（原标题：SFC Markets and Finance | Hong Hao: The Chinese market offers big opportunities for global investors）
南方财经全媒体记者 施诗 上海报道
Editor's note:
After over 40 years' booming, is China's economy collapsing? The recent data gave the answer. China's economy grew faster than expected in the first five months of 2024, showing its strong growth momentum. As the 20th Communist Party of China Central Committee is set to meet at its third plenary session in July, known as the Third Plenum, people are keenly awaiting developments to see how this will further reshape the Chinese economy and stock market. Despite challenges and uncertainties, how will China's economy perform this year? At the mid-year, Chief economists and chief investors from financial institutions will share their insights to SFC Markets and Finance's "Chief's View on China".
As we reach the midpoint of the year, the global stock markets and economies present a complex picture of resilience and volatility. Reflecting on these developments, Hong Hao, Chief Economist at GROW Investment Group, offers his insights.
How are economic policies and global trade tensions influencing these developments? What are the prospects for China's economy in the second half of the year? In an exclusive interview with an SFC reporter, Hong Hao discusses the peculiar performance of the US and A-share markets, the impacts of global monetary policies, the future trajectory of China's economy and more.
Looking ahead, Hong Hao highlights some positive factors, such as the Federal Reserve potentially shifting towards interest rate cuts, which could drive a recovery and rebound in the Chinese stock market. More importantly, he emphasizes that China's economy needs to consolidate its foundations and strengthen its core to ensure sustainable growth.
SFC Markets and Finance: As we're now halfway through the year, I'd like to start by asking about the stock market performance in the first half. You described the performance of the A-share market and the U.S. stock market as peculiar. Could you elaborate on what you meant by this?
Hong Hao: At the beginning of the year, many observers widely anticipated that the U.S. stock market and even the U.S. economy might enter a recession. Since the U.S. economy had experienced several years of robust growth and according to the economic cycle, it seemed poised to transition from prosperity to decline.
Currently, various indicators indeed suggest a slowdown in the U.S. economy, with the inflation rate dropping below 3%. However, the Fed still leaves rates unchanged. Not only is the Fed not cutting rates, but also it maintained its hawkish stance. This indeed imposes certain constraints on our monetary policy.
Despite having undertaken two reforms of RMB exchange rate over the years, in the basket of currencies that determine the RMB exchange rate, the U.S. dollar still holds a relatively significant weight. Therefore, if the Fed does not opt to cut rates, our space for rate cuts will be somewhat limited. If we were to lower interest rates while the Fed maintains its rates, the interest rate differential between the two countries would spread further, exerting pressure on the RMB.
Currently, the RMB exchange rate is roughly at around 7.3. Meanwhile, the U.S. side (the Fed) continues to be hawkish. On our side, in China, in a recent speech at the Lujiazui Forum, our central bank made it clear that although interest rates play an important role in monetary policy, but short-term rates form the upper end of the interest rate corridor, the more important adjustment goal is focus on the exchange rate. The exchange rate is clearly one of our policy priorities.
This is where the "peculiar" aspect lies: despite the U.S. economy is slowing down, and inflation is declining, yet the Fed still maintains its hawkish stance, leading global capital flows to continue favoring the U.S. For example, since 2023, the United States attracted about one-third of global foreign direct investment (FDI), or possibly even more, in normal years, that number is around 15%. China in general tends to attract more foreign capital inflows than the U.S. However, we are currently witnessing a significant shift in the direction of capital flows. This shift in capital flows provides sustained strength for the U.S. dollar.
This round of dollar strength has lasted for relatively long period. As a result, the emerging markets overall have been performing relatively flat.
SFC Markets and Finance: If we look closely, it seems that the U.S. stock market is primarily supported by the Magnificent Seven. However, how is the current situation different from the Internet bubble of 2000?
Hong Hao: There are indeed differences between the two. If we consider the price-to-earnings (P/E) ratio as a simple indicator, it might give the impression that market valuations are high. However, when we exclude the Magnificent Seven and focus only on the remaining 493 companies, their combined P/E ratio is roughly in line with historical long-term levels.
If we only focus on these Magnificent Seven, the fundamental difference compared to back then is that it only required a concept, a story, for many companies to easily go public simply with the ".com" concept.
