A-Shares Face Stagflation Risk From West

In a significant announcement that has set pulses racing in the financial sector, Jerome Powell, the Chairman of the Federal Reserve, made a statement this Wednesday indicating that interest rates will likely remain unchanged moving into the next yearThis development stirs a complex atmosphere for both the American and Chinese housing markets, casting a shadow over future optimism for stock marketsAs the Federal Reserve signals possible continued tight monetary policy into the early part of next year, analysts are on the lookout for how this might spill over into global inflation trends, particularly into the Chinese marketsConcerns are mounting about the dual implications of stagnation in the U.Sand its potential ripple effects on China's economic landscape.

As we dissect the current financial conditions, a pivotal data release at the end of November revealed interesting trends in Chinese monetary policy

The figures showed that the broad M2 money supply saw a year-on-year increase of 12.4%, while the narrower M1 measure rose by 4.6%. This marked a shift in momentum, with increases of 0.6% and a decline of 1.2% respectivelyHowever, along with these expansive monetary trends, industrial output and the consumer price index (CPI) exhibited year-on-year increases of only 2.2% and 1.6%, suggesting a cooling off from previous monthsThese figures illuminate a complex scenario characterized by what can be termed a "loose monetary policy coupled with a weak economy and low inflation." Such an atmosphere likely contributed to the recent rally in the Shanghai Composite Index, which gained 8.91% last month and saw a slight uptick of 0.55% this month.

Historically, the Chinese A-share market has often functioned as a barometer for macroeconomic control expectations, revealing an inverse relationship with economic growth targets and corporate earnings

• Cambrian's Market Value Exceeds 300 Billion
• Managing Business Revenue and Expenses
• Credit Spread Trends in the Bond Market
• US Stock Market Rebounds
• Global Expansion: Weighing the Costs of Trade

To paint a clearer picture, looking back to 2020 and 2021, there was a noteworthy divergence: GDP growth for the first three quarters of 2020 clocked in at a mere 0.9%, while in 2021, it jumped to 9.8%. During these periods, the Shanghai Composite Index registered annual gains of 13.9% and 4.8%, respectivelyYet, as of mid-December this year, the same index has endured a decline of 12.94%. Meanwhile, the Asian Development Bank forecasts a paltry growth rate of 3% for the Chinese economy this year, encapsulating a scenario where the stock market's performance does not reflect underlying economic health.

Examining macroeconomic indicators, the trend of the M1-M2 growth differential has served as a sensitive indicator in the past; pre-2010, there was a strong positive correlation with the stock marketThis was largely due to a robust relationship between property stock prices and sales

However, as regulatory measures around the housing market tightened, property stocks found themselves spiraling into a troubling conundrum: valuations fell faster than earnings could keep upRecently, the M1-M2 differential reached a staggering -7.8%, illustrating a landscape of heightened government leverage combined with corporate and household deleveraging effortsThis juxtaposition illustrates why the soaring stock market, characteristic of the A-share environment, reflects policy market-driven dynamics rather than a correlation with corporate earnings projections.

From a cautious standpoint, the recent acceleration of the M2 money supply growth reaching levels not seen since May 2016 is a cause for concernThe sustained negative differential between M1 and M2 indicates a lack of confidence in both business investment and consumer spending—a worrying sign indeed

As John Maynard Keynes suggested regarding the ephemeral effects of expansive monetary policy, it’s akin to trying to "push on a string." Here, we see widespread instances of property developers facing significant balance sheet contractions, which further cloud economic expectationsGiven that the ratio of M2 growth to economic growth is currently about 4:1, solely relying on debt expansion to fuel the economy may prove to be ineffective.

Regardless, keeping a keen eye on the money supply's upper limits is imperativeHistorically, the three great bull market cycles within the A-share market—spanning from 1999 to 2001, 2005 to 2007, and 2014 to 2015—were characterized by simultaneous exuberance in both the property and stock markets, with real estate trends preceding substantial gains in financial heavyweight stocks.

If last month’s M2 growth of 12.4% marks a mid-term peak, one could interpret the assertion that the July high of 3,424 points is a significant turning point as more than a mere coincidence

Recalling history, M2 growth recorded its historical peak of 29.64% in November 2009; notably, the Shanghai Composite Index had already topped out at 3,478 points in early August of that same year, suggesting a lead of about four months prior to the peak cash influx.

The pressing question at present revolves around whether the M2 growth trajectory has truly reached its zenithGiven this year's relatively elevated M2 performance (with a low point in February marked by 9.2%), expectations for continued expansion next year are fadingSince the end of 2014 and throughout 2015, when the fabled "bull market" reached its conclusion, M2 growth has oscillated within a contained range, with peaks noted at 13.97% in January 2016 and troughs plummeting as low as 7.97% in May 2018. A cautious projection indicates that should the U.Sproperty and stock markets face synchronized downturns next year, China is also unlikely to witness a return to excessively loose monetary policy akin to that of the 2009 financial environment.

Could we be witnessing a resurgence of the historical pattern where minor fluctuations in the property market lead to abrupt rises elsewhere? Since October 2007, the stock and property markets have seemingly diverged despite substantial monetary easing from the central bank, with much of the liquidity primarily funneled into the housing sector

Data indicates that the astronomical rise in both housing and stock prices in 2009 stemmed from a drastic pivot in macro policy.

Last month, the average purchasing price of commercial housing across China hit 9,785 yuan per square meter—a drop of 3.51% compared to the preceding yearThe risk within the housing market feels reminiscent of the crises of 2000 and 2008, with this year likely marking the third instance of declining house prices since 1998. The largest degree of uncertainty for next year surrounds whether the housing market will see a chaotic surge akin to that of 2009’s dramatic turnaround.

Presently, numerous institutions are advocating bullish positions on the financial and real estate sector, hoping that heavyweight stocks will react favorablyHowever, it’s critical to recognize that the expansive fiscal and monetary policy seen in 2009 is not replicable

As noted by Wang Wei, the head of the Market Economy Research Institute at the Development Research Center, the "macro leverage ratio" has escalated from 246.5% at the end of 2019 to 273.9% currently—significantly higher than the 249% societal leverage rate recorded at the end of 2015. Thus, if any signs of recovery emerge in the housing market, it is crucial to stay alert for potential signals of macro tightening.

Since 2020, a recurrent W-shape cycle, oscillating between economic downturns and recoveries, has become apparent, and the spring of next year may bring another U-shaped recovery scenarioMeanwhile, the optimism surrounding economic rebounds may well be postponed until the summer of next yearOn the horizon, the Federal Reserve appears poised for two more interest rate hikes by March 16 next year, during which time the risks of stagnation from Europe and the U.S