Dunhe Asset Management's Xu Xiaoqing: Macroeconomic and Major Asset Class Outlook for 2025

Chinese Economy: Confidence is more important than gold One key issue currently affecting China's economic growth is the sluggish household consumption. Is it because people don't have money to spend, or is it because they lack confidence in the future and are unwilling to spend money? Looking at per capita disposable income, it is projected to grow by 5.2% by 2024, which is 1 percentage point lower than the compound growth rate from 2020 to 2023, and significantly lower than the pre-pandemic growth rate of 9%. When calculating the ratio of household consumption expenditure to disposable income, the consumption tendency reflected has not recovered to the pre-pandemic level of over 70%. It seems that weak consumption demand is due to both decreased income expectations and a lack of willingness to consume. However, from the perspective of the distribution of savings among various sectors due to monetary injections, the potential consumption capacity of households has not decreased. Monetary and financial data are of the highest quality among all economic data, making it unlikely for overestimation or underestimation to occur. In the incremental M2 each year, the proportion of deposit growth allocated to the household sector was only about 30% in 2015, but this has continued to rise in recent years and is currently close to 2/3, reaching a historical high. Another 30% comes from non-bank deposit growth, with a significant portion of this coming from residents purchasing wealth management products and funds. Therefore, the proportion of resident cash assets in the money supply increment is actually higher. In contrast, the proportion of deposit growth allocated to corporate and government entities has significantly decreased to near 0. This distribution pattern means that residents have not converted their excess savings into cash flow for businesses through consumption or investment. Some argue that most of the residents' deposits are concentrated in the accounts of a few high net worth individuals, which may not represent the wealth status of ordinary income families. The consumption tendency of high net worth individuals is generally not high, and these savings may not effectively be converted into consumption. However, the unequal distribution of deposits has been a long-standing phenomenon, and since 2022, the increase in residents' deposits has been consistently higher than the long-term trend. This increase cannot simply be attributed to high net worth individuals being more willing to save money than low-income individuals in recent years. Moreover, the significant increase in residents' deposits in recent years has coincided with a persistent decrease in loan increments in CKH HOLDINGS, which is related to the significant increase in the repayment of existing mortgage loans. However, this has not affected the residents' capacity to save. Using another set of data for verification, subtracting the residents' annual consumption expenditure and annual housing expenditure (calculated based on 30% of the annual real estate sales volume as the down payment amount for residents) from the household disposable income reported by the National Bureau of Statistics, and then subtracting the annual principal and interest that residents need to repay for existing housing, yields a savings amount that normal families can save annually. This data has also been significantly higher than the trend line in recent years, consistent with the significant increase in deposit growth. When comparing the increment of residents' deposits calculated based on income with the actual increment of residents' deposits, the largest gap between the two occurred between 2017 and 2021, indicating that a considerable portion of the residents' savings did not come from normal income as per the statistical method, but from wealth growth achieved through entrepreneurship, investment, and other means. After 2021, these two lines have begun to converge, reflecting the general perception that it has become increasingly difficult in recent years to acquire wealth through non-income means. Through the analysis above, the main point is to illustrate that the abnormal growth in residents' deposits in recent years cannot simply be attributed to wealth becoming more concentrated among high net worth individuals, as both middle- and low-income residents have shown a tendency towards excessive saving. Although the mainstream view in the market suggests that Chinese residents are undergoing an asset-liability recession similar to that of Japanese residents in the 1990s, when it comes to savings, the situations in China and Japan are not entirely similar. After a sharp drop in housing and stock prices, Japanese residents' wealth plummeted, while at the same time, household deposits and cash continued to grow initially but did not exceed the normal trend, falling continuously after 1998, and even experiencing negative growth at one point. Why did Japanese residents not exhibit an excessive saving phenomenon after the crisis? The key reason was that after 1997, Japanese residents' disposable income continued to decline, making it impossible to meet necessary consumption and mortgage expenditure, leading them to rely on consuming savings to cope, ultimately causing a further decline in household consumption capacity. The