Four Black Swans In 2014 China Market

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Four Black Swans in 2014 China Market

The attraction of macro economy lies in its non-linear and uncertainty. To better prevent us from those impossible events we'd better discuss them in advance.

We think there may be four potential Black Swans:

1. Accelerated inflow of foreign capital, which may change the status of domestic monetary supply and demand;
2. PPI continues its deflation;
3. The slowdown of U.S economy;
4. Accelerated deflation of Yen, which may change the expectation of the whole economy.

Domestics: Accelerated inflow of foreign capital

The tapering has brought a second turning point of global liquidity. One important impact is that the capital flows to emerging market will be slowed down. In the first half of 2014, global macro asset allocation should still follow the logic of economic growth. In other words, international capital flows to China is determined by China's own economic growth in the first half. The greater risk lies in the second half. If U.S.'s core inflation comes as early as what we have expected, there will be a serious withdraw risk. In a word, under the situation of high leverage, economic growth and the need of capital while in transaction, the overall inflow of foreign capital will not change the problem of tight capital supply.

Accelerated inflow of foreign capital, which may change the status of domestic monetary supply and demand.

1. Economic growth changes into sustainable growth mode. Under the government's "promote transformation" and "maintain stability" idea, the economic growth in 2014 will be limited or slowed, improves in the relative stability of China's economic growth will weaken concerns. Meanwhile, the government-led economy reform changes from investment-based growth to focus on the extensive growth of the quality of sustainable development. Thus, the slowed economic growth does not mean a decline in corporate profits. Return on capital will shift to a more healthy recovery. The slowdown of economic growth might not have so much impact on foreign capital inflow.
2. Tight liquidity creates arbitrage opportunities. From the attitude of the government and PBOC, 2014 domestic liquidity is likely to remain tight, and capital price will still be high. The tapering will bring about a second turning point of the global liquidity. Meanwhile, the political need of RMB globalization will cause RMB appreciation. This will cause an interest arbitrage opportunity.
3. The opening of capital account will cause substantial inflow of foreign capital. Third Plenum of Eighteen has greatly improved the expectation of foreign investor to the domestic market and brought in a large amount of capital inflow. However, the FDI data showed that those inflow are more inclined to short-term arbitrage than long-term investment because of the doubts about the reform. However, from the recent moves taken by the government and PBOC, the reform might be faster than market expectation. If some reform policies are introduced next year, the further inflows might occur.

In a word, the future possible inflow of foreign capital might ease the problem of debt risk and cleared the road for China's economy reform.

Domestics: PPI continues its deflation

The surplus of 2013 and the reduction of inventory will led to a continued deflation of PPI. However, as the inventory level goes down to 1999-2003' reduction of inventory medium level, the continuously drop of price will be slowed. In a norm condition, PPI will be positive in the mid of 2014.

Supply and demand factors resulted in PPI deflation continues

1. Government to promote the transition to further suppress the traditional industrial needs. 2014 annual production overcapacity situation may be better than 2013, but capacity utilization is likely to remain at a low level. This means that when demand picks up may bring more supply, making PPI slow recovery. In addition, the government in "promoting transformation" of ideas, even though there are still appeals to the GDP, but its GDP pulling means may be little correlation with traditional industrial sectors of environmental protection, social security and so on. The initiative is likely to slow down investment in infrastructure-related spending. If this factor led to a sharp slowdown in investment-related industrial demand may lead to a larger proportion of the relevant industrial PPI be a second round of price declines.
2. Global commodity prices face downward pressure. Inflection point of the second-order global liquidity to bring downward pressure on commodities, and a slowdown of growth and transformation of China's economic growth will weaken demand for copper and other commodities, resulting in further downside on global commodity prices pressure. Also, if the Fed from the middle of next year, "the initiative to withdraw" to "passive tightening" of the expected changes, could cause commodity prices to fall further. Meanwhile, negative factors such as oil, nonferrous metals, such as iron ore supply may also be commodity prices.

United States: Deceleration again

The basic judgment on the U.S. economy is "continuing to recover, but the potential growth rate of the economy has led to the ceiling, core inflation start early."

Due to the current market expectations for the U.S. economy is high, so even if the U.S. economy downturn than we think, it will be a long-term asset allocation categories subvert the market direction is huge "black swan."

