'Peak Momentum' and a New Phase for Asian Stocks

Episode Summary

Executive Summary: Goldman Sachs’ Tim Moe argues Asia-Pacific equities are benefiting from reflation, especially China’s turnaround in producer prices and profits, but the pace of gains should moderate as growth momentum peaks. He sees China as the region’s most attractive overweight due to improving earnings, a policy-stability “put” ahead of the Party Congress, and favorable investor positioning, while warning that trade shocks and higher input costs could create sector-specific risks.

Main Topics: Asia-Pacific reflation and equity returns (Priority: 5/5): The discussion opens with how the end of deflation in Asia, especially China, is improving corporate profits and supporting regional equity markets after a strong first quarter. Peak growth momentum and moderating returns (Priority: 5/5): Moe explains that both global and Asia-Pacific activity indicators suggest growth momentum is peaking, implying future returns should remain positive but less dramatic than the recent surge. Why China is overweighted (Priority: 5/5): China is favored because it has the strongest nominal GDP acceleration, a policy-stability backdrop ahead of the 19th Party Congress, and supportive investor flows and low positioning. Nominal GDP, earnings, and consumer transition (Priority: 4/5): The conversation clarifies why nominal GDP matters more than real GDP for equities and notes that reflation mainly boosts upstream manufacturing, while consumer and e-commerce growth remain a steady secular theme. Sector winners and losers in reflation (Priority: 4/5): Upstream industries such as coal and steel benefit from higher prices and profits, while downstream sectors with weak pricing power—such as utilities—face margin pressure from higher input costs. China banks and credit stress (Priority: 5/5): Despite debt concerns, Moe argues the near-term operating environment for Chinese banks is improving because non-performing loan formation is slowing and stressed industrial borrowers are again profitable. Fed, dollar, and trade risk (Priority: 5/5): The interview addresses how modest U.S. rate hikes and dollar strength may be manageable, but the largest risk is trade policy, where extreme scenarios could be disruptive and warrant downside protection.

Key Arguments: Asia-Pacific equities have benefited from reflation because deflation had suppressed earnings for years; a shift in Chinese PPI has sharply improved nominal growth and industrial profits. Global and regional activity data suggest the recovery in growth momentum is peaking, so returns should remain positive but normalize from the first-quarter surge. China stands out as the region’s best idiosyncratic opportunity because nominal GDP growth is improving most strongly there and is feeding directly into earnings. A policy “put” exists ahead of the 19th Party Congress: authorities are expected to prioritize stability and avoid abrupt currency or tightening moves. China’s positioning is favorable: southbound capital flows are supportive and global fund allocations to China are at decade lows relative to benchmark weight. Nominal GDP is more relevant than real GDP for equities because markets, revenues, earnings, and valuations respond to price levels, not just inflation-adjusted activity. Reflation helps upstream manufacturing more than consumption; the consumer story remains intact, with e-commerce as the standout growth area. Higher commodity/input prices can hurt downstream sectors lacking pricing power, particularly regulated utilities. Chinese banks look better near term because improving industrial profits are reducing NPL formation and recent bank results beat expectations. U.S. rate hikes are manageable in the near term, but trade policy is the bigger uncertainty; extreme tariff outcomes would be harmful and merit options-based protection.

Data Points: MSCI Asia Pacific ex Japan Index Q1 return rank: Best first quarter in 26 years; second-best quarter in the index’s history - Jake Seward cites the regional benchmark’s strong start to the year. Asia ex Japan earnings growth (2011-2016): 2.6% annual growth in local currency; 1% in U.S. dollar terms - Used to explain weak profit growth during the deflationary period. China PPI at start of 2016: -5.8% - Illustrates the depth of deflation in Chinese producer prices. Latest China PPI (February): +7.8% - Shows the shift from deflation to strong reflation. China industrial sector profits (Jan-Feb, y/y): +30.5% - National Bureau of Statistics figure demonstrating the profit turnaround. Global CAI growth proxy: Improved from roughly 2% to over 4% - Signals the global economy’s growth momentum has strengthened but may be peaking. Typical 3-month return in phase one: 7.9% - Historical average return for MSCI Asia-Pacific ex Japan when above trend and improving. Typical 3-month return in phase two: 1.5% - Historical average return when above trend but moderating. China debt-to-GDP in 2009: About 150% - Baseline for the rapid build-up in leverage. China debt-to-GDP today: About 260% - Indicates a more than 100 percentage point increase since 2009. Long-term trend growth in China: About 6% to 6.5% - Supports the argument that China can grow out of its debt burden. China’s benchmark weight: 25% - Used to explain why underweight positioning may need to be closed if China outperforms. Size of mutual fund universe analyzed: 1.2 trillion - Refers to the universe of mutual funds used to assess China allocations.

Pivotal Quotes: "Simply put, it means better returns." — Tim Moe: On what reflation means for Asia-Pacific investors after years of deflation. "We think we're going to a period where returns will still be positive but decidedly more muted in their magnitude." — Tim Moe: On the shift from peak momentum to a slower but still constructive market environment. "The good comparison between China and Japan, for example, is that Japan got into a significant debt problem... But the key difference is that Japan wasn't growing." — Tim Moe: On why China may be able to manage its debt burden better than Japan did.

Implications: Asia-Pacific investors should expect gains to continue but with less upside than Q1. China remains the preferred regional exposure, though trade shocks and rate surprises could still trigger volatility and make hedging prudent.