Currently, tech giants like Microsoft and Nvidia exhibit strong free cash flow performance. At this growth rate, their free cash flow could reach around $200 billion to $300 billion this year, and next year, this figure might even surpass $400 billion. From this perspective, the valuations of these companies are not high. The story can continue to flourish because corporate earnings are steadily increasing. Even if current prices appear high, as long as earnings growth outpaces price growth, the price-to-earnings ratio will gradually decline.
Therefore, despite the current high market valuations, there are sufficient reasons behind. If you consider cash flow, if you consider profitability, today's market is fundamentally different from back then. Many companies back then had no earnings, whereas the tech companies we see today are very profitable.
SFC Markets and Finance: Is there any sign of an end to this round of tech frenzy?
Hong Hao: This round of tech frenzy hasn’t come to an end yet particularly driven by innovations like artificial intelligence. Such change could continue for several years. We are now seeing the U.S. semiconductor cycle at its high point. Generally, there are ups and downs in the cycle, highs and lows. But this time it has been at its highs for over a year, almost two. Such performance is indeed surprising.
Throughout human history, there have been several major innovation revolutions. For instance, the Age of Discovery interconnected people around the world when humanity discovered new continents. Next came the Internet revolution around the year 2000, which interconnected people more closely. Today, we are witnessing the breakthrough of AI. The development of AI achieves human-machine integration, enabling machines to possess human intelligence. This revolution significantly expands human creativity and productivity.
Indeed, this is critically an important revolution that not only greatly taps into the potential of human productivity but pushes the productivity of the machines and networks. The AI revolution has only just begun.
SFC Markets and Finance: Unlike the U.S. stock market, the Chinese stock market experienced some volatility in the first half of the year. What’s your take on that?
Hong Hao: The performance of our stock market did not meet expectations.
Earlier, we discussed why this year seems unusual, and that's what we're seeing. Because of the interest rate differential between the U.S. and China, our stock market underperformed. If we compare the performance of the CSI 300 Index with changes in the China-US interest rate differential, we find a correlation exceeding 90%. This means when the China-US interest rate differential widens, capital tends to flow towards the United States, putting pressure on China’s asset prices. That’s the key factor explaining the underperformance of the Chinese market. I made a related chart which is widely circulating in the market. The interest rate differential between China and the United States indeed imposes certain constraints on China's capital markets.
However, we can think about this the other way around. If the Fed's monetary policy tightening cycle ends and rate cuts begin, the China-US interest rate differential is expected to gradually converge, easing pressure on Chinese asset prices. Looking back at April and May, we did witness a very strong rally in the market. The A-share market rose from around 2600 points to above 3000, reaching 3100. The Hong Kong stock market surged from 15000 points to 19000 points. That’s a very strong market rally.
This round of the market rally mainly occurred due to changes in expectations about when the Fed would cut interest rates. At that time, U.S. inflation was clearly lower than expected, with the market expecting over 3% but actual figures around 2%. Meanwhile, signs of a slowdown in the U.S. economy were evident.
This shows that the interest rate differential between the U.S. and China is one of the key factors determining market trends.
SFC Markets and Finance: However, if the Fed starts to cut rates, would foreign capital necessarily flow into the Chinese stock market?
Hong Hao: In fact, the emerging markets around the world are still performing relatively well. The ETFs of the Indian market have attracted substantial fund inflows. Indeed, you are right, especially nowadays, the distribution of capital is global.
This year, despite Prime Minister Modi not securing an absolute majority in the election, hindering some of his reform agenda, the Indian stock market has performed well. However, signs of a stock market bubble in India are very clear now, characterized by significant retail participation and inflows of retail funds while foreign investors are not increasing their positions. Index funds, however, due to their need to track index movements, have had to increase their positions during market rises.
Therefore, while Fed rate cuts may not guarantee global capital flows into China, they could serve as sufficient conditions. The necessary condition, however, lies in our own economic and market conditions.
Recently, we introduced the concept of "consolidating the foundations of the economy," akin to a concept in traditional Chinese medicine where one must be strong and healthy to forge ahead. We need to excel in our own market and economy.
In the first quarter of this year, China's economy did indeed show a noticeable rebound. All economic indicators, from the Purchasing Managers' Index (PMI) to retail sales and monetary supply, pointed to this economic recovery. However, the momentum seemed to weaken somewhat in April and May, possibly as anticipation builds for the upcoming important meeting (the Third Plenary Session) and awaiting policy signals.