root cause of the decrease in Japanese residents' income post-1997 was the significant appreciation of the yen by 60% after the Plaza Accord, weakening Japan's industrial competitiveness and causing a more than 50% decline in global export market share. To address the deleveraging of Japan's private sector, the Japanese government also actively expanded fiscal policy, increasing the annual growth rate of government debt to 10-15%, basically offsetting the decline in private sector leverage, thereby maintaining stable overall leverage. However, the positive fiscal expansion did not boost Japanese household income, as household income growth continued to decline and even registered negative growth post-1997. Chinese residents still have the ability to increase savings, indicating that the deterioration of income and the pressure on liabilities are not as severe as in Japan in the 1990s. Understanding residents' excessive saving requires consideration of cyclical and structural factors. From a cyclical perspective, economic downturn leads to a decrease in income expectations, while property and stock values shrink, necessitating an increase in deposits to ensure overall asset stability. In recent years, residents have significantly reduced expenses related to real estate, but the saved funds have not been used for increased consumption, resulting in higher savings. Changes in asset prices actually have a significant impact on residents' consumption behavior, with real estate accounting for nearly 60% of the residents' assets, a higher proportion than in other countries, making the wealth effect of real estate prices more pronounced. The substantial drop in housing prices in recent years has caused the growth rate of residents' assets to fall below the growth rate of income, exacerbating residents' insecurity about shrinking wealth. There are two structural factors at play. First, population aging means that older people no longer buy houses, have already paid off their mortgages, and the income levels of elderly urban residents in China are similar to the overall urban population and more stable, making it easier for the elderly to increase their savings. China's unique one-child policy also makes it easier for older people to transfer their savings to younger generations for consumption or home purchases. Second, the secondary housing market has become the mainstream of the real estate market. Currently, the area of second-hand housing transactions accounts for 40% of total housing transactions, and second-hand housing transactions are inextricably linked to first-hand...The biggest difference in sales is that the former will not reduce the overall level of residents' savings, but only transfer between different residents' savings, so the release of real estate demand will no longer consume residents' savings on a large scale as before.Due to insufficient consumer willingness, M1 growth has been continuously lower than M2 growth, leading to an increasing gap between the two. The deflation pressure felt at the micro level, as well as the pressure on enterprise profitability, are both related to this. How to increase the velocity of money circulation is the most pressing issue in current macroeconomic regulation in China, rather than the fiscal deficit rate which is often discussed in the market. In fact, the debt growth of government departments in the past year has remained around 15%, and the overall macro leverage ratio has been increasing. However, such a large-scale debt increase has not effectively converted money from M2 to M1, which is equivalent to continuously providing blood to a patient but the blood circulation does not improve, resulting in greatly reduced effectiveness. How can excessive savings of residents be converted into actual purchasing power? Changing income expectations is not easy, and even giving out money is only a one-time solution; improving basic living security is a long-term issue that is difficult to achieve in the short term; boosting asset prices is relatively easier, as indicated in the Central Economic Work Conference which explicitly stated the need to stabilize the real estate and stock markets, signaling the government's attention to the wealth effect of asset preservation on consumption. Comparing Japan in the 1990s and the United States after the subprime crisis, the former fell into long-term deflation while the latter quickly entered into reflation. The biggest difference lies in the U.S. successfully raising asset prices through quantitative easing policy, thereby stimulating domestic demand and boosting the economy. In other words, the rise in asset prices is not a result of economic recovery but an important driver of economic revival. Based on historical experience, M1 growth tends to rebound only after housing and stock prices stabilize. This can eventually lead to an increase in the prices of real goods and an improvement in business profitability. The transmission sequence that led China out of deflation from 2014 to 2016 went as follows: in 2014, the stock market rose first, in 2015, housing prices began to stabilize, M1 growth gradually exceeded M2 growth, and it was not until 2016 that the Producer Price Index (PPI) began to stabilize. It can be seen that whether housing and stock prices rise is a key factor in improving consumer willingness to spend. Housing prices play a more important role, especially since