KGI Asia: 2024 Mid-Year Global Market Outlook Target in Sight

While the world is fighting against inflation, the economic growth is under pressure. The slowdown in the United States has already raised concerns. How will it bring risks and opportunities to investors? When will the rate cut cycle begin? In China, the economy recorded robust growth in the first quarter, but the subsequent growth momentum appears unsteady. With the central government’s increased policy support, coupled with the inflow of capital into the Hong Kong market, what insights does this provide for investors?

Under this backdrop, we recommend the “GUIDE” strategy for the second half of 2024:

1. Gold: Buy Gold and Related Mining Stocks on Dips
2. Utilities: Rate Cut Expectations and “AI” Electricity Demand favor Utility Stocks
3. Investment Grade: Seize Investment Grade Bond Yields, favor Corporate Bonds
4. Defensive Stocks: Sector rotation, overweight defensive stocks
5. Eastern Regions: Capture Asian growth

Global Macro and the US Market
The global economy is expected to show a downward trend in the second half of the year. The United States, which previously had the best performance, has begun to experience a significant economic downturn in the first quarter of this year, with the annualized quarterly growth rate dropping to 1.3%, below its long-term trend growth of 1.8-2%. This downward trend is expected to be more pronounced in the second half of the year. While other regions are expected to recover from the bottom after a period of bottoming out, it is feared that it will be difficult to offset the impact of the US decline, coupled with the unimpressive performance of emerging markets, the global economy is likely to show a downward trend.

From an industry perspective, the US manufacturing industry may show a weak recovery, while the service industry is expected to decline slowly. From the perspective of spending, the rapid accumulation of wealth in the US during the epidemic due to the rise in the stock market, coupled with the expansion of fiscal expenditure, US consumption has been stronger than expected. Due to changes in consumption habits and mentality, the marginal consumption tendency of the United States has structurally increased, pushing the consumption power higher than the past perceived level; however, due to the relative lack of resources for low-income earners in the future, their consumption power may be difficult to guarantee.

Regarding inflation, due to a significant drop in commodity inflation in the latter half of 2023, the annual growth rate of core inflation (Core PCE) fell to 2.9% by the end of 2023. However, a resurgence of commodity and service inflation in the first quarter of 2024 caused core inflation to plateau. This, combined with a slow cooling of the labor market, may lead the Federal Reserve to maintain high interest rates for an extended period. It is anticipated that inflation data will start to decrease again in the second quarter of 2024, and the labor market will continue to decelerate. The market anticipates that interest rate cuts will commence in the fourth quarter of 2024, with the interest rate potentially being reduced by 25-50 basis points by the end of this year.

In addition, the focus of the US economy in the second half of the year will be on the presidential election. Trump, who is currently leading in the polls, may be re-elected as president. His proposed corporate tax cuts may be beneficial to corporate profits, but based on the tax cut experience of 2017-18, the effect may not be too obvious; because the current tax rate is already low, it cannot further increase productivity. On the contrary, restrictions on immigration and increases in tariffs may have a negative impact on the economy, corporate profits, and the stock market.

In terms of US stock market, the market atmosphere and economic data since May have basically confirmed that the Fed will not raise interest rates again, so the valuation concerns for US stocks have eased. Although the economy is currently slowing down, due to the limited degree of slowing down, KGI Asia expect that the real interest rate will slowly decline in the future, which will be a favorable factor supporting stock market valuations. What really needs to be noted is the aforementioned Trump’s election or a significant deterioration of the labor market could increase the likelihood of the US economy falling into a recession (hard landing) by the end of the third quarter, and thereby putting downward pressure on the stock market.

As for bond investment, since the United States currently maintains a soft-landing route, and the first interest rate cut is expected in the fourth quarter, the credit spread in the United States will not increase significantly in the short term, government bond yield curve will remain inverted. At this stage, investors can choose investment-grade corporate bonds with shorter durations to earn higher yields; when the US and global economies continue to decline, the US labor market shows an accelerated decline or the risk of a hard landing increases, they can switch to longer-duration government bonds to obtain capital gains brought by the decline in government bond yields.

