Hong Hao's Economic and Market Outlook: So Many Indicators Show Historic Divergence! We are at the turning point of a major cycle.

Hong Hao is the chief economist of Sui Rui Group. This article is a transcript of Hong Hao's speech at the 2025 China Chief Economist Forum Annual Meeting: Let me share my views on next year. It is obvious that many of you have heard the discussions of chief economists in the past two days. The main uncertainties focused on next year are clearly the relationship between China and the US, tariffs, and China's response to the uncertainties in these China-US relations. It is clear that on September 24, we had a series of important meetings where major policies were introduced, such as the 12 trillion debt-for-equity plan, the central bank's re-lending mechanism, the repurchase mechanism, and the recent operations of the central bank, including operations in the exchange rate market. We do not believe that the market seems to have very low expectations for policies, which led to a series of poor declines in the first three days of this year. The beginning of this year is the worst since 2016, and of course, the US stock market is not doing well either. If it wasn't for Friday, the tech stocks in the US stock market boosted the market. This year's "Santa Claus rally", which typically refers to the period from the 24th to the first week of January, would also be the worst in the past 10 years if it weren't for the rise of tech stocks on Friday. Today, it seems that there are various uncertainties about the future. It is clear that we are now at a major turning point in a large cycle. Since China joined the WTO in 2001 and hundreds of millions of Chinese farmers transitioned to manufacturing, we have seen China join the global manufacturing system, helping the continuous decline in global economic inflation and leading to risk-free returns globally, including China's ten-year bond yields continuously declining for 40 years. Until 2021 or 2022, after seeing the Fed's unlimited quantitative easing, suddenly the US inflation, as well as the long-term inflation expectations in the US, experienced a qualitative change, leading to a sudden reversal of the 40-year downtrend, which is a major cycle. At the end of each year, chief economists will forecast the next year, usually indicating the economic growth and GDP growth next year. This year is different because if we continue to focus on the market volatility of the next several months, we may not be well-prepared for the future. Many historical regularities are quietly changing, such as a recent chart that went viral, showing the yield of Chinese ten-year bonds, both domestically and internationally. Whenever this chart is posted, the traffic reaches millions. Chinese ten-year bonds hit a historical low of below 1.6 at the end of last year, despite the "central mother" constantly warning funds not to cluster for warmth. Short-term debt in China seems to be approaching zero-point several billion. These are trading environments that were not very familiar before, especially the yield of ten-year bonds. The rapid decline in the yield of ten-year bonds is demonstrating to us that the market is fundamentally changing its expectations for economic growth and future inflation. Even with the "central mother" taking action, even shorting government bonds did not successfully reverse the downtrend. There were several market events in 2024 that not only defined the market trend for the whole year but also revealed opportunities for the future. During the 2024 Chinese New Year, the entire Chinese market experienced a quantitative earthquake, directly leading the Shanghai Composite to rebound from a low point around 2600 that hadn't been seen for a long time. Many funds, especially quantitative funds, were involved in buying a basket of small and micro-cap stocks while also shorting the entire market index in a hedging strategy to gain alpha from the Beta within the basket of stocks. This strategy had generated stable and high returns for investors in the past decade. However, it collapsed during this quantitative earthquake. This was similar to the quantitative earthquake that occurred in the US stock market in February 2018, causing all ETFs with implied volatility trades to collapse overnight from 100 to 1. This situation actually created opportunities by bringing the overall market down to 2600, and opportunities emerged within the small and micro-cap stocks due to the forced liquidation of funds. Looking back, which sector has performed the best? Before this adjustment, it was obvious that small and micro-cap stocks, the Science and Technology Innovation Board, and the A50 index have provided very good returns for investors this year. Although 2024 was challenging, especially for traders with the market fluctuating here and there, various meetings and policies being introduced, analysts barely sleeping by the end of September were on the phone every evening. The results were the quantitative earthquake that occurred in February, revealing that this opportunity actually performed the best, possibly due to its partial policy connections. What was more important was the value highlighted after the quantitative earthquake in February. In August this year, there was a historic market collapse of the yen carry trade. This was another unprecedented market event. The severity of the plunge of the Nikkei in Japan that day was the most severe since the Black Monday market crash in October 1987. The jump in implied volatility in the US market that day was the largest we have ever seen. The