Currently, perhaps the most concerning issue for the market is not only how long and how high will Chinese concept stocks rebound? When playing the policy game, it is indeed difficult to answer this question, but the Dolphin Jun will try to provide a perspective in this article, which is just one opinion.

As the space for the rebound of Chinese concept stocks opens up, starting from the Fed's rate cut (not the liquidity and exchange rate improvement that the rate cut itself can bring to the RMB, but the domestic policy space opened up by the rate cut).

Therefore, the size of the space largely depends on how much room the US rate cut actually has. After the confirmation of the US channel, the next question that the market really needs to seriously consider is, will the economy really have a soft landing? Because this is the fundamental reason that will determine whether the equity market will turn downward after the rebound or continue to rise.

Therefore, Dolphin Jun will first analyze from the basic fundamentals of the US economy, policy orientation, and finally towards the rate cut space for Chinese concept stocks. The following is the detailed content:

I. No inflation risk, consumption weakening again

After the 50 basis point rate cut in September, Powell's implicit meaning in the press conference was that inflation can basically be considered a story of the past, and in August, the most relevant price index for the Fed - core PCE, also confirmed Powell's view.

In August, the US core PCE increased by only 0.13% month-on-month, which is basically within the normal range of 0.1%-0.2% monthly fluctuations around 2% inflation. If we add in energy and food, the overall PCE month-on-month dropped to only 0.09%.

While inflation continues to weaken, consumption in August also weakened significantly: after excluding inflation, personal consumption expenditure increased by only 0.15% month-on-month. While service consumption remained relatively stable at 0.2% month-on-month, goods consumption weakened significantly, with durable goods almost zero growth month-on-month, but to some extent, this is related to the previous month's increase.

So, where did the slowdown in overall consumption growth come from, an increase in the savings rate or a slowdown in income growth? Looking at the US resident income and expenditure data for August, the earning ability of US residents is still increasing (indicating that overall employment or wage levels are not bad), it's just that asset income (such as dividends, etc.) has decreased, affecting the overall income growth, but the overall income side is not a big issue.

The decline in August's consumption is mainly because the squeeze on savings by consumption was not as exaggerated as in July. During this period, due to the sense of security brought by good balance sheets and job security, Americans have been squeezing the savings rate to consume, leading to consumer spending growth consistently outpacing income growth, especially in JulyHowever, in August, although consumption continued to be squeezed, the rate of decline in the savings rate has slowed down. As mentioned in the previous strategy weekly report by Dolphin Jun, by the end of the second quarter, the coverage ratio of residents' savings relative to residents' debts has gradually approached the trend line before the epidemic, and the space for further compressing the savings rate is very limited.

The growth in consumption in the future may have to return to the source of income growth. Currently, total resident income and disposable income have fallen to a month-on-month growth rate of 0.2%-0.3%, corresponding to a nominal year-on-year growth of 2.5%-3.7%.

From the perspective of inflation and consumption data, inflation is falling back to the long-term target of 2%, and residents' consumption is also declining. The space for further squeezing savings to release consumption is becoming smaller and smaller. In this situation, inflation seems more like a transitional issue, and the key has gradually shifted to how to maintain the growth rate of residents' income, that is, to maintain the employment rate of residents.

II. The other side of the ineffective rate hike argument: Rate cuts are also ineffective

In this economic background, Dolphin Jun is increasingly concerned about the possibility of the Fed accelerating rate cuts. Especially recently, two small events put together have made Dolphin Jun pay more attention to the possibility of the Fed accelerating rate cuts in the future.

As we all know, during this round of rate hikes by the Fed, there have been repeated voices saying that inflation has risen due to disruptions in the supply chain, the Russia-Ukraine war, and the epidemic, and has fallen back due to the end of these factors. In addition, the effect of the Fed's rate hikes is very limited due to the low interest rate sensitivity of U.S. fiscal borrowing. For example, the nominal growth rate of the loan balance of the entire U.S. commercial banking system in 2023 was only 2%, which did not hinder the actual growth of 3% in GDP for the whole year.

On the other hand, now that we are in a rate-cutting cycle, there are doubts that rate cuts may also have limited effects on credit and economic stimulus. Dolphin Jun has observed three very interesting phenomena:

a. On September 27, Nick Timiraos, a Wall Street Journal reporter known for his insights into the Fed, wrote an article titled "Rate Cuts May Not Lead to a Soft Landing." His point is that whether rate cuts can support the economy depends on how weak the economy is and whether rate cuts can stimulate credit demand.

