.
There is, however, clear evidence that emerging markets (EMs) and those with high EM exposure are going to experience higher and longer periods of volatility as we see a slowing China (not a crashing China) and a crescendo into the first Fed funds rate rise hitting trade – making equities or currency selection all the more crucial.
Has the sell-off created bottom-up value that will override the crushing top-down pessimism?
US earnings season should be able to give us a clearer insight into this question. But what we’re seeing is that earnings and revenue growth remain below historical trends, yet the pull back in the S&P, for example, has created some of the largest discount gaps to present value in the past three years – so value is there.
Asia has seen some sectors with record discounts (as well as record premiums if you look into Chinese mainland valuations) this year, and the bounce over the past week shows that bottom-up has force and can override the pessimism.
Therefore, is this a cyclical move or something more significant?
Looking at face value, this is more than just a late cycle dip. In fact, if it is a multi-year cycle, this is more likely to be an early cycle dip as moves of this size are normally seen in the beginning of a cycle and not at the end. They are almost never seen in the middle.
That raises another question, have we now transitioned to a mid-cycle pattern? It does have the hallmarks of the beginning of a mid-cycle lull period. We have recovered from the lows and the record discounts in individual stocks have closed – but not fully. If we trade in a sideways pattern until 31 December, this would be confirmed.
Timing is crucial, but if we are in a multi-year cyclical market, stocks with high discounts that are seeing an easing in the top-down pessimism thematic are looking attractive as a buying opportunity as they return to historical discounts even fair value. But be on the lookout for the second leg of the downturn.
Ahead of the Asian open
China is back from its week-long National Day celebrations and has plenty to catch up on.
Here are the moves in various key markets since the mainland has been away:
- Hang Seng +8%
- H-Shares +10.5 (+4.7% yesterday)
- S&P 500 +3.4%
- ASX 200 +3.5%
- ASHR ETF (CSI 300 ETF) +6% – bear in mind, the 120-day correlation between the ASHR and CSI 300 is 80% (or 0.8)
- FXI ETF (LARGE CAP ETF) +8.5%
- China A50 index (IG’s quote) – 9884 +6.8%
- Brent oil +6.3%
Since the mainland has been shut for holidays, the ASX:
- The energy sector as a whole +13%
- Materials +7.3%
- Discretionary shares +4%
Other individual moves to note:
- AWE +35%
- STO +27%
- OZL +22%
Overnight, the WTI fell 3.7% so we may see a trimming of those gains. However, Brent only lost 1.6%. Ahead of the open, we are calling the ASX up 45 points to 5243 – the highest level on the ASX since mid-August.