1. The contribution of labor to economic growth or decline. U.S. labor force growth slowing, if the economic growth is split into labor, capital and TFP contribution, the contribution of labor to economic growth is weakening. Aging and declining population, the U.S. labor force participation rate also reflects the plight of the labor force.
2. Structural unemployment could damage potential economic output. After the financial crisis, some people may be due to prolonged unemployment and the loss of the necessary labor skills, leading to rising structural unemployment, the economy's potential output has also been negatively affected. From the recruitment rate and unemployment data, there has been a significant structural unemployment. The result is an uplifting of the natural rate of unemployment, if not fully understand this point, it may lead to slow stimulus exit, causing inflation.
3. Uncertainty remains financially. Although the budget agreement reached by the two parties to get through and some of the large probability eliminates uncertainty on fiscal spending, but the debt ceiling expires February 7, 2014 is not resolved, it is uncertain financially. Moreover, the specific spending may continue on a bipartisan wrangling.
4. Shale gas revolution could not be like imagination. Shale gas revolution in the U.S. labor productivity has improved significantly the energy industry, has brought great advantages to the United States on energy, for promoting the recovery of the U.S. manufacturing sector is a major driving force. But the high cost of shale gas exploitation and the rapid decay to shale gas production has brought great uncertainty. Meanwhile, there is a huge political uncertainty shale gas exploration itself. If the exploration and development of shale gas weaker than market expectations, then it may affect the strength of the U.S. recovery.
5. Recovery slower than expected QE exit may affect the rhythm. At current market expectations that the Fed may further cut each FOMC meeting on the scale of $ 10 billion purchase of bonds by the end of 2014, the end of QE. But if the U.S. recovery is slower than expected, could lead the Fed to exit the tempo slowed, QE is likely to drag completely finished in 2015.

The more important question is that, if the U.S. economy has experienced three rounds of QE plus round OT after down again, it may cause the market began to question the effectiveness of QE. If the market began to question this issue, the overall global asset allocation categories are likely to change subversive appear. Over the past few years, substantial repair their balance sheets through QE economies (U.S., Japan, Britain, etc.) may be subject to abandonment, and early entry into the monetary tightening economies (Europe, Japan) there may be a substantial sought funds.

Japan: Accelerated depreciation of the yen on the Japanese economy is expected to change again.

Current expectations are for the Japanese market, in the "Abe economics" to stimulate its economy is finally showing the momentum of recovery, but the 2014 increase in the consumption tax to cast a shadow over the Japanese economy. Judging from the market, despite the recent depreciation of the yen signs appeared again, in dollar terms was significantly weaker than the Japanese stock market returns on the performance of one yen devaluation period, indicating that the market for the Japanese economy is expected to remain weak. Although Japanese consumption tax will affect hedge again allow the depreciation of the yen, but the overall efforts to pull the economy is limited, this is our basic judgment.

Consumption tax is an excuse; depreciation of the yen is the core.

1. Consumer concerns about high taxes. From 1997 to increase the consumption tax situation, in 2014 the consumption tax increase may jeopardize the economic recovery at risk. Japan's fiscal stimulus helped Japan's recovery, but also brought the budget deficit. One reason for the increase of the consumption tax to make up the deficit, but the government overcharged tax, a direct result of the private sector will be squeezed out and cut spending, in order to sustain economic growth before the government will increase spending (or increase monetary policy stimulation, which causes the depreciation of the yen), which will weaken the taxes to make up the deficit through the efforts of the efficiency of government spending unless significantly higher than the private sector (efficiency is high we do not discuss here). In short, the economic recovery has just established a hurry to raise taxes will bring great risk.
2. Japan's economic performance since April shows that the current yen remains strong. BOJ quantify qualitative easing significantly stimulated double Japan's economy, it also brings a depreciation of the yen. However, the strong monetary policy stimulus, the yen exchange rate since April maintain a level of around 100, because of the pressure of the United States makes its continued depreciation of the Japanese did not, the specific operation in Japan by foreign exchange market operations to stabilize the exchange rate, thus lead to a net yen put on the market discounted. If the increase in the consumption tax reflects the significant negative effects, then we need more policy stimulus to stabilize the economy.

From the beginning of the process of accelerated depreciation of the yen's point of view, once with the depreciation of the yen is expected to rise in systemic and views on the Japanese economy began to change, this black swan event, will result in:

1. Capital flows into U.S. combined economies (such as China).
2. Assets of Southeast Asian (Japanese manufacturing backyard) will be sought after.