Especially in stimulating credit demand, first: the expectation of rate cuts has formed, and everyone knows that interest rates will continue to decline; second, even if the rate has been cut by 50 basis points, the current interest rate level is still higher than the level before the start of this rate-cutting cycle and higher than the average interest rate of existing loans in the market. In other words, even if rate cuts have started, users may not immediately leverage up

b. At the same time, the President of the Federal Reserve Bank of New York announced on September 26th that a Reference Rate Usage Committee will be established, starting operation in October, to supervise the use of benchmark interest rates in financial markets, as well as the evolution and changes in the underlying markets that support the reference rates.

c. There have been two instances of interest rate cut expectations this year, one at the end of last year and the other towards the end of the second quarter. During the interest rate cut expectations at the end of last year, the credit growth rate in the first quarter quickly rose to 3.5% year-on-year. However, when interest rate cut expectations emerged again towards the end of the second quarter, bank credit had not increased significantly, and the stimulus effect seemed less apparent. From the end of the second quarter to the present, the year-on-year credit growth rate is only 1.6%.

Similarly, with two rounds of interest rate cut expectations, and even the recent decline in the yield of the 10-year Treasury bond being lower, the credit growth rate this time has not been stimulated. Does this indicate that the stimulus effect of interest rate cuts and expectations on credit is not so obvious? If this is the case, it is understandable why the Federal Reserve is establishing a Reference Rate Usage Committee to observe whether actual market interest rates can keep pace with the benchmark interest rates.

Looking at all of the above, the Dolphin cannot help but wonder:

1) Various economic data (such as labor market supply and demand status, household balance sheet savings-to-debt ratio, price growth trends, non-farm employment numbers, etc.) are gradually returning to historical average levels of 2% inflation. The risk of inflation rebound seems to be diminishing;

2) At this time, the Federal Reserve, through quasi-media channels and a newly established regulatory agency, is discussing that its designated benchmark interest rate has not effectively penetrated into the real market. Does this mean that if a 50 basis point interest rate cut has limited stimulating effect on credit demand, then corresponding to the rapid rate hikes, in this special cycle, the Federal Reserve may also need to use a higher rate of interest rate cuts to achieve the effect that could be achieved with small rate cuts in the past interest rate cut cycles when interest rates were efficiently transmitted?

Currently, the guidance given by the Federal Reserve is to cut interest rates by 50 basis points in 2024, 100 basis points this year, another 100 basis points next year, and 50 basis points the year after, with long-term nominal interest rates approaching around 3%.

However, if we look at its other long-term guidance - a long-term inflation rate of 2% and a long-term economic growth expectation of 1.8%, the nominal interest rates implied by these two economic performance indicators do not support a long-term nominal interest rate of 3%.

In other words, Dolphin believes that the guidance path of this policy interest rate does not necessarily reflect the true extent and pace of the Fed's interest rate cuts, but rather more about managing inflation expectations: By guiding a slightly tight interest rate cut path, while suppressing inflation expectations, it can actually bring down interest rates faster and to a greater extent in reality, thereby alleviating the interest rate pressure on the real economy (as well as the borrowing and interest payments of U.S. government debt), gradually bringing the cost of new loans back to pre-pandemic levels.

In this scenario, Dolphin suggests that starting from now until next year, there may be a possibility of the Fed actually cutting interest rates faster than the guidance pace.

III. If the Fed accelerates interest rate cuts, will Chinese concept stocks continue to shine?

Faster interest rate cuts under this approach actually help achieve a soft landing for the economy, because fundamentally: Through expectation management, while stabilizing interest rate expectations, faster interest rate cuts can occur to reduce the interest payment pressure on large economic sectors, such as similar to the interest payment pressure of U.S. bonds, the repayment pressure of floating rate bonds, and if the economy truly weakens, under proper inflation management, allowing interest rates to quickly fall back to pre-pandemic levels, similar to the level of existing loan interest rates, truly stimulating new credit demand.

Of course, in this scenario, besides technology, stock selection in the U.S. stock market can truly achieve industry diversification, such as pro-cyclical options, energy, transportation, and so on. Of course, judging from the market performance during this period, what everyone may really want to discuss is the assets of Chinese concept stocks. Will Chinese concept stocks benefit from the significant interest rate cuts in the U.S. stock market?

In fact, even before Powell confirmed the opening of the interest rate cut channel at the Jackson Hole meeting, Dolphin had already hinted in the late August strategy weekly report "U.S. Stocks: Scare Over, What's Next?":

After the start of the U.S. interest rate cuts, there is a possibility of slightly opening up the space for RMB interest rate cuts, which can help alleviate the current high actual borrowing costs, thereby easing expectations of a weak economy.
Furthermore, in the second half of the year, there is hope that government fiscal spending will catch up. In the case of the economy not further deteriorating, and with the gradual release of negative earnings reports, Chinese concept stocks may have a short-term opportunity to rebound with the help of the peripheral U.S. interest rate cuts.
In this scenario, Dolphin gradually starts to add back the positions that were previously cut.