Therefore, while a Fed rate cut may provide sufficient conditions, the real necessary condition lies in our own strength for our market to thrive.
SFC Markets and Finance: Recently, China has introduced numerous policies to stimulate the stock market, but the results seem to be less effective. Why is this?
Hong Hao: The stock market doesn't rise simply because of stimulation. The intrigue of the stock market lies in every transaction having a buyer and a seller, so even with measures like allowing state-owned enterprises to enter the market, if more people are selling, there's little impact. Thus, it boils down to a confidence issue.
Observing China's consumer confidence index, while there has been some recovery, it remains historically low. This is where confidence becomes crucial. As we often say, "confidence is golden," and we've undertaken various efforts toward this. However, the key factors lie elsewhere.
First, stability in the real estate market is essential. Second, the job market needs clear visibility, especially with impending graduations and current employment pressures. Hence, both employment prospects and income levels need attention.
For instance, personal income tax collections indicate that people's income hasn't grown as significantly as before, encompassing both wages and wealth effects. The wealth effect is vital for consumer confidence as it can significantly surpass the impact of wages and employment alone.
Looking at the U.S. during economic recoveries, whether post-pandemic or after the 2008 financial crisis, the role of monetary policy in influencing economic recovery through the wealth effect is evident. Bernanke's Nobel Prize-winning research on the Great Depression highlighted this, showing how monetary policy affects economic recovery by influencing the wealth effect.
SFC Markets and Finance: How can this confidence be restored?
Hong Hao: As for this issue, I think the key to restoring confidence lies in the recovery of capital market prices. For example, the market rally we saw in April and May, where many were able to profit, naturally uplift spirits.
We hope that there will be more favorable policies supporting the capital market, as these will contribute to its recovery and the restoration of confidence.
SFC Markets and Finance: You mentioned that the Chinese stock market is closely related to international trade frictions, which might continue. How should we handle this?
Hong Hao: Former U.S. President Trump, back in 2018, he started the trade war, followed by the global pandemic from 2019 to 2020. Since then, tariff barriers have risen, and embargoes have been frequent. However, despite these measures, the U.S. trade deficit with China has reached historical highs. Some suggest that the U.S. aims to decouple from China, but the data suggests otherwise. The so-called trade war is actually unsuccessful.
There are many misconceptions among foreigners about China, particularly concerning tariffs. They often wrongly assume that China's competitive advantage primarily stems from subsidies, which isn't the case. When foreign investors establish factories in Southeast Asian countries like India and Vietnam, they encounter different work attitudes compared to China. For example, college graduates in China are highly educated, diligent, and responsible. The situation is different abroad.
Recently, the EU proposed a 13% tariff on BYD, yet BYD's stock price unexpectedly rose by 6% that day. Even with a 13% tariff, BYD remains competitive in the European market. Prior to the 13% tariff increase, BYD's prices in Europe were already 10,000 to 20,000 euros higher than in China. Buying a BYD car in Europe costs significantly more than buying it in China. This demonstrates the strong competitiveness of Chinese exports, which have achieved historic highs in added value globally.
It's intriguing because this competitiveness isn't solely due to subsidies—countries like the US also provide subsidies. For instance, First Solar, a US solar energy company, receives subsidies despite its unit power generation costs being ten times higher than China's. Its market value surpasses that of many advanced Chinese solar companies. How do you explain this?
So the initiative is not in our hands, but what we can do is "consolidate the foundations". Because of our low costs, even with increased tariffs, it won't cause too much trouble for us. But what about the impact on inflation in other countries? This is something they have to figure out.
SFC Markets and Finance: Looking ahead to the second half of the year, how do you think the Chinese stock market will perform?
Hong Hao: Regarding this question, it is indeed difficult to provide answers. For those holding substantial positions, everyone hopes the market can regain its momentum and revive its strength. In the second half of the year, the Federal Reserve is expected to cut interest rates, which will create more room for China's monetary policy and ease exchange rate pressures, benefiting the Chinese market.
