When will the rebound happen?

Key Points

1. Domestic: From Weak Demand to Recovery.

Last week (2024-09-09 to 2024-09-15, same for the entire text), all economic data for August in China was released, basically meeting the market's previous expectation of "weak demand". However, we need to see the potential for future demand recovery: firstly, China's dependence on "price-for-volume" exports has not decreased, but has unexpectedly strengthened, with the resilience of exports exceeding investors' expectations multiple times this year; from financial data, thanks to the accelerated issuance of government bonds, the new social financing scale in August slightly exceeded expectations. Whether in absolute value or proportion, the government bond issuance in August 2024 was the highest since 2017, indicating a reversal of the unexpected fiscal contraction in the first half of the year. With the combined effects of exports and fiscal policy in the future, a temporary trough in total domestic demand may have emerged. Since 2023, due to the effects of de-financialization and excessive capacity in the midstream sector, PPIRM is more elastic in the upward direction compared to PPI and more resilient in the downward direction. This means that the upstream sector remains a better indicator of demand recovery.

2. Overseas: Transitioning from Recession Trades to the Momentum Stage of Second Inflation.

For overseas markets, the resilience of inflation is once again evident, with core CPI slightly exceeding expectations. At the same time, long-term inflation expectations have deviated from short-term expectations: the short-term inflation expectations at the University of Michigan in the U.S. for September continued to fall to 2.70%, but the 5-year inflation expectations rebounded to 3.10%. Despite weak employment data, global commodities that were previously in recession trades have begun to stabilize and rebound, indicating that the recession trades may have come to an end. From a fundamental perspective, a "soft landing" for the U.S. economy is the most probable scenario: the U.S. fiscal deficit expanded further in August, significantly higher than forecasted and the same period in previous years, massive fiscal support ensuring the resilience of the U.S. economy; and rate cuts themselves are more conducive to the recovery of physical demand.

3. Prepare for the Next Scenario: Path Deduction After Precautionary Rate Cuts.

Using the absolute value of manufacturing PMI as a historical benchmark, this round of rate cuts is closer to historical precautionary rate cuts. It may take about five months (the historical average duration) from rate cuts to substantial recovery in manufacturing data, slower than the pace of recovery in manufacturing PMI after low-rate cuts, but the direction alone is not correct: the absolute level of real demand is equally important. Our statistics show that during rate cuts with manufacturing PMI at relatively high levels, even if manufacturing activities have not immediately recovered, the retreat in commodity prices has been very limited: since 1970, the average change in energy, metal, and mineral indices during high PMI rate cuts has been -0.40%/-2.94%, compared to -12.29%/-12.71% during low PMI rate cuts. Once manufacturing activities rebound, commodity prices will rise to varying degrees, with energy and gold experiencing higher increases compared to other commodities. Overall, considering that the Chinese real estate market has found a new, lower platform, the recovery of global physical demand is only a matter of time, and the probability of commodities and related stocks transitioning from recession trades to rate cut trades has significantly increased 4. A Turning Point May Have Arrived

In the past two months, both the overall market and physical assets have faced systematic headwinds, including further decline in domestic real estate demand, temporary fiscal contraction, and more importantly, a decline in overseas trade. As physical assets retreated, the market also experienced a downward spiral, confirming the market's focus on physical consumption. Currently, the suppressing factors are gradually fading away, with real estate investment oscillating on a lower platform, signs of marginal improvement in fiscal expenditure, and most importantly, the continued strong exports and the imminent overseas interest rate cuts are accumulating strength for a rebound in physical assets represented by commodities. Similarly, the probability of a rebound in the market from February to April 2024 is increasing. We recommend: first, after physical assets experience a decline in trade, upstream resource assets will usher in a turning point: energy (oil, coal), non-ferrous metals (copper, gold, aluminum), shipping (oil transportation, shipbuilding, bulk cargo); second, after the global recession expectations recede, Chinese manufacturing remains a dominant industry, with expectations of stabilizing external demand, household goods and appliances undergoing capacity clearance, intermediate goods driven by emerging market production (special steel), and capital goods under investment restart (instruments, general equipment); third, relatively advantageous assets with decreased capital returns will highlight cost-effectiveness after adjustments, recommending banks, railways, gas, and ports.