The U.S. interest rate cuts actually present two opportunities for Chinese concept stocks:

After the interest rate cuts, liquidity improves, and there is a small chance of repair for offshore Chinese assets. However, due to the relatively weak domestic fundamentals, the resilience increasingly depends on the improvement of domestic demand, and this sensitivity has been decreasing
The second real opportunity is after the interest rate cut, the domestic policy space opens up, and interest rate cuts and reserve requirement ratio reductions may support the economy.

By the end of last week, both of these logics have been confirmed. However, in addition to the confirmation, what truly exceeded Dolphin's expectations was the expectation of a policy focus adjustment implied in the political bureau meeting. Especially the cognitive change implied in the judgment of inflation - shifting from initially considering the sluggish prices as a symptom of the real estate downturn and economic structural adjustment, to the possibility that deflation may have turned into a situation where enterprises reduce costs and increase efficiency - residents are more reluctant to consume - domestic demand further collapses - enterprises further reduce costs and increase efficiency, forming a negative cycle of self-realization, turning the symptom into the cause itself. For details, refer to the commentary in the Dolphin APP "Crazy! Chinese Concept Stocks".

Based on this understanding, the focus is on truly boosting domestic demand, rather than using production-side methods to increase or optimize supply, allowing the demand side to make purchases on its own. Especially considering that if enterprises expand production again, and overall consumer demand is prevented by precautionary savings in negative expectations, no matter how much demand is stimulated, these sectors will choose not to consume, and enterprises will not invest.

If the management of deflation is divided into a) expectation management mainly through slogans and loudspeakers, and b) policy formulation and implementation as the main body of action. Then, what is currently lacking in the domestic policy is the announcement and implementation of fiscal policy.

Currently in the market, there are indeed some concerns that if the market reaction is too excited, it is equivalent to a good effect of expectation management, but the actual policy will be discounted, once again entering the path of "initial enthusiasm, subsequent decline, and eventual exhaustion".

Dolphin really has no way of knowing, to speculate on the market for a day or two, it may indeed be necessary to look at the consumption situation during the National Day holiday, and even whether there will be substantial fiscal policy announcements at the October meeting.

But one good point is, if a) the actual rate cut in the United States is indeed faster than currently expected; b) the RMB exchange rate management adopts appreciation against the US dollar, and relative devaluation against a basket of currencies, then objectively, the external market will still provide further policy space for the domestic market. At least in terms of domestic policy formulation, if willing, the steps can be taken even further.

And in China, some high-quality assets, even if they fall again after a sharp rise due to lackluster consumption data during the National Day holiday, still have room for further increase in value given the relatively low valuation, in conjunction with the brewing of fiscal policy.

IV. Portfolio Rebalancing and Returns

Based on the logic outlined in the last strategy weekly report by Dolphin Jun "Dropping 50 basis points, is the Federal Reserve the ultimate big shot for US stocks?" , after the Fed's rate cut, with the opening up of domestic policy space, Dolphin Jun first increased its holdings of some relatively high-quality Chinese assets, and after the policies of the three major financial departments exceeded expectations, further adjusted into secondary high-quality Chinese assets with improved fundamentals.

Specific stocks and the rationale for the adjustment are as follows:

After the rebalancing, Dolphin Jun's virtual portfolio Alpha Dolphin rose by 12% last week, underperforming the Shanghai and Shenzhen 300 Index's 16%, Hang Seng Tech Index's 20%, and MSCI China's 17%, but outperforming the S&P 500's 0.6% increase. The main reason for underperforming Chinese assets is the holding of US stocks and gold in the portfolio.

From the start of testing the portfolio to the end of last week, the absolute return of the portfolio was 60%, with an excess return compared to MSCI China of 66%. From the perspective of asset net value, Dolphin Jun's initial virtual assets of $100 million have now fallen to $162 million.

V. Portfolio Asset Distribution

The Alpha Dolphin virtual portfolio holds a total of 13 individual stocks and equity ETFs, with 5 core holdings and 8 equity assets underweighted. The rest is distributed in gold, US bonds, and US dollar cash, with a relatively high amount of cash and cash-like assets currently, considering increasing holdings in the near future. As of the end of last week, the asset allocation and equity asset weights of Alpha Dolphin are as follows: