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Chinese equities rallied 24% in USD terms through September, much of this in the final week of the month following the announcement of significant monetary and fiscal easing by the PBoC and Politburo respectively. Leading the move were the prime victims of China’s deflationary slump, including online securities broking company East Money (up 90%), property developer Vanke (82%), consumer laggards such as JD.com (57%) and Meituan (46%), along with names in banking, insurance and construction.

Our more cash generative and growing holdings surged, just not as much as the wider market. This included pan-Asian life insurer AIA Group (27%), energy drink beverage maker Eastroc (20%), Spring Airlines (24%), and tech giant Tencent (17%).

The majority of GEM investors, who have been significantly underweight Chinese equities for years, were caught out by the vertiginous rally fuelled by hopes the policy measures signalled a shift from the CCP towards domestic reflation.

GEM investors have maintained underweight positioning in China

Source: EPFR October 2024

We flagged in our Q2 commentary that despite the risks of institutional quality deteriorating under Xi Jinping, the market was incredibly cheap and positive earnings revisions were beginning to come through:

Instead of allowing a market clearing to resolve supply and demand imbalances in Chinese property, Beijing is attempting a “managed” deleveraging. The issue is that a long and drawn out unwind threatens to entrench deflationary forces that undermine efforts to rebalance the financial system. Further complicating this is that efforts to prevent capital outflows through currency management limit Beijing’s monetary policy flexibility. We wrote in Q1 that a CAPE of 10x for Chinese equities likely signals the build-up of risks that prompts a shift in policy priorities to prevent a bust. While the shift to reflationary policy may indeed be a positive catalyst for unloved Chinese equities, the timing is uncertain.

Hence, we decided to stick with a defensive equal weight exposure in China, on a view that a policy pivot could come at any time and spark a sharp rally.

Our chief economist Simon Ward flagged in Money Moves Markets a few days before the rally that monetary growth was potentially bottoming, and that a falling USD/strengthening yen was opening up space for Chinese policymakers to act:

A key reason for expecting money / credit reacceleration is that the yen rally has relieved pressure on the RMB, easing monetary conditions directly and opening up space for further PBoC policy action. The balance of payments turnaround is confirmed by a swing in the banking system’s net f/x transactions, including forwards, from sales of $58 billion in July to purchases of $10 billion in August. This series captures covert intervention via state banks (h/t Brad Setser) and an August reversal had been suggested by a sharp narrowing of the forward discount on the offshore RMB, which has remained lower so far in September.

Source: LSEG Datastream

The stage was set for the largest rally in Chinese equities since 2008.

The rally reflects the significance of the monetary and fiscal policy announcements, which signal a shift in the way Xi Jinping views the state of China’s economy and the approach needed to break the malaise. How far is he willing to go?

Structural policy shift the fuel for a rally

Our view is that to break deflation, and for this rally to be anything more than just a liquidity driven trading opportunity, monetary and fiscal measures must be truly forceful. This would represent a structural shift in policy, and even the abandonment of a managed exchange rate in order to free up more room to stimulate. We aren’t so sure how likely this is. Although a falling USD and Fed rate cuts will certainly make a shift easier.

The signals from Beijing are certainly positive and indicate that a new approach is being embraced. Notably, the government is preparing to inject liquidity into the commercial banking system to expand balance sheets and boost money growth. In addition, the Politburo has pledged to deploy the fiscal bazooka to support local governments, small businesses, property and families (and not infrastructure).

Perhaps what is most significant is that Xi himself acknowledged the severity of China’s deflationary spiral and has taken up responsibility for fixing it. Will consumers and entrepreneurs respond, or will the stimulus be more pushing on a string? If the response is weak, Xi may feel compelled to do more lest he look incompetent.

Overall, the relative attraction for Chinese equities has increased. The rally has been short and currently looks overbought. We expect pullbacks to provide opportunities to add to China exposure and become less defensive, while favouring A-shares which should pick up some of the running from here.

Monetary prospects and cycle considerations suggest global economic strength in H2 2025 / 2026 but a “hard landing” – or at least a scare of one – may be necessary first.

Commentary here at mid-year proposed the following baseline scenario:

A “double dip” in global industrial momentum in H2 2024 with limited recovery in early 2025, reflecting the profile of real narrow money momentum with a roughly one-year lag.
Pass-through of industrial weakness to the services sector and – crucially – employment, the latter contrasting with experience during the first “dip” in 2022 when labour markets were in excess demand and unaffected.
A further decline in consumer price inflation rates to below target in H1 2025, echoing a fall in broad money growth to very low levels in H1 2023, assuming a typical two-year lag.
A rapid response of monetary policy-makers to downside labour market and inflation surprises, resulting in official rates falling by more by spring 2025 than markets expected in mid-2024.
A consequent strong pick-up in real narrow money momentum by spring 2025, laying the foundation for an economic boom starting in late 2025, consistent with the cyclical framework suggesting joint strength in the stockbuilding, business investment and housing cycles.

The near-term hard – or hard-ish – landing in this scenario is necessary to elicit policy easing sufficient to drive the later boom. Without it, the global economy could remain stuck in a slow-growth equilibrium into 2026, with policy rates kept above a neutral level despite low inflation.

Incoming news has been consistent with several elements of the baseline scenario but others require confirmation:

The global manufacturing PMI new orders index fell to a 21-month low in September. Global six-month real narrow money momentum bottomed in September 2023, signalling a likely PMI trough by end-2024 – see chart 1.

Chart 1

Real narrow money momentum has been moving sideways since the spring at a low level by historical standards, consistent with industrial momentum remaining weak in early 2025.
Manufacturing weakness appears to be transferring to services. The global services PMI new business index remained at an expansion-consistent level in September but output expectations fell sharply to a 23-month low – chart 2.

Chart 2

Employment weakness has yet to crystallise. The global composite PMI employment index is below a low reached during the first dip in 2022 but not yet in contraction territory (50.0 in September). The US economy has continued to add jobs, although payrolls numbers are probably still overstating growth and average weekly hours have fallen.
Inflation news has been favourable. Six-month headline / core consumer price momentum in the US and Eurozone has moved lower since mid-2024, while global PMI output price indices for consumer goods and services have stabilised close to their 2015-19 averages, when G7 annual core CPI inflation averaged 1.6% – chart 3.

Chart 3

Monetary authorities have in most cases shifted dovishly since mid-year. A major Chinese policy pivot at quarter-end could lead to a strong rebound in narrow money growth, supporting the expectation of global acceleration.

To summarise, the baseline scenario is still on track but requires confirmation from early further deterioration in labour market news as well as continued inflation progress.

The stabilisation of global six-month real narrow money momentum at a weak level conceals significant geographical dispersion. A strong pick-up in the US has been offset by falls in China and Japan, while a slow recovery in the Eurozone has caught up with a stalling UK – chart 4.

Chart 4

The rise in US momentum is puzzling and challenges the expected scenario of economic weakness and labour market deterioration into H1 2025. A near-term stall or reversal would reduce this tension and is plausible, with large monthly rises in March / April about to drop out of the six-month comparison.

Momentum remains negative across Europe but – except in the UK – has continued to recover, with a further acceleration expected as a pattern of rate cuts at successive policy meetings is established. UK-Eurozone monetary convergence is at odds with market themes of UK relative economic resilience and inflation stickiness, and incoming data could force the MPC to shift dovishly soon.

Interpretation of Chinese monetary trends has been clouded recent regulatory changes that have reduced the attractiveness of demand deposits, resulting in a switch into time deposits and money substitutes. The narrow money measure shown in chart 4 incorporates an adjustment but the “true” picture could be stronger or weaker. Previous large stimulus packages have fed rapidly through to monetary acceleration but – even if this occurs – economic momentum is likely to remain weak through Q2 2025, at least.

The cyclical framework used here judges current global economic weakness to reflect mid-cycle corrections in stockbuilding and business investment upswings, rather than new downswings in either cycle. The stockbuilding cycle (3-5 years) bottomed in Q1 2023 but an initial recovery due to an ending of destocking has fizzled as final demand has remained weak. The assumption is that policy easing will generate a second leg up in 2025, with a cycle peak possibly delayed until 2026.

The primary trend in the business investment cycle (7-11 years, last low 2020) is also still up, with the current correction probably attributable to a combination of restrictive interest rates, a profits slowdown and heightened uncertainty. Corporate financial balances (retained earnings minus capex) are in surplus in the US, Japan and Eurozone and a recovery in global economic momentum in 2025 could generate a strong “accelerator” effect on investment as animal spirits revive.

A key assumption is that the long-term housing cycle (average 18 years), which bottomed in 2009, will enjoy a final burst of strength in response to lower rates before peaking, possibly in 2026. One reason for believing that the upswing is incomplete is that peaks were historically associated with mortgage lending booms: annual growth of US residential mortgages reached double-digits before downswings into lows in 1957, 1975, 1991 and 2009. The high so far in the current cycle has been 9% (in 2022), with lower numbers in the Eurozone and UK.

The mid-year commentary suggested that defensive equity market sectors would outperform as a H2 double dip unfolded. They did through early September but cyclical sectors rebounded on hopes of rapid Fed easing and large-scale Chinese stimulus. Even if forthcoming, the economic effects will be delayed and may already be discounted in relative valuations – chart 5.

Chart 5

Markets have historically correlated with the stockbuilding cycle, so one approach to assessing investment potential is to compare returns so far in the current cycle with an average of prior upswings. As shown in table 1, US equities, cyclical sectors and gold have performed more strongly than the historical average in the 18 months since the cycle trough in Q1 2023, suggesting limited further upside and possible reversals, even assuming a late cycle peak.

Table 1

International equities – particularly emerging markets – have, by contrast, underperformed relative to history in the current cycle, while commodity prices have been unusually weak. Though also likely to suffer in any near-term hard landing scare, these areas have catch-up potential in the baseline scenario of global economic acceleration through 2025 driven partly by the stockbuilding cycle upswing entering a second phase.

Logistics have become as essential to our daily lives as electricity and water. Operating largely behind the scenes, the growing logistics sector ensures the seamless movement of goods and services across the globe. Just like utilities, we only notice it when things go wrong – be it delays, shortages, or supply chain disruptions – that remind us how indispensable logistics have become to everyone.

Many of us still recall the severe supply chain disruptions during the pandemic, which exposed the vulnerabilities of global logistics networks. While those acute challenges have eased, the industry continues to face headwinds. For example, recent geopolitical tensions in the Red Sea have blocked critical shipping routes, further complicating the already strained system.

Closer to home, the recent port worker strikes on the East and Gulf coasts over wages and automation have impacted roughly half of all containerized imports into the United States. Although a prolonged strike has been avoided with the tentative agreement, the ripple effects might soon be felt. Retailers began moving shipments earlier this year to prepare for potential port strikes, the effects of which can raise freight cost by up to 20% due to the extra warehousing needed to store the larger inventories. The rising cost, along with higher wages, may add pressure to inflation – an indicator the Federal Reserve is closely watching.

These events highlight how reliant businesses and consumers are on the smooth operations of logistics networks. In 2023, the industry was valued at $9.41 trillion, representing 9% of the global GDP. By 2028, it’s projected to grow to $14.08 trillion, at an annual growth rate of 8.4%. The Asia-Pacific region leads the logistics market, contributing $4.6 trillion, as trade routes expand and production shifts to the region. In fact, the container trade flow within Asia is larger than any trade lane globally.

A key segment of the logistics industry is third-party logistics (3PL), which offer a comprehensive suite of services, including warehousing, inventory management and automated shipping. The global 3PL market was valued at over $1 trillion in 2023.

One of our holdings in this space is Kerry Logistics Network (636 HK). The company is an Asia-based 3PL leader with an extensive global portfolio. With its strong presence in Asia, Kerry Logistics supports multinational corporations by providing value added solutions, including integrated logistics, international freight forwarding, e-commerce, industrial and infrastructure project logistics. The company demonstrated resilience during the pandemic, with proven capabilities to move shipments efficiently despite global supply chain disruptions.

Another one of our holdings is ID Logistics Group (IDL FP), a leader in contract logistics, with over 8% market share in France and a growing presence in Europe and the rest of the world. Contract logistics, a specialized service offered by 3PL providers to manage supply chain operations on behalf of clients, generates high levels of recurring revenue under multi-year contracts. The segment was worth $426 billion in 2023 and is expected to grow at over 7% annually by 2032. Given the recurring nature, the business is not very sensitive to recessions and freight cycles. ID Logistics has been constantly gaining market share in Europe and has entered the US through an acquisition, which opens new growth opportunities for the company.

One of the key issues during the recent port strike was the opposition to automation. However, persistent labour shortages, rising operational costs and the growing complexity of global supply chains are pushing CEOs to adopt automation to boost productivity and reduce human error. The global logistics automation market was valued at $34.6 billion in 2023 and is expected to grow at CAGR of 15% from 2024 to 2030. GXO Logistics (GXO US), a holding, which focuses on contract logistics and provides integrated automation solutions to its blue-chip customer base, which includes about 30% of Fortune 100 companies. Its large-scale automation solutions can lead to 50% reduction invariable costs, 60% reduction in inventory wastage, and 50% improvement in inventory efficiency.

As the logistics industry continues to evolve and expand, it creates many opportunities for innovation and growth. It will remain a key area of focus for our investment strategy.

“Climate change is the biggest opportunity of our generation.” This is one the key messages that resonated throughout some of the panels, conferences and workshops at Climate Week NYC. Our participation underscored the inevitability of the energy transition. Beyond advocacy, the event offered actionable insights that enhanced our expertise, helped identify investment opportunities and sharpened our understanding of the challenges we face as investors in a rapidly evolving landscape.

Below are 5 key takeaways from Climate Week NYC.

Energy transition is no longer an option – It’s reality
Global ambitions aligned with the Paris Agreement, aiming to limit warming to 2°C, are becoming increasingly tangible. The momentum from stakeholders, clients and regulatory bodies is driving industries toward cleaner, more sustainable practices. For investors, recognizing this trend is crucial as it opens new avenues for growth and opportunities in transforming sectors. Furthermore, with 2024 being a pivotal election year across many regions, understanding how political shifts will influence climate policies equips us to adapt our strategies proactively.
The regulatory landscape is a game changer
One of the most significant insights was the increasing impact of climate-related regulations and policies. The Inflation Reduction Act (IRA) has emerged as a pivotal policy, promoting both the energy transition and economic growth. With incentives for renewable energy projects, efficiency upgrades and sustainability initiatives, sectors such as renewable energy, energy storage and green infrastructure present attractive investment opportunities. Understanding these policies enables us to capitalize on emerging trends while mitigating risks.
Technology as a catalyst for change
Advancements in renewable energy, energy storage and efficiency are accelerating the energy transition. Innovations in areas like geothermal energy, large-scale battery storage and AI-driven energy management are reshaping the competitive landscape across multiple sectors. These technologies enable greater energy resilience, support the integration of renewable sources and drive efficiency improvements. Staying attuned to these technological shifts helps us to identify emerging opportunities and understand how they contribute to a more sustainable and adaptable investment landscape.
Sustainable practices enhance competitiveness
Sustainable practices are increasingly recognized as a hallmark of sound management and operational excellence. Integrating sustainability into business strategies is seen by many as an indicator of strong leadership, efficient resource management and long-term vision. This alignment not only helps companies reduce risks and adapt to evolving regulations but also enhances their competitiveness by fostering innovation and resilience. By embedding sustainability into their core operations, businesses position themselves for success, signaling to investors that they are well-prepared to navigate future challenges while driving value and growth.
Engagement is key to understanding and investing in resilience
Engaging with companies on their sustainability practices is an effective way to gauge the quality of their management and approach to risk mitigation. Through active dialogue, we gain deeper insights into how businesses manage climate risks, adapt to changing regulations and integrate sustainability into their operations. This engagement not only helps us assess a company’s long-term resilience and adaptability but also ensures that we identify organizations committed to effective management and strategic thinking. By understanding how they address sustainability challenges, we can better align our investments with businesses that are proactive, forward-thinking and poised for sustained success.

Why this matters to our clients

The insights gained from Climate Week reaffirm our commitment to identifying and investing in companies that are not just resilient but capable of thriving amidst changing global regulatory landscapes and climate transition. By staying informed, engaged and proactive, we continue to position ourselves as investors ready to navigate the complexities of a rapidly changing world.

Monetary trends suggest that UK economic performance will converge down to a weak Eurozone.

A post in June argued that Eurozone monetary trends were too weak to support a sustained recovery. The composite PMI output index peaked in May and fell below 50 in September (flash reading of 48.9), confirming an ongoing “double dip”.

The UK economy has outperformed year-to-date: GDP grew by 1.2% between Q4 and Q2 versus a 0.5% rise in the Eurozone, while the composite PMI has moved sideways above 50 (September flash reading of 52.9).

This outperformance, however, follows relative weakness in H2 2023, when GDP contracted in the UK but eked out a small gain in the Eurozone. Q2 year-on-year GDP growth rates are similar, at 0.7% and 0.6% respectively.

This pattern – of UK underperformance in H2 2023 followed by a catch-up in 2024 – had been signalled by monetary trends. Six-month real narrow money momentum was weaker in the UK than the Eurozone in 2022 through Q2 2023 but UK momentum recovered faster last year and had opened up a lead by Q1 2024 – see chart 1.

Chart 1

The lead, however, has been narrowing since April and almost closed in August, partly reflecting a recent stalling of the UK recovery. With momentum still negative, the suggestion is that UK and Eurozone economic performance will be similarly weak through early 2025.

As well as supposed UK relative economic strength, the expectation that rates will be slower to fall in the UK than the Eurozone incorporates a belief that inflation will prove stickier. This is also at odds with monetary trends.

Inflation rates are tracking the profile of broad money momentum two years earlier, in line with a simplistic monetarist prediction. Annual broad money growth was lower in the UK than the Eurozone in 2022 and 2023, suggesting that an undershoot of UK annual CPI inflation versus the Eurozone over May-July will resume in 2025 – chart 2.

Chart 2

A UK double dip would be blamed partly on the confidence-sapping impact of the new government’s gloomy fiscal pronouncements. The MPC’s failure to deliver timely easing would carry much greater responsibility.

The Germans’ reputation for their persistent pessimismus (pessimism in German) is not anything new. Going back as far as the 19^th century when the pessimismusstreit (pessimism controversy) was all the rage among German philosophers such as Taubert and Nietzsche. There is a case to be made however that Germany’s woes in the last couple years, especially since the invasion of Ukraine in 2022, are deserving of such emotions. From being dubbed the sick man of Europe in the 90s after the reunification, to being its industrials crown jewel just 15 years ago (even outpacing US growth at various points), it is now again the poster child of the variety of issues that are causing Europe to lag behind its global peers.

Let’s go through the list:

Internal politics:
While France often takes the spotlight for its chaotic politics in Europe, Germany have its own brand of messy fiscally conservative politics. Well-renowned for their high aversion to fiscal deficit, Germany’s government amended its constitution in 2009 to include a debt brake (Schuldenbremse) which limits annual structural deficit to 0.35% of GDP. Although that rule was suspended during COVID and the Russian invasion of Ukraine, it is now back in place and spending cuts must be agreed on to get back to target. Consequently, Germans have been falling behind in allocating funds to meet climate transition targets along with making many necessary investments in infrastructure and new, growth- focused sectors. Furthermore the low government approval rating and weak economic environment has led to a resurgence of the far-right party “Alternative For Germany”. The far-right party won its first parliamentary seat in the most recent regional elections, the first time a far-right party is represented in parliament since WWII. EU elections earlier this Spring also saw a far-right resurgence from German voters, as dissatisfaction with the political and economic environment becomes more pronounced. We find it unlikely that the current divided politics will lead to any meaningful breakthrough in spending in the short term.
Dependence on the Chinese economy:
Of all large Western economies, Germany remains the most exposed to China. Between 2011 and 2022, growth in German exports toward China grew at a CAGR of over 4%, peaking at €107 billion and representing more than 3% of 2022 GDP. This collapsed in 2023 with the Chinese economy reopening after COVID lockdowns, as its consumers spending deteriorated meaningfully. As such, 2023 exports to China were down just short of €10 billion to €97 billion and unlikely to reach new highs anytime soon. Furthermore, the largest export to China, German-made cars, is under considerable threat from Chinese carmakers that are far ahead on EV development and selling at large discounts to European cars, implying large market share losses from German carmakers. When we factor in supply chains moving out of China and reshoring, we do not expect that China exports will contribute to Germany’s growth anytime soon.
Energy costs:
Germany uses twice as much energy in its industrial sector as the next-biggest country in Europe. It was one of the primary beneficiaries of cheap Russian gas exports before the Ukraine invasion that increased natural gas prices tenfold in 2022, before settling back down to more reasonable levels. Nonetheless the more energy-intensive nature of German industrials and chemicals now makes German producers uncompetitive on the global stage thanks to a higher-cost structure. There also does not seem to be a strong willingness to change its mind on turning away from nuclear energy, with insufficient investment in the energy grid. Firms like BASF and ThyssenKrupp have gone through significant restructuring of their German operations in the last 2 years, with a focus on relocating some plants to lower cost areas.
Cautious consumers:
A 6% unemployment rate has been gradually increasing but remains in line with the average of the last 20 years in Germany. Income is rising faster than prices and rates are coming down. So why the pessimism? Germany was one of the few economies contracting in Europe in 2023, and 2024 has not inspired much optimism so far with many pundits projecting stagnation or another slight downturn in the country. Further negative messaging on adverse demographics and underexposure to secular growth themes for the next decade (climate transition, AI, service economy, etc.) have led investor sentiment to reach new lows.

An important question mark remains around how much of this is weakness is structural and how much can be addressed in the shorter term. Consumer sentiment can shift quickly and the balance sheet of German consumers remain solid. However, no level of internal demand growth will compensate for the weakness from China, which is not expected to improvement anytime soon. There are also questions around whether that demand will be redirected toward Chinese companies as reshoring becomes an ever increasingly important geopolitical topic. When Germany was last facing such structural issues in the 90s, it showed a willingness to cut through red tape and embark on painful but necessary reforms, leading to over a decade of outperformance. We have yet to see signs from current leaders that they are willing to repeat this process.

Despite the all the gloominess, we still see pockets of opportunity within German small caps, although we remain highly selective. The downward trajectory of rates, undemanding relative valuation to large caps and declining energy costs are all positives for small caps which represent 14% of its overall equity market. We continue to prefer names with globally diversified exposure and/or a secular theme that will support growth over multiple years. Here are two examples:

Earlier this year we initiated a position in RENK Group AG, a global leader in mission-critical propulsion and drive technology components for the defense industry and a solid example of German industrial and engineering prowess. Founded in 1873, the company was spun off from a Volkswagen division and acquired by private equity. It is globally diversified as a primary provider to most NATO militaries, which are under more pressure to increase their spending to 2% of GDP. RENK is already present in 75% of tracked military vehicles (excluding China and Russia) and 33% of large surface vessels, with an average content per tracked vehicle around 15%, providing plenty of opportunities to increase its share of sales from higher-margin aftermarket content. Given the strong barriers to entry as a NATO supplier, its backlog extending to 2028 and its strong brand reputation, we find RENK to be one of the best quality names Germany has to offer.

We are also shareholders in Aurubis AG, the largest copper smelter and refiner in Europe, with a market share of over 40% in the region and a growing presence in the US. It sources copper and various other metals both from miners directly and from industrial and scrapyard waste. Copper as a commodity is set to see continued high growth in demand over the next decade given its uses across virtually all industrial segments and its central role in the renewable energy landscape. Copper can also be infinitely recycled, so being the first mover and having existing infrastructure provides a tremendous advantage to Aurubis. The materials sector – more specifically the mining industry – is often seen as a sustainability laggard, but Aurubis distinguishes itself nicely as a unique recycling play with multiple growth levers.

Most data points toward Germany facing continued headwinds. Nonetheless, we seek to retain exposure to the second-largest economy in Europe and we believe names such as RENK Group and Aurubis are the right fits for the job.

A pick-up in US narrow money momentum is a hopeful signal for 2025 but requires confirmation and does not preclude near-term economic deterioration.

The measure of narrow money tracked here (M1A, comprising currency in circulation and demand deposits) rose by 0.8% in August, pushing six-month annualised growth up to 10.5% – see chart 1.

Chart 1

The broad M2+ measure (which adds large time deposits at commercial banks and institutional money funds to the official M2 aggregate) also rose solidly in August, by 0.5%, but six-month growth remains subdued and within the recent range, at 3.5% annualised.

Six-month expansion of official M1 is weaker, at 2.1%. M1 is no longer a narrow money measure, following its redefinition in 2020 to include savings accounts.

Narrow money outperforms broad as a leading indicator of economic direction. The recent pick-up suggests that demand and activity will be gaining momentum by mid-2025. It does not, however, preclude – and may be consistent with – current economic deterioration.

Six-month narrow money momentum similarly recovered from negative to 10% annualised in September 2001 and September 2008. In both cases, the economy was within a recession that the NBER had yet to recognise.

Those narrow money rebounds may have partly reflected a rise in liquidity preference associated with an increase in saving, i.e. they may have been a signal of a reduction in current demand. They also, however, implied potential for future economic reacceleration when liquidity preference normalised and money balances were redeployed.

The 2001 / 2008 experiences were atypical: in earlier recessions, six-month narrow money growth rose strongly only at the end of – or after – the period of economic contraction.

A reasonable assessment, therefore, is that a pick-up in narrow money momentum is a neutral or negative signal for current economic momentum but positive for prospects six to 12 months ahead.

The current positive message is tempered by several considerations.

First, six-month momentum is likely to fall back in September / October because of negative base effects: narrow money rose by a whopping 3.1% (20.0% annualised) in March / April combined.

Secondly, the currency and demand deposit components of narrow money have been individually correlated with future activity historically but the recent pick-up has been solely due to the latter, with currency momentum unusually weak – chart 1.

Thirdly, the Fed funds target rate had been cut by 350 bp and 325 bp respectively by the time six-month narrow money momentum reached 10% annualised in 2001 and 2008. The Fed’s tardiness has increased the risk of a monetary relapse.

Chinese money / credit trends remain weak but could be at a turning point.

Six-month rates of change of broad money and total social financing have stabilised above June lows – see chart 1. (Broad money here refers to M2 excluding money holdings of financial institutions, which are volatile and less informative about economic prospects.)

Chart 1

Narrow money is contracting at a record pace but has been distorted by regulatory changes in April that have reduced the attractiveness of demand deposits, resulting in enterprises shifting into time deposits and money substitutes while repaying some short-term bank borrowing. (The “true M1” measure shown adds household demand deposits to the published M1 aggregate to align with international monetary convention.)

Chart 2 compares six-month rates of change of the raw narrow money series and two adjusted measures. The first assumes that the share of demand deposits in total bank deposits of non-financial enterprises would have remained at its March level in the absence of the regulatory changes. The second additionally adds the inflow to instant-access wealth management products (WMPs) since end-March (data sourced from CICC), on the assumption that this represents a transfer from demand deposits. Six-month momentum of the latter measure was similar in July to the series low reached at end-2014.

Chart 2

Chart 3

Actual and expected monetary easing has been reflected in a further steepening of the yield curve, which has correlated with, and sometimes led, money momentum historically – chart 4.

Chart 4

An easing of Chinese monetary conditions coupled with the start of a Fed rate-cutting cycle could have a powerful monetary impact in Hong Kong, where six-month momentum of local-currency M1 recently returned to positive territory, having reached its weakest level since the Asian crisis in October 2022 – chart 5.

Chart 5

After delaying the inevitable, it’s finally time to upgrade the family car. Now you’re wondering whether to switch to an electric vehicle (EV) or plug in hybrid (PHEV) or stick to the traditional internal combustion engine (ICE) vehicle?

The answer varies by region. In key markets like China, Europe and the United States, the penetration for new EV or hybrid sales ranges from 10.4% to 51%. China leads with over twice the penetration levels of Europe and five times that of the US.

Figure 1 – Global plug-in sales in key markets

Source: Autodata, CPCA, CAAM, KBA, CCFA, OFV, Macquarie Research, August 2024; *Sales in France, Germany, UK, Italy, Norway, and Sweden comprise around 80% of the total European sales

A survey conducted by McKinsey found that 49% of current EV owners in Europe and 46% in the US are likely to switch back to an ICE vehicle due to the lack of public infrastructure and the high total ownership cost. In China, only 28% of current EV owners are considering switching back.

Chinese citizens have made their decision and it’s clear to us where the trend is heading. As of July 2024, China has surpassed the 50% mark for new vehicles purchases being EV or hybrids. Some might find it surprising considering the penetration was closer to 10% during early 2021, according to Macquarie Research.

Figure 2 – China vehicles sales volume

Source: Macquarie Research

The penetration trend is attributed to government support. The Chinese government unveiled a 520B yuan ($72.3B) package of tax breaks over 4 years for EVs. From 2024-2025 all new EVs purchased will be tax-exempt and during 2026-2027 the tax exemption will be reduced by half.

A company well position to benefit from the transition from ICE vehicles to EV or PHEV in China is Hongfa Technology (600885 CH). Hongfa is the largest relay manufacturer, with 40% share of the global market in the high volt direct current (HVDC) segment (70% in its domestic market). Hongfa supplies HVDC relays to most major EV original equipment manufacturers, including Tesla, Volkswagen and BYD.

Unlike ICE vehicles that adopt 12-48V electrical systems, EVs typically operate at over 200V requiring greater reliability, insulation, durability under high voltage, large currents, high temperatures and the ability to extinguish electric arcs.

A typical EV requires 5-8 units of HVDC relay including 2 main relays, 1 pre-charge relay, 2 normal charging relays, 2 fast-charging relays (not required for PHEV) and 1 auxiliary relay. Average content per vehicle ranges from RMB750-1,250 for battery electric vehicles (BEV) and RMB500-850 for PHEV.

Figure 3 – HVDC relay in electric vehicles

Source: Hongfa Technologies, BofA Global Research

The growing demand for relays is driven by three factors:

EVs require a higher content per vehicles when it comes to relays.
EVs require special relays to handle the arcs, which has a higher price point.
EV manufacturers transitioning from 400V to 800V infrastructure (+30% relays vs 400V).

The competitive advantage comes from three main factors:

Lowest cost manufacturer due to scale and vertical integration.
High quality, with a customer complaint rate of ceramic high-voltage DC relays being less than 0.5 ppm.
Stickiness, as relays approved for car builds are not interchangeable due to third-party verified regulations. Hongfa works with EV makers during the design phase, 3 to 5 years before launch.

We believe the company will greatly benefit from the transition to EVs and is well-positioned to thrive within its market, given its leading position, high-quality products and growing demand for HVDC relays.

The recent push by Mexico’s ruling Morena Party to undermine the country’s judiciary is a perfect example of why relying on company fundamentals alone in emerging markets can leave investors exposed to being whipsawed by macro factors.

We covered election risks across EM In July – Political risks in EM spike as Indian, South African and Mexican elections surprise – and flagged that outgoing president AMLO and president-elect Claudia Sheinbaum threaten to undermine Mexico’s institutional quality through a series of regressive reforms. The most damaging of these is the proposal to overhaul the country’s judicial system through having all judges elected by popular vote, along with relaxing the term limits and age/experience hurdles for Supreme Court justices.

As the Financial Times put it in September (FT: Mexico’s retrograde path on the rule of law):

Mexico is barrelling ahead with one of the world’s most radical shake-ups of a legal system, alarming investors and citizens alike. In his final month in office, President Andrés Manuel López Obrador is using his coalition’s congressional supermajority to ram through constitutional changes to change the entire supreme court and several thousand state, federal and appeal court judges with replacements elected by popular vote. Candidates for some posts will need only a law degree, five years of undefined “legal experience” and a letter of recommendation from anyone in order to run.

Lawmakers have been on strike in recent months protesting the move, but to no avail. In September, Morena wielded supermajorities in both the lower house and Senate to push the reform through, which will see thousands of judicial positions up for election over the next three years. Rather than officials working their way up the legal hierarchy, the judiciary will now be exposed to the corruption, bribery and intimidation of Mexico’s cartels, according to critics.

Snatching defeat from the jaws of victory

Mexico should be in prime position to benefit from supply chain reshoring following the pandemic and ratcheting-up of the Sino-US dispute. Indeed, FDI (much of it from China – Why Chinese Companies Are Investing Billions in Mexico – The New York Times (nytimes.com) was pouring into the country to pursue a bright trade story. We saw this in the sharp appreciation of the Mexican peso and a bull market in Mexican equities through 2023 (MSCI Mexico up 42% in USD terms) with the market a favourite among foreign investors.

US imports from Mexico have outpaced imports from the rest of the world
US imports, index Jan. 2017 = 100

Source: GBM Nearshoring Barometer, August 2024.

Mexico a favourite for foreign equity investors through 2023

Source: EPFR

Sentiment soured on deterioration in the political outlook as Morena’s dominant performance in Mexican elections in June emboldened the party to pursue a series of regressive policies. As we noted in June:

Investors fear that a strengthened mandate will allow Sheinbaum (or even an outgoing AMLO) to undermine judicial independence and pursue plans to eliminate autonomous government agencies overseeing telecoms, energy and access to information, as well as weaken electoral supervisory bodies.

Currency overvaluation correcting in Mexico and Brazil
Real broad effective exchange rates, % deviation from 5y ma

Source: NS Partners and LSEG Datastream

From being one of the consensus overweights among EM investors last year, Mexican equities have been hammered in 2024. MSCI Mexico is down 21% in USD terms to mid-September, while the broader index is up 7%.

Source: Bloomberg

Losing the FDI beauty pageant

As one trade official explained to us on a recent research trip in India, competing for FDI is a beauty contest where participants must maximise their appeal relative to their competition to attract those seeking to deploy capital. China’s retrogressive turn to favour state-owned enterprises rather than the entrepreneurs that fuelled its economy’s meteoric rise is a golden opportunity for ambitious leaders in other emerging markets to step up and attract capital and supercharge development. We are seeing this across ASEAN and in India, eastern Europe and the GCC.

But none have Mexico’s advantage of geographic proximity to an economic juggernaut in the US. President-elect Sheinbaum has talked up Mexico’s nearshoring potential and support for private investment in recent months. However, the rhetoric belies an agenda to undermine Mexico’s institutions, which has unnerved key trade partners and investors.

Nothing scares investors and compromises progress up the development ladder more than attacks on key institutions such as the judiciary. In August, the US Chamber of Commerce warned the Mexican government that the reforms would be likely jeopardise trade relations:

“The U.S. Chamber of Commerce respectfully calls on the sovereign Government of Mexico to continue deliberations with the private sector, academics and legal experts on the package of reforms the new Mexican Congress intends to consider in September. This dialogue is essential to ensure that the proposed reforms contribute to strengthening the rule of law and conditions for economic growth in Mexico.

Given our longstanding commitment to Mexico’s growth and prosperity, the U.S. business community is an important stakeholder in the reform process. American companies represent by far the largest source of foreign direct investment in Mexico and provide good jobs to millions of Mexicans. Whether operating in the U.S., Mexico or anywhere else in the world, American businesses depend on respect for the rule of law as the foundation of a vibrant investment climate, sustainable development, and job creation.

While there is a broad consensus about the need to strengthen Mexico’s judicial system, we strongly believe that certain constitutional and legal reforms currently proposed by the Mexican government – in particular, the judicial reform and the proposed elimination of independent regulatory agencies – risk undermining the rule of law and the guarantees of protection for business operations in Mexico, including the minimum standard of treatment under the U.S.-Mexico-Canada Agreement. The reforms also put at risk Mexico’s obligations under other international treaties to provide all with the right to a competent, independent, and impartial judicial system.

Further deliberation to address these concerns is needed to avoid jeopardizing the incoming Mexican government’s ability to generate shared prosperity and to tap into the potential of nearshoring to strengthen the country’s economic growth and development.”

Macro matters – downgrading Mexico

Our process involves scoring the level of team conviction for every emerging market each month and includes an assessment of the direction of travel for politics in the short run and institutional quality in the long run. The trajectory is negative on both counts, and we think souring sentiment could have some way to run.

We have been underweight and defensively positioned in Mexico for well over a year, on a view that a slowing US economy would be an economic drag for Mexico. The deteriorating political backdrop flows through to a downgrade of our conviction rating for Mexico, and consequently a reduction in exposure. The market is already trading at a significant valuation discount to the 10-year average, but we think it can get cheaper still.

Portfolio activity

We sold our defensive staple Walmex last month, in favour of shale oil producer Vista Energy. While listed in Mexico, Vista is actually an Argentinian company boasting a growing production profile. Its shale assets in the Vaca Muerta (Spanish for Dead Cow) geologic formation are some of the best in the world. In contrast to Mexico, there are also some signs that the political backdrop in Argentina is improving under libertarian president Javier Milei, including efforts to deregulate the oil and gas sector which could provide an additional tailwind for Vista.

The race is on

As Mexico falters, we expect competition to reap the fruits of reshoring to heat up. ASEAN, the GCC and India are all banging on the door for foreign investment flows. Political stability, as well as safeguarding and improving institutional quality, will be the keys to success.