James Chu, Chairman at KGI Investment Advisory, says: “After a rapid correction in early April, the major global stock markets returned to the bullish track and hit new highs under the stabilization of interest rate cut expectations and the decline of bond yields. However, due to the gradual negative impact of high interest rates on the economy, it is expected that the economy will continue to slow down, especially in the second half of the year, the downward speed may accelerate. Although the current downward trend of the economy is gradually becoming clear, the degree is relatively limited. Therefore, when this phenomenon helps to establish the expectation of an interest rate cut, it is still in the “bad news is good news” stage for the stock market; if we observe in the future that the degree of economic downturn is increasing, for example, when the labor market deteriorates rapidly, we need to worry about the stock market moving to the next stage – “bad news is really bad news”. In the short term, we believe that the market should become more volatile under the influence of high valuations and the gradual slowdown of economic momentum. The policy risk of Trump’s possible election as the next US president and the rapid cooling of the labor market in the future are risks to watch out for in the second half of the year. If the US economy successfully achieve a soft-landing, under the drive of AI demand, corporate profits will continue to grow rapidly next year, and the stock market is expected to return to the bullish track before the end of the year after a volatile correction.”

Mainland China and Hong Kong Markets
1H24 Review: Growth exceeds expectations, but unbalanced growth remains a concern

In the first quarter, China’s economy experienced a growth of 5.3%, surpassing market expectations and establishing a strong foundation for achieving the targeted economic growth of approximately 5% for 2024. However, monthly released economic data indicates that the growth is under pressure. The economic drivers is not yet synchronized to a positive direction. For example, in May, while retail sales growth was satisfactory, the industrial value-added growth was slower than expected, and there was a deceleration in infrastructure and real estate investment, which led to a drag on fixed asset investment. Furthermore, the official manufacturing purchasing managers’ index fell to 49.5 in May, from 50.4 in April, which was worse than expected and within the contraction range, indicating the continued combination of fiscal, monetary, and stimulating policies remains important.

2H24 Preview: Policy efforts are in sight to reach the target
KGI Asia maintain a positive outlook on the China economy. KGI Asia anticipate that the continued implementation of policies will contribute to the restoration of confidence and sustain the momentum of the ongoing economic recovery. Notably, with regard to Fixed Asset Investment, the issuance of ultra-long-term special government bonds and the accelerated issuance of special bonds are expected to play a stabilizing role in infrastructure investment. Furthermore, the central bank’s initiatives targeting the property market, including (1) the reduction of down payments requirement to a record low, (2) the elimination of the lower limit on mortgage interest rates, and (3) the establishment of a RMB 300 billion housing re-loan, are designed to stabilize property market and alleviate the liquidity challenges faced by the property developers. KGI Asia expect that the impact of these policies will begin to materialize by mid-June. As the influence of the high base effect diminishes, KGI Asia foresee a positive year-on-year growth in new home sales (in terms of GFA) starting in the third quarter.

With the positive momentum of capital expenditures on global manufacturing industry, further increase in exports is anticipated, but investors need to stay cautious on the update of U.S. tariff policy. Domestically, in the foreseeable future, the goods and equipment renewal policies are expected to further stimulate growth, hence domestic demand is projected to stabilize.

KGI Asia anticipates that the People’s Bank of China will have one interest rate cut this year and have the deposit reserve ratio reduced by 1 – 2 times. Additionally, KGI Asia have revised our full-year economic growth forecast to 5.0% (previously forecasted at 4.9%); the consumer price index is expected to rebound from 0.2% last year and is estimated to rise and hover around 1% in the second half of this year.

From high growth to high-quality development
Market attention will be given to the “Third Plenary Session” scheduled in July, to discuss economic development. KGI Asia believes that the coming meeting may focus on cultivating newfound industries and accelerating the development of “new productivity.” It is also expected to involve collaboration with “long-term capital” to further enhance development momentum and achieve the goal of “Chinese-style modernization.” Notably, in the government work report of the “Two Sessions” in March this year, “accelerating the development of new productive forces ” was listed as the top priority among the top ten tasks for the year.

