China

The combination of a global manufacturing recession and tight/tightening policy is raising a red flag for global non-TMT stocks. In China, households are entering a liquidity trap, and deflationary pressures are heightening. Authorities need to reduce interest rates considerably and allow the currency to depreciate. By doing so, China will export its deflation to the rest of the world.

China’s economic and diplomatic interests in the GCC region will expand, as will its military presence. Whether or not this stabilizes the region is yet to be determined, particularly if tensions in the South China Sea and other international waters traversed by both the US and China escalate. Underlying risk in energy markets will remain elevated. We remain bullish energy generally, and continue to favor equity ETF exposure to energy (XOP and XME), and commodity exposure via the COMT ETF.

Talks of a détente are premature and there is no domestic political basis in China or the US to support a true détente. Investors should not underappreciate global risk, on the basis of a détente, and should avoid Greater China equities in the next 18 months.

China is facing a risk of deflation. Marginal interest rate cuts and targeted stimulus will be insufficient to boost China’s growth given the current deflationary mindset and the danger is that the economy may be entering a liquidity trap. Deflation is bullish for government bonds, but negative for equity prices. Chinese share prices will continue to decline.

The normalization of oil storage markets in the Northern Hemisphere; strong demand, aided by China stimulus this year; and continued production discipline supports our view Brent prices likely have bottomed, and will move higher from here. We raised our 2023 Brent forecast $2/bbl to $92/bbl. Our forecast for next year is revised upward by $5/bbl to $120/bbl. Price risk remains to the upside, particularly if KSA exercises its option to extend production cuts of 1mm b/d.