probability of such a yen carry trade collapse is once every tens of thousands of years, meaning that this was not supposed to happen in the market's history. However, there were two instances of such events last year; one was the quantitative earthquake in the Chinese market and the other was the yen carry trade collapse that caused a global market upheaval. Such market events occurred tens of thousands of years apart, and never seen in the market's history, but they happened twice in a year, making it an extraordinary year. Finally, in the first week of November was the US election, which typically, especially with extremists like Trump, will be accompanied by market turmoil. Take a look at which asset category prices are most affected by such political events within the market, and it must be exchange rates, especially for large trading countries with the US, as exchange rates are the relative value between two countries. Therefore, their exchange rate implied volatility will inevitably experience a significant surge. The yellow line represents the implied volatility of the Mexican peso that we saw. This year's November.On November 5th, the offshore Chinese yuan implied volatility spiked to a historical high, with the blue-green line showing that it reached unprecedented levels during the U.S. presidential election. At the same time, the implied volatility in the U.S. market also suddenly surged, which is very interesting. We often say that opportunities arise from market downturns, but when the market crashes, no one enters. The stock market is a strange phenomenon during a big sell-off, no one rushes in to buy, and everyone rushes to close out their positions. It is very intriguing.However, if we look back at history, what happens when the implied volatility of the market, that is, when we observe the market volatility reaching historically high levels, what happens? Looking at the Mexican peso on November 5, 2024, during the US presidential election, it was March 20, 2020, when the US was dealing with the outbreak of the COVID-19 pandemic and the stock market experienced 4 historic circuit breakers within 10 days, and the Federal Reserve began various market intervention measures. At that time, the Fed even violated its own charter by purchasing stock funds, which were originally prohibited, with regulations allowing only the purchase of government bonds. In 2008, they bought everything, even stock funds, leading to a very good opportunity, resulting in a significant increase in the US stock market. In November 2016, was the previous time Donald Trump won the US presidential election. Lastly, on October 23, 2008, during the collapse of Lehman Brothers, as the entire US stock market began accelerating its decline, China was preparing to announce a 4 trillion stimulus plan. Do you think the surge in implied market volatility is a coincidence? Do you think the market surges we observed in 2008, 2016, 2020, and this November coinciding with later market opportunities are coincidental? Definitely not. Because every time there is such a high level of market volatility, it inevitably leads to policy responses. We believe this time will be no exception. With Trump taking office on January 20th, the easiest thing he can do is impose tariffs because tariffs can be signed with an executive order, something he started already in 2018. After Biden took over, the tariffs were not reduced, but increased in various projects, along with technological sanctions and bans against China. In terms of tariffs, sanctions, and bans, the US president's executive power is significant, which explains Trump's preference for tariffs. Trump called tariffs the most beautiful word in the dictionary because their implementation does not require approval from both houses of Congress, enabling him to demonstrate his power as a dictator. Over the past few days, experts have discussed the prospects of tariffs extensively, with some being optimistic. However, as a hedge fund manager, I must be responsible for my investors and manage the risks in our portfolio to the minimum range possible. I cannot risk blindly assuming that tariffs will be better than expected and pushing investors to bet without a clear strategy. Tariffs pose a significant uncertainty this year, and while we hope for the best, the high-level market volatility we are currently experiencing will definitely prompt policy responses. If tariffs exceed expectations, policy responses will also be unexpected. This will create opportunities for the investments we made this year. In the case of the US, which seems invincible, the returns have been over 20% for two consecutive years, a situation seen once before from 1995-1999, with continuous 5-year returns exceeding 20%, which is quite remarkable. With the dominance of the US stock market, many attribute it to American "exceptionalism." Many people believe that advancements in AI technology, including the impending physical manifestation of AI in humanoid robots like Siasun Robot & Automation, will revolutionize the global economy. How to trade the technological wave generated by AI is undoubtedly a new technological trend. Everyone who has used AI technology can feel its power. With GPT 4.0 or even version 3.5 showing research capabilities closely resembling those of a research assistant in their second or third year, AI can easily replace them. AI will follow instructions precisely and work diligently without any emotions, a crucial factor in its appeal. Such innovative technology will inevitably drive economic progress. However, it must follow the economic cycle, as every technological revolution has its cycle. At the peak of every cycle, there is a strong wave of technological advancements, innovations, and international confrontation. This time will be no different. By analyzing the semiconductor cycle in the US and comparing it with the S&P 500, we see a pattern that follows a 3-4 year cadence. The US semiconductor cycle bottomed in November 2008, and in August 2012, the US experienced a historic downgrade in its credit rating. In June 2016, the A-share market hit a bubble peak of 5000 points, which then dropped to around 2400 points, while the global economy hit the bottom and began to rise. In January 2019, the trade war was paused, and the US and China reached the first phase of a trade agreement. Finally, in October 2022, when China's economy reopened after lockdown. Comparing this with the continuous rise of the S&P 500, it seems that not much attention has been paid to the fact that the US semiconductor cycle has peaked and is now falling. The chart was made in the last two weeks, and if updated today, we would see a clear downward trend in the US semiconductor cycle. At this point, how should we trade? Should we rely on technological advancements to drive economic growth endlessly, or should we adhere to the patterns of the economic cycle to control risks? I believe most people will choose not to control risks, as the US stock market seems too strong. Looking at the growth of profits and operational cash flows of several tech giants in the past year, they are at historic highs. Even experts from another famous US semiconductor company, Broadcom, predict that the AI industry will reach its peak by 2027.The sales of fresh products are expected to increase significantly by over 30%, approaching the level of 40%, causing excitement in the market. Broadcom's market value has surpassed $1 trillion, with the stock value increasing by over $300 billion in just two days. Essentially, a large Chinese bank has been created.This market is gaining momentum and pushing forward, with some AI-related concepts, such as the efficiency of cryptocurrency mining needing to be improved. There is a token called Pi coin whose market value has recently surged to 1.2 billion USD in the past two weeks. This is a speculative market, and when speculation becomes too strong and deviates from the economic fundamentals, it can lead to a divergence from the cycle of the US semiconductor industry and the S&P 500 index. Trading at such turning points requires a great deal of patience. We may now see a small technical rebound after many days of decline, testing patience and trading skills. Turning to China, the price-to-earnings ratio of the Shanghai Stock Exchange rose from September to the first week of October. The market value is rising because the fourth quarter earnings are not yet visible, possibly not until January or February of next year. This rapid market rise has brought the Shanghai Stock Exchange PE ratio back above historical average levels. Before this rebound, Shanghai was indeed very cheap, but this rebound has made valuations more normal. Looking at our ten-year government bond, it is clear that it is going in the opposite direction of our P/E ratio. A 1.6% ten-year government bond corresponds to an 11 times P/E ratio for the Chinese market, a deviation we have not seen before. Each deviation presents an opportunity. Looking at China's economic operation itself, the yellow represents China's economic cycle indicators, which follow a 3-4 year rule, from bottom to top to bottom every 3-4 years. We are now in a period of cycle repair, and with various policies helping the economy recover, unfortunately this time the real estate market is seriously hindering economic recovery. After 4 years, our real estate market has not yet returned to normal levels in terms of transaction volume, sales, or prices in the primary and secondary markets. This year's sales may be around 7-8 trillion, compared to the peak of around 18 trillion in 2021. This economic repair cycle has not been as smooth as before, and faced many challenges. After the rebound, there are hidden expectations about the economic cycle, which have already recovered to historical average levels. However, real estate has not yet returned to normal. So, it is difficult in 2024, but opportunities have been created. Many people do not know that if measured in US dollars in 2024, Hong Kong-listed Chinese stocks and Chinese government bonds are among the best-performing asset categories globally. Many opportunities are overlooked, and these opportunities arise in a specific timeframe during the year. Therefore, if friends without the ability to time the market miss these opportunities, they will have missed out this year. By 2025, we have just demonstrated a series of market divergences, not only between the Shanghai Stock Exchange P/E ratio and the ten-year government bond yield, but also as the ten-year government bond yield continues to hit new historical lows, despite the central bank's efforts to discourage fund companies from investing in government bonds. There is a clear divergence between the cycle of the US S&P index and the semiconductor cycle, indicating uncertainty in tariffs this year, as reflected in the above-mentioned indicators. 2025 is another extraordinary year, with historical divergences in many indicators presenting more interesting trading opportunities for those who are prepared. This year may be challenging, but if the strategy is right, it will be rewarding. Wishing you all a successful investment year in 2025! Smooth sailing!