In recent months, there has been a shift in policy directions regarding short-term “countercyclical adjustment,” particularly in the form of a “subsidy shift.” This change entails a reduction in subsidies for certain public utilities spending by local governments, resulting in price increases. The adjustment is expected to moderately promote inflation and alleviate the financial burden on local governments. Furthermore, the relevant financial resources are reallocated towards boosting goods trade-in activities. Also, to promote city-specific and improved flexibility on policy implementation is seen as instrumental in facilitating the new development of the economy, particularly in light of the constantly changing environment and challenges.

Relationships between China – U.S. remain a market concern
The U.S. presidential election will be held in November this year, and both parties (Democrats and Republicans) are expected to leverage the “anti-China concept”. The reason is that according to poll results from the Pew Research Center, more than 80% of Americans surveyed hold a negative view of China, and 43% of the respondents hold a very negative view of China. It is imperative to closely monitor the dynamics of the U.S.-China relationship and the potential responses of other nations targeting China. Given the geopolitical uncertainties, fluctuations in the capital market are anticipated in the latter half of the year.

HSI target at 20,900
KGI Asia anticipate that in the second half of 2024, the Hong Kong market may better reflect the positive factors. Key drivers include, (a) the “package of stimulus measures” to accelerate the bottoming out of the property market, (2) the proactive dividend payouts by state-owned enterprises, and (3) capital inflow to the market could help to improve market condition. However, the potential deterioration of China-U.S. relations, especially considering the U.S. presidential election year as mentioned earlier, remains a significant negative factor.

Analyzing the HSI’s trading range over the past decade, the median one-year volatility of the index is approximately 6,130 points. Given that the 2024 year low for the HSI was 14,794, our base case scenario projects that the HSI would reach 20,900 within the next six months. This projection suggests a potential maximum one-year return to be at approximately 22%.

In terms of valuation, the FY24E Earnings Per Share (EPS) of HSI is HK$2,045, representing a yoy increase of 7.5%, aligning with our 2Q24 market outlook. Our base case scenario of 20,900 implies a 10.22x forward Price-to-Earnings (P/E), which remains below the average level over the past ten years. KGI Asia believe that the market’s upward momentum can be sustained under the aforementioned conditions.

5 Major Investment Themes:

1. Economy regains momentum
2. Easing real estate policies
3. State-Owned Enterprise (SOE) reform
4. Increasing energy consumption
5. Going overseas

Top Picks

Prepared by KGI Asia Limited

Kenny Wen, Head of Investment Strategy at KGI Asia, says: “Several economic indicators of the mainland have recently fallen short of expectations, reflecting a deceleration in growth. However, with satisfactory economic growth in the initial quarter, coupled with various stimulus measures, the 5% economic growth target is projected to be achievable. Our focus will be on monitoring the real estate recovery progression in the future. A stabilized real estate market would positively impact the economy and investment sentiment. Regarding Hong Kong stocks, the steady expansion of China’s economy and appealing valuations present an opportunity for capital inflows to increase, potentially propelling the Hang Seng Index to rally. However, while maintaining optimism, stakeholders must stay attuned to updates of geopolitical issues. Taking China-U.S. relations as an example, there is a likelihood for Washington to announce additional sanctions, potentially exerting downward pressure on the stock prices of relevant companies. We suggest five themes for the 2H24, (1) Economy regains momentum, (2) Easing real estate policies, (3) State-Owned Enterprise (SOE) reform, (4) Increasing energy consumption and (5) Going overseas.”

Taiwan Market
As for the Taiwanese market, since the end of last year, the Taiex has seen a rise of more than 30%, ranking among the top globally. This mainly reflects the structural growth of over 20% in the profits of tech stocks in the next two years driven by the AI boom. Secondly, it reflects the market’s expectation for the Fed’s interest rate cut, which has led to a significant rise in the stock market and, in turn, driven the profits of financial stocks to increase more than twofold in the first quarter of this year compared to last year.