Main Content

Domestic Economy: Resilience in Exports + Continued Fiscal Efforts Remain the Main Theme

Last week, important economic data for August in China were all released. In summary, the current domestic economic growth still heavily relies on the resilience brought by exports exceeding expectations through "price-for-quantity" exchange. Financially, there seems to be signs of fiscal efforts starting, and in the future, exports + fiscal measures will be the dual driving force for the recovery of physical demand. In the process of physical demand recovery, upstream prices will be more elastic than midstream and downstream prices. Specifically:

(1) In August, China's export amount saw a year-on-year growth rate rebound to 8.70%, far exceeding the forecasted 7.04%. In fact, in the past 8 months since 2024, 6 out of 8 months have seen export growth rates exceeding market expectations. Looking ahead, consistent forecasts indicate that the year-on-year growth rate of export amounts will continue to rise, even exceeding 10%, meaning that exports will remain one of the core driving forces of domestic economic growth in the future.

Looking at the export country structure, exports to Europe, Africa, and Latin America have significantly improved, while exports to ASEAN and the United States have slowed down, possibly due to the temporary decline in manufacturing activities

One of the core sources of export resilience is the continuing trend of "trading price for quantity". Looking at the export quantity value data for major commodities released by the General Administration of Customs in August, for commodities with a high year-on-year growth rate in export quantity, prices have generally shown a significant decrease.

(2) Looking at the financial data for August, the year-on-year growth rate of M1 continues to hit historic lows, while the year-on-year growth rate of M2 and social financing stock remains relatively stable. On one hand, the impact of regulatory "squeezing out excess liquidity" persists, but on the other hand, it also reflects weak overall financing demand and business activity. However, structurally, thanks to the accelerated issuance of government bonds, the newly added scale of social financing in August slightly exceeded expectations. Whether in absolute value or proportion, the government bond issuance in August 2024 was the highest for the same period since 2017, which may indicate signs of increased fiscal efforts in the second half of the year as we mentioned earlier.

(3) Looking at the inflation data, the unexpected decline in PPI is not only due to the decline in purchase prices of raw materials (PPIRM), but also because in the face of insufficient demand, the midstream manufacturing industry, in a relatively redundant supply environment, also relies on "trading price for quantity" as a core factor. In the August 2023 cycle of China's PPI hitting bottom and rebounding, we found that compared to PPI, PPIRM is more elastic when prices rise and more resilient when prices fall. Therefore, if demand recovers in the future, the elasticity of PPIRM will be greater, and upstream raw materials will still be a better tool to express demand recovery

Overseas: From Recession Trades to the Prelude of Second Inflation

For overseas markets, there is a divergence between long-term inflation expectations and short-term resurgence. Despite ongoing weakness in employment data, with the support of massive fiscal spending and the arrival of precautionary rate cuts, a "soft landing" scenario for the U.S. economy is highly probable. Overseas investors may have shifted from previous recession trades to the next scenario: expectations of second inflation, as there are clear signs of stabilization in prices of major global commodities. Specifically:

(1) In August, the U.S. CPI continued to decline as expected; however, the core CPI slightly exceeded expectations, mainly due to the contribution of housing components, demonstrating the resilience of U.S. inflation. At the same time, there has been a divergence in short-term and long-term inflation expectations: while the short-term inflation expectation from the University of Michigan for September continued to fall to 2.70%, the 5-year inflation expectation rebounded to 3.10%.

(2) In August, the U.S. non-farm payroll increased slightly compared to July, but fell short of market expectations. The weakness in employment data has led to significant fluctuations in market expectations for the extent of the Fed's rate cuts.

(3) Fiscal policy in the U.S. remains the foundation for preventing a significant downturn in the U.S. economy: in August, the U.S. fiscal deficit further expanded, significantly higher than the forecast value and the same period in previous years, ensuring the resilience of the U.S. economy.