Secondly, our profits this year are expected to achieve high single-digit growth, which is not bad at all. At the same time, we also hope that the overall economy can continue to recover. The market expects support from fiscal policies. Currently, China's deficit rate is about 3.8%, close to but not yet reaching the 4% level. With the consideration of ultra-long-term government bonds, the overall fiscal space can reach about 7%, providing the government with more room to take measures. Additionally, tax reforms such as reducing individual and corporate tax burdens will also help in economic recovery and development. Therefore, how policies will guide the market is crucial.
For the current Chinese market, I believe we should not be overly pessimistic. The reasons are simple: first, the Chinese market is undervalued; second, in global investment portfolios, the Chinese market is significantly underrepresented. China's GDP accounts for less than 20% of the global economy, but its market weight in global indices is in the single digits, and the same goes for the Hong Kong market. This provides a huge opportunity for investors.
If I were an active manager of an index fund with a global index benchmark, to outperform this benchmark annually, I cannot rely solely on developed markets. These strong indices tend to revert to the mean, and the underweighting of the Chinese market in global indices compared to its share of the real economy provides us with an excellent opportunity to outperform the benchmark.
However, the specific timing is difficult to determine. it could be in the second half of the year or later, but the underweight and deviation of the Chinese market from the index will eventually experience mean reversion. I also hope it will be in the second half of the year, but I am unsure.
SFC Markets and Finance: I remember you said that there are still well-performing stocks in a bear market. Shouldn't investors be too concerned about the 3000-point level?
Hong Hao: Yes, I believe they shouldn't. For years, people have been saying that the Shanghai Composite Index is distorted. People believe it does not truly reflect the state of China's economy, and these views are correct. If the Shanghai Composite Index is indeed distorted, why do people still use it to judge the health of China's stock market? In fact, this year we've seen many sectors perform very well. For example, the banking sector, due to high dividends and high yields, has performed exceptionally well. Hong Kong's Chinese-funded companies have performed particularly well. Companies like China Mobile and China Unicom have hit new highs in recent years. Therefore, I believe opportunities are always there for those who are prepared.
Therefore, I think everyone should explore the many opportunities this year. Besides the banking sector, China concept stocks, and high-yield sectors, we mentioned earlier, people should not overlook the commodities sector.
SFC Markets and Finance: After discussing the stock market, I'd like to talk about the economy. What are the highlights of China's economy in the first half of the year?
Hong Hao: In the first half of the year, especially in the first quarter, industrial output exceeded expectations, and several indicators in the PMI such as consumption showed strong resilience. Domestic consumption is robust, while the Hong Kong residents also travel north to consume, with monthly spending reaching nearly 20 billion HKD, which is quite astonishing. The consumption market can hardly be a highlight, but at least can be a surprise. Our consumption capacity remains strong; although there is some downgrading in certain areas, overall consumption volume is still rising. Overall, the consumer market remains quite resilient.
Despite concerns about obstacles to international travel, I don’t quite agree. Europe and the US are too expensive, making Japan become more attractive to Chinese tourists. Whenever I travel to Japan, I often run into acquaintances. Anyway, everything, whether it's the stock market or the economy, has both positive and negative aspects. In the real estate sector, some data are not satisfactory. However, we should focus more on the unknown information, as these are the key factors affecting market pricing. What we really need to think about are the factors that have not yet been fully priced into the market, as these unknown factors will ultimately determine market trends.
SFC Markets and Finance: There's an opinion that if China's economy is to achieve sustainable development, it should not rely solely on real estate. So, which industries will have new opportunities?
Hong Hao: Firstly, I think there are several trends. First, there's been more investment in manufacturing and high-tech industries. Despite double-digit declines in real estate investment in recent years, investment in manufacturing has achieved double-digit growth. This represents a notable trend in China's manufacturing sector.
Secondly, there's been a rapid rise in the high-tech sector. Numerous semiconductor research and development companies emerged domestically. Meanwhile, Chinese AI technology had outstanding performance in Gao-kao’s paper ranking at the forefront in the field of artificial intelligence. I forgot which company it was. This is quite impressive, by catching up in a short time.
However, we shouldn't lightly suggest replacing real estate, as its weight in the economy is enormous. Despite other industries growing rapidly, their development will still take time and cannot be achieved overnight. Therefore, these industries can fill the gap left by the decline in real estate.