Looking ahead, although the AI boom will continue to support the Taiwan stock market to maintain its long bullish pattern, from now until the fourth quarter, the index is likely to be mainly volatile. The reasons are as follows: (1) Although the manufacturing industry is in the inventory replenishment cycle that started at the end of last year, weak end demand leads to weak inventory replenishment. (2) The market’s expectations for AI stocks are too high to further push up stock prices. (3) Valuations are stretched currently and higher than the normal level by 1 to 2 standard deviations. The estimated PE of Taiwan’s stock market is over 20 times, higher than the past 5-year average of 15 times.

As for investment recommendations, from the third quarter, it is recommended to focus on sectors or individual stocks with a low base and low valuations. For stocks benefiting from AI, it is recommended to await a correction in valuation before identifying more favorable entry points for medium-to-long-term investment.

James Chu, Chairman at KGI Investment Advisory, says: “The AI theme is coming in waves, extending from cloud AI to edge AI, with new stars in the game constantly emerging. Besides AI PCs, Apple’s AI upgrade has introduced Apple Intelligence, which is only compatible with A17 Pro and M1 or higher chip models. This is expected to boost market expectations for an iPhone replacement wave, and serve as another catalyst to promote Taiwan stocks. The industry still holds the belief that “only AI is good, everything else is not”, and although AI is good, its supply chain’s current valuation has fully reflected its growth potential, and has pushed the overall valuation of Taiwan stocks to a historical high. It is predicted that the growth momentum of Taiwan stocks’ earnings will slow down from the second to the third quarter, which will limit the index performance in the third quarter, and the high valuation will make the stock market more sensitive to any negative news, so the risk of a correction should be noted. However, due to the structural growth of AI continuing into the years after next, if the valuation of the related beneficiary sectors is properly adjusted, medium and long-term layouts can be carried out again. AI PCs brings topics to the PC industry, with various brand manufacturers successively launching AI PCs. The demand for PCs will gradually recover in the second half of the year, and Apple concept stocks will also benefit from the potential replacement wave driven by the Apple AI upgrade. These are directions that can be gradually laid out during the stock market’s volatile correction period. It is estimated that the growth momentum of Taiwan stocks’ earnings will strengthen again from the fourth quarter, when the improved visibility for next year will help promote the performance of Taiwan stocks.”

Singapore Market
Singapore’s economy continues to maintain its health and stable growth in the post-COVID era. Global tailwinds outweigh regional headwinds, enhancing the city-state in economic strength. Owing to the persistent tensions in the Middle East region, air-born and seaborn transportation further grows in Singapore as logistic companies shift some shipping routes to this Asia logistics hub or increase air cargo load to Asia. The bottom-out of the consumer electronics industry and the upswing of the semiconductor sector help improve Singapore’s manufacturing sector. The visa-free agreement between China and Singapore further boosts tourism, and the hospitality and food and beverage sectors thrive. However, China’s soft economy continues to impact Singapore’s trade. The service sector remains robust, and ongoing capital inflows strengthen Singapore’s status as an Asia wealth hub. KGI Asia expect Singapore to extend growth in the overall economy, especially from the recovery in the manufacturing sector. Meanwhile, the rate cut expectations will enhance sentiments in the real estate investment trust industry. The banking sector will remain resilient as growth in the wealth segment shall offset the projected narrow net interest margin.

Chen Guangzhi, Head of Research, KGI Asia at KGI Asia Singapore, says: “Singapore’s pillar industries are expected to benefit from the global and regional macro environment, recovering and growing to various extents in 2H24.”

Indonesia Market
KGI Asia are positive about economic growth in 2024, despite some volatility in the private sector and ongoing uncertainties. The government’s role in the economy and infrastructure remains steady.

Yuganur Wijanarko, Senior Analyst at KGI Asia Indonesia, says: “The challenges for the country include investing in long-term growth, wise budget allocation, revenue generation, and stabilizing the economy after the new government settles. As an exporter, Indonesia is vulnerable to fluctuations in global commodity prices, affecting export revenue. Keeping headline inflation in check is crucial to protect household purchasing power.”