![](https://mmbiz-qpic.wallstcn.com/mmbiz_png/8npuEFsWaVRjVnOtDt4YQ1vsVicoibJyo5V3ENnYIeRNxOKM2srXYkq40Rpx0LTU88U8tbhia9loWBsGKibOVXOXLg/640? Previously, the prices of major commodities globally had already factored in expectations of a recession. After weakening at the margin, commodities have recently stabilized instead of continuing to decline, perhaps indicating that investors are starting to shift towards trading in the next scenario. In the future, with the combination of precautionary rate cuts and loose fiscal policies, a rebound in physical demand can be expected, and the second round of inflation in the United States will likely return to the market investors' view.

Be prepared for the next scenario: historical experience and milestones

From an investment perspective, real estate may have entered a new plateau phase of drag. Based on the data released last Saturday, the growth rate of real estate development investment in August did not further decline, in line with our mid-term strategy of around -10%. Meanwhile, the negative growth of commercial housing sales area continued to narrow, and the national housing prosperity index continued to rise. Although investors do not have high expectations for the "Golden September and Silver October", the continued stabilization of real estate without further drag is already a good result. The market has already laid the foundation for focusing on overseas changes.

Reviewing the time lag from the start of the Fed rate cuts to the bottoming out and rebound of the PMI in history, depending on the position of the PMI when the rate cuts start, it can be divided into two scenarios:

(1) The first type is rate cuts when the PMI is at historical lows, which has occurred a total of 6 times since 1970, accounting for 50%. These instances were in July 1974 to January 1975, April to May 1980, April to May 1982, December 2000 to May 2001, August to December 2008, and March to April 2020. The average duration for the PMI to rebound after rate cuts in these times is about 3 months, with three instances rebounding after just 1 month. Most of these six stages correspond to significant economic downturns, such as the typical economic/financial crises in 1980 and 2008.

(2) The second type is rate cuts when the PMI is at historical relatively high levels, which has also occurred 6 times since 1970, accounting for 50%. These instances were in August 1984 to May 1985, May to August 1989, May 1995 to January 1996, From September to December 1998, from July 2007 to February 2008, and from July to September 2019. This is somewhat similar to the current situation, where interest rates are cut before a substantial recession, with PMI mostly at historically high levels starting to rebound when the bottom is no lower than 46. The average duration from the rate cut to the rebound of PMI during the above time periods is about 5 months, significantly longer than the lag in rebounding from a low level, as the stimulus may not be as strong as in the low phase, and the extent of economic recession is not significant.

During the period of rate cuts and PMI bottoming out and rebounding, commodity prices do not necessarily all fall, and may even experience a significant increase before the rate cut, ultimately leading to a sharp decline in commodity prices due to a substantial economic recession. Therefore, if there is a rate cut but no substantial deep recession in the economy, commodities may rise under expected driving forces.

It is evident that during the period of preventive rate cuts at historically high levels of PMI, commodities are more resilient, with limited declines, while at low levels, due to economic impact, the declines are often larger. In the 3 months, 6 months, and 1 year after the rebound of PMI, commodities will experience varying degrees of rebound, with energy and gold generally performing better than other commodities.


A Turning Point May Have Arrived

In the past 2 months, physical assets have faced systematic headwinds, including further decline in domestic real estate demand, temporary fiscal tightening, and more importantly, expectations of overseas recession. Currently, the suppressing factors are gradually fading away, with real estate investment fluctuating at a lower level, signs of marginal improvement in fiscal expenditure, and most importantly, the continuous strong exports and the imminent overseas interest rate cuts are accumulating strength for a rebound in physical assets represented by commodities.

We recommend:

First, after experiencing a downturn in trading, upstream resource assets will usher in a turning point, which remains our top recommendation: energy (oil, coal), non-ferrous metals (copper, gold, aluminum), shipping (oil transportation, shipbuilding, bulk cargo);

Second, with the global recession expectations receding, Chinese manufacturing remains a competitive industry, with expectations of stabilizing external demand, household goods and appliances undergoing capacity clearance, intermediate goods driven by emerging market production (special steel), and capital goods under investment restart (instruments, general equipment);

Third, relatively advantageous assets with declining capital returns, highlighting cost-effectiveness after adjustments, we recommend banks, railways, gas, and ports.

Analysts

Mu Yiling SAC ID S0100521120002

Fang Zhiyong SAC ID S0100522040003