Chinese companies going global is also a significant current trend, whether in the e-commerce sector in the United States or in the development of payment systems in Southeast Asia. Chinese companies at varying degrees filled market gaps, much like Japanese companies did years ago. After Japan's bubble economy burst, Japanese companies turned to overseas investments, supporting the Japanese economy over the subsequent two to three decades. These experiences undoubtedly offer important lessons for China.
SFC Markets and Finance: From a global perspective, how do you view the global economy?
Hong Hao: If the US and China both demonstrate stable performance in the global economy, and if China can achieve better-than-expected economic growth,under current low expectations , any performance that exceeds expectations would be relatively easy to achieve. Indeed, if both the Chinese and U.S. economies perform well, then the overall global economy won't be too bad. This viewpoint was put forward earlier in the year.
Recently, the International Monetary Fund and the World Bank have both revised their expectations upward for the global economy and China, precisely because previous expectations were quite low and relatively easy to surpass.
SFC Markets and Finance: Some are concerned that the European Central Bank may have cut interest rates too early.
Hong Hao: Yes, there are. Europe is currently facing multiple challenges: there are wars, severe issues with aging populations, and persistent inflation pressures. Additionally, this year's political elections have been full of uncertainties. The unclear outcomes of elections in Germany and France. Stock indices in France falling back to early-year levels. However, even in this context, the market has not fully digested these adverse factors, making the situation quite precarious. This year, Europe is an area of significant concern.
Japan is also under scrutiny due to its exchange rate issues. If exchange rates continue to fluctuate unpredictably, it could potentially destabilize the entire Japanese economy, which is undoubtedly a worrisome risk. In the past, especially when the Nikkei Index surged to over 40,000 points, around 41,000 points, the market was in a frenzy. Foreign investments are bullish on the Nikkei, believing it was on the verge of a springtime recovery. However, the problems are glaringly apparent. The economic conditions in Europe and Japan do pose risks to the global economy. However, we should not use these risks as benchmarks. Our economic forecasts are still based on stronger-than-expected global economic performance, particularly driven by the United States and China.
SFC Markets and Finance: Looking ahead to the second half of the year, what is the biggest risk to the global economy? Could it be the U.S. presidential election?
Hong Hao: The U.S. presidential election is indeed a risk factor that is difficult to price in. This uncertainty indeed poses a risk.
Another concern is inflation. Despite the current moderation in the U.S. inflation rate, components like rent have shown resilience. Furthermore, if tariffs increase and commodity prices perform well above market expectations, inflationary pressures in the U.S. could persist. This uncertainty might be one of the reasons why some Fed officials maintain a hawkish stance.
SFC Markets and Finance: Besides the U.S. election, what other risks should investors be alert to?
Hong Hao: There are many risks that investors need to be vigilant about. It's the ones we can't foresee that are the real risks. Capital markets themselves are highly sensitive and react swiftly; even minor fluctuations can trigger market overreactions. This can also greatly affect people's psychological fluctuations and emotions.
This year, being an international election year, the issue of the U.S. stock market bubble is particularly noteworthy. The overall market considers the prices of U.S. stocks are high. If there is a decline in U.S. stocks that would pose a significant risk. The risk of capital flows in other markets and the appreciation of the U.S. dollar could also exert considerable restraint on the U.S. economy.
SFC Markets and Finance: Although it looks like there are many risks, we still hope for the stock market to prosper.
Hong Hao: Without risks, there wouldn't be any rewards. Financial markets price in risks, and we need to reasonably price in those risks that we can anticipate. So, what we just discussed is, whether it's surprise or disappointment, where does it come from? Given that market expectations are already so low, for China, the situation is unlikely to deteriorate much further. During this year's Spring Festival, we experienced a wave of market volatility triggered by quantitative trading, especially hitting the small and micro-cap markets hard. However, it's worth noting that at that time, the index was around 2600 points, and I firmly believe that was a low point for this year. From this perspective, what we are witnessing now is a market recovery trend, where the lows are continuously rising. Despite the market still experiencing sharp fluctuations, the trend has changed as the lows continue to rise. This is positive and something everyone should pay attention to not the daily fluctuations, but the direction in which our market is developing.
（市场有风险，投资需谨慎。本节目嘉宾意见仅代表本人观点。）
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记者：施诗 李依农 杨雨莱
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