after 2018, the influence of second-hand housing prices in first-tier cities on M1 has become more pronounced than across the country, with their stabilization often corresponding to the turning point in M1 growth. Although the wealth effect of stock prices is not as significant as that of housing prices, the turnaround of the stock market often precedes that of housing prices and provides a stronger forward-looking indicator for improving M1. The consensus in the market used to be that only when M1 rises will the A-share market rise. By examining the turning points of A-shares and M1 in the past, it is evident that A-shares have consistently led the way. For example, in July 2014, A-shares entered a bull market, while M1 began to improve in November. This time is no different, as the market surged at the end of September 2024, while M1 only began to narrow its decline in October. When stocks become profitable, some people will convert their savings into investments, naturally speeding up the circulation of money. The most surprising aspect of the recent surge in A-shares is that trading volumes and turnover rates quickly returned to peak levels seen in the bull market, indicating that residents may not be lacking money, but rather confidence. The best performers at the moment are small-cap stocks, while large-cap stocks held by institutions have not seen significant increases, suggesting that the current influx of funds comes mostly from individual investors rather than a few high-net-worth individuals. Can loose liquidity continue to boost asset prices? The basic framework for analyzing price movements is the supply-demand relationship. For example, the significant increase in the price of Bitcoin is mainly due to its limited supply. From a supply-demand perspective, both the stock and real estate markets have experienced significant contractions in supply. In an environment of loose liquidity, they are more likely to rise compared to physical goods that suffer from excess production capacity. Taking A-shares as an example, the rolling 12-month margin financing amount is currently less than 300 billion yuan, at a historical low. Moreover, due to the continuous increase in the dividend payout ratio of listed companies, A-shares have seen dividends exceeding the amount raised for two consecutive years, turning the market from a capital-absorbing market to a capital-injecting market - this is the most profound fundamental change that has occurred in the stock market in recent years. Comparing the fluctuations in the free float market capitalization of A-shares with the fluctuations in the index, it is clear that most of the time during market increases, the index lags behind market capitalization, while during declines, the index falls more than market capitalization, revealing the significant dilution effect of new share issuances and shareholder reductions. After the substantial contraction in stock supply, the index's increase has exceeded market capitalization, indicating a market characterized by easy rise and difficult fall following a contraction in supply. Currently, the ratio of free float market capitalization in A-shares to resident deposits remains at historically low levels. Similarly, the real estate market in first and second-tier cities is likely approaching a turning point in supply-demand dynamics. For three consecutive years, the gap between new real estate construction and sales area has been maintained at 300 million square meters, indicating a significant decrease in future residential supply. Currently, new housing inventory is at historically low levels. Looking at the decline in land supply relative to the peak in 2020-2021, first and second-tier cities are experiencing a greater reduction in supply compared to third and fourth-tier cities. At what level will national real estate sales stabilize? The three northeastern provinces can serve as a good example because this region has experienced population decline and aging for the past ten years. Up until today, the region has not found any new economic growth drivers. The permanent population in the three northeastern provinces started to significantly flow out from 2011 to 2012, and the proportion of elderly people has remained higher than the national average. Real estate sales peaked in 2013. After a 50% decrease relative to the peak, sales stabilized. The proportion of real estate sales to resident deposits in the three northeastern provinces is approximately 8% after stabilization. Following a stabilization in real estate, the nominal GDP growth rate of the three northeastern provinces began to rebound, not due to any new economic growth drivers but because the drag of real estate on the economy weakened. Currently, national real estate sales have fallen by nearly 50% compared to the peak, with the decline occurring at a slower pace than in the three northeastern provinces. The ratio of real estate sales to resident deposits nationwide is also at around 8%. Due to population concentration in major cities after aging, real estate sales in the provincial capitals of the three northeastern provinces have rebounded. After many years, the property prices in these cities have set new highs. The real estate market evolves after entering a declining population cycle.Currently, there is significant differentiation, with third and fourth-tier cities facing the dilemma of continuous population outflow. The real estate market is still in a state of oversupply, making it difficult to reverse the trend of falling house prices, but it does not have obvious wealth effects. Only first and second-tier cities can still maintain a long-term upward trend in house prices, which will have a true wealth effect in the future. Since 2021, the consumption share of first and second-tier cities in the country has continued to decrease, reflecting the greater negative impact of falling house prices in densely populated cities on residents' consumption willingness. What is the difference between the urban village transformation mentioned in the recent central economic conference and the monetized resettlement in the shantytown renovation from 2016 to 2018? Previously, there were 3 million units, but now there are only 1 million units, with a greater focus on first and second-tier cities, which account for 30% of national sales area. By accelerating the clearance of real estate in these cities and improving the supply-demand pattern, stabilizing house prices in these cities can create a spillover effect on the wealth of the entire population.Can the long-term bond yield continue to stay below 2%? The market generally believes that the stimulatory effect of loose monetary policy on the economy is limited and relies more on active fiscal policy. But has China really entered a liquidity trap? If we look at the benchmark interest rate of 7-day reverse repurchase agreements, the central bank has been cutting rates by 20-30 basis points each year from 2022 to 2024, it seems that it has always been loose. However, compared to market rates represented by certificate of deposits rate, the decrease in 2022 was less than 20 basis points, there was almost no decrease in 2023, and only in 2024 did it reach 80 basis points. This means that true monetary easing did not start until 2024, when the rate decrease exceeded the decrease in inflation, and real interest rates began to decline. In December, the political bureau meeting for the first time changed the wording of monetary policy from "prudent" to "moderately loose." The last time the phrase "moderately loose" was used was at the end of 2008 when the 4 trillion yuan stimulus package was introduced. Loose or not is not determined by whether interest rates are lowered, but by whether interest rates are below the neutral level to stimulate the economy and boost inflation expectations. In history, there have been instances where short-term market rates dropped by an amount similar to or higher than in 2024, in 2008, 2014-2015, and 2018, and the economic performance improved in the following year. The continued depreciation of the RMB in 2022-2023 has limited the downward space for interest rates. The central bank's rate cuts have not effectively lowered market rates, and the natural effect of easing is greatly diminished. Also, the central bank has focused too much on regulating quantity targets, mainly M2. If M2 growth is higher than the target values of GDP+CPI, then further easing of monetary policy is unnecessary. 2022 was a typical example, when M2 growth had already exceeded target values, while the RMB was depreciating to 7.2-7.3. The central bank, in order to stabilize the exchange rate, guided market rates upwards, but core CPI was still declining year-on-year, leading to further increase in real interest rates, exacerbating deflation expectations. In 2024, there was a significant change in the central bank's policy approach. Faced with a similar situation of M2 growth rebounding and core CPI declining, even with continued RMB depreciation, the central bank resolutely guided market rates to continue to decline, shifting the focus from stimulating growth to stabilizing prices. The control target shifted from monetary supply to benchmark interest rates, emphasizing the need for price levels to match interest rate levels, rather than focusing solely on matching economic growth with monetary supply. This shift, on the one hand, is because M2 has lost its transmission process to inflation, and on the other hand, the Fed's rate cuts have made it easier for China to take the lead in monetary policy. The yields of China's 10-year government bonds and policy bank bonds have both fallen below 2%, does this mean that interest rates will permanently enter the 1% era? Japan's 10-year government bond yields have been below 2% since 1998, while the US 10-year government bond yields only temporarily fell below 2% after the subprime crisis. By comparing the differences in economic growth, stock capital returns, and long-term real estate returns between Japan and the US from a historical perspective, it can provide a reference for the reasonable range of interest rates in China's future. In the past 20 years, Japan's nominal GDP growth has mostly been below 3%, while the US has only been below 3% in certain years. Currently, China's nominal GDP growth is still above 3%, even if it decreases further in the future, it seems unlikely to remain below 3% in the long term. Comparing the ROE of listed companies in China and Japan, although the ROE of Chinese non-financial enterprises has decreased in recent years, the overall level is still significantly higher than that of Japan in the 1990s. From the perspective of capital returns of enterprises, it is difficult to conclude that China's interest rates will align with those of 1990s Japan. Looking at the changes in housing prices over a decade, Japan has been experiencing a decline since the 1990s, while the US housing prices have had temporary declines, but overall returns over a decade have been positive. The total property value to GDP ratio of Chinese residents is much lower than during Japan's bubble period, and after a decline in recent years, it has fallen to a level similar to Japan's current level. The likelihood of a continuous decline over the next decade seems low. The US economy: Can Trump 2.0 achieve the prosperity of the Reagan era? When it comes to Trump, many people will compare him to Reagan. Both of them were in a phase when the US was entering a period of intensified competition among major powers. Their policy proposals are very similar, emphasizing small government, tax cuts, reduced government regulation, increased trade protection, and strengthened immigration control. Reagan's eight years in office were very successful. In the 1970s, the US economy was in a period of stagflation, but in the 1980s, the US economy entered a period of long-term prosperity. and the US firmly established itself as the winning side during the US-Soviet rivalry. The biggest feature of the "Reagan era" was the reduction of government revenue, with a noticeable decrease in the proportion of fiscal revenue to GDP during his tenure, but it did not achieve drastic reductions in government spending as promised during his campaign. Cutting spending is easier said than done, as it affects the interests of many. Reagan mentioned in his biography, "We are only reducing the growth rate of spending, not actually reducing spending." The fiscal situation faced by Trump compared to the Reagan era allows for very limited room for further expansion. In Trump's first term, tax cuts had already reduced the proportion of fiscal revenue to GDP, and in Biden's term, the proportion of fiscal expenditure to GDP has increased significantly. Now the former is at a historical low, while the latter has already surpassed the highest year of Reagan's era. All fiscal expansions have limits. Historically, the net interest expenditure in US fiscal spending will not exceed 15%. In the 80s and 90s, after this proportion reached 15%, there would be increasing pressure on refinancing, leading to a decrease in the proportion of fiscal expenditure to GDP, indicating that the capacity for fiscal expansion is becoming limited. In recent years, with the rise in deficit rates and a significant increase in interest rates, the interest expenditure on US government debt has grown at an unprecedented rate. 90% of the incremental fiscal spending from 2022 to 2024 will be used to cover the increased interest expenditure. The marginal utility of fiscal expansion on the economy is diminishing. Although the US economy has been experiencing a period of sustained economic growth and reduced unemployment rates under Trump, the long-term trajectory of US economic performance may face challenges due to the constraints of fiscal policy options.The Federal Reserve has started a rate-cutting cycle, but it cannot effectively reduce the financing costs of the Treasury Department. This is because the average cost of medium and long-term outstanding debt in the United States is still below 3%, so as long as the interest rate on newly issued government bonds is higher than 3%, the overall cost will continue to rise. The rising trend will not be reversed by a decrease in interest rates, unless the issuance rate of government bonds can fall below 3%. Even under optimistic estimates, assuming that the Fed lowers the benchmark interest rate to 3.5% by 2025, the proportion of net interest payments in fiscal expenditures will also be close to 15%, reaching the historical limit threshold level of fiscal expansion.The success of the "Reagan era" economic prosperity was another key factor in the joint leveraging of the private and government sectors, achieving a true resonance of fiscal expansion and private sector credit expansion, which is not currently seen. During Reagan's tenure, the leveraging of the private sector was attributed to the animal spirit stimulated by relaxed government regulation. Therefore, there are high expectations for Trump's relaxation of regulation to stimulate new economic vitality. However, what truly drove private sector credit expansion during the Reagan era was the decrease in interest rates, not solely relying on relaxed regulation. How to distinguish whether interest rate factors or regulatory factors have a greater impact on the private sector? During the Reagan era, small cap stocks represented by the Russell 2000 outperformed large cap stocks represented by the S&P only in Reagan's first term. In the second term, small cap stocks continued to underperform large cap stocks. In the first term, the rapid decline of U.S. CPI provided significant room for interest rate declines. In the second term, the CPI trend was more volatile, making it difficult for interest rates to continue to decline. Therefore, monetary easing is the most important factor in stimulating animal spirits, and monetary easing is possible because inflation has been effectively controlled. Currently, the U.S. does not have the conditions for sustained monetary policy easing because inflation is showing strong resilience. The core CPI service prices have been higher than pre-pandemic levels, while commodity prices have gradually turned positive since the second half of 2024. The divergence of import prices in the U.S. and China's industrial prices indicates the effects of trade decoupling after the trade relationship between the two countries began to diverge. The effects are starting to show in the U.S., with inflation showing a feature of being difficult to decrease. The fundamental reason why U.S. inflation cannot significantly decrease is that the money supply has not been effectively controlled. M2 started to decline in 2023 but began to grow again in 2024. At the current growth rate, M2 relative to pre-pandemic trends will remain in a state of overissuance in 2025. Why hasn't the Fed's balance sheet reduction led to a decrease in M2? There are two reasons. First, U.S. fiscal policy remains expansionary, with the first two months of the 2025 fiscal year seeing historically high deficits. Second, global liquidity remains in surplus, with global M2 still higher than pre-pandemic trends. Due to the U.S. economy's significantly better performance compared to other developed economies and emerging markets, much of this money flows into the U.S. Even if U.S. monetary policy tightens, money will still flow into the U.S. currency if other countries' monetary policies remain loose. If core CPI cannot return to below 3%, the pace of Fed rate cuts will significantly slow down, or even stop. With interest rates remaining high, it will be difficult for the private sector to become the main leverager solely through relaxed government regulations. In general, the U.S. economy is transitioning from an overheated phase to a stagflation phase, where the stimulative effects of fiscal expansion on the economy are diminishing, but the inflationary stickiness is increasing. This makes significant monetary easing difficult, and with high interest rates being sustained for longer periods, it will further constrain fiscal and private sector credit expansion, ultimately leading to a significant slowdown in the economy before inflation and interest rates significantly decline. U.S. stocks and gold: Can they continue to win together? In 2024, the two best-performing assets were gold and U.S. stocks, both recording gains close to 30%. Risk assets and safe-haven assets rarely rise significantly together, and this is the second consecutive year that gold and U.S. stocks have experienced significant gains. Historically, there have been only four occasions where both assets have risen by over 10% in two consecutive years, often during periods of fiscal expansion. Fiscal expansion is both the foundation that supports U.S. economic prosperity and the stock market bull market, and an important logic for going long on gold to hedge against U.S. credit risks. If the fiscal expansion in the U.S. weakens in 2025, it will have adverse effects on both types of assets. Historically, when both assets have risen in two consecutive years, they have not continued to rise together in the third year, with performance depending on changes in interest rates. If U.S. bond yields rise significantly, both gold and U.S. stocks will experience noticeable declines; if U.S. bond yields decline, gold may rise, but the performance of U.S. stocks will be average. In other words, gold may perform better relative to U.S. stocks, but absolute returns may not be as good as in the previous two years. The simultaneous rise of gold and U.S. stocks is also a result of global liquidity surplus, with the greatest potential risk factor for liquidity shocks coming from the Bank of Japan intensifying its tightening measures, which is a grey rhino that everyone knows will happen in the future but may underestimate its impact. Among the major developed economies, the Bank of Japan is the only one that has not yet begun to reduce its balance sheet, and true balance sheet reduction is expected to begin in 2025. The Bank of Japan is making the same mistake in 2021 as the Fed did in underestimating the long-term resilience of inflation, always assuming that the rise in inflation is only temporary and delaying rate hikes. Japan's credit expansion is no longer solely dependent on the government's fiscal deficit; the growth rate of private sector debt in Japan has surpassed that of the government sector, and inflation pressures are becoming endogenous. An interesting phenomenon is that the year-on-year increase in rice prices in Japan has reached a historical high, very similar to the first sign of inflation in China in 2004 when pork prices skyrocketed. As one of the most basic food items, the immediate cause of a surge in prices is often related to supply, but because supply is relatively scarce, when total demand begins to expand, prices are more likely to become an explicit indicator of coming out of deflation. At some point in 2025, the Bank of Japan will have to respond to inflationary pressures with faster rate hikes, as this will also be the time of the greatest impact on global liquidity. The Bank of Japan's spillover effect on global liquidity is primarily achieved through interest rate differentials trading, and the basis of interest rate differential trading is that the short-term interest rate differential between the U.S. and Japan must reach a sufficiently large level to inject liquidity into the global market through yen financing. Historical data shows that when the U.S.-Japan short-term interest rate differential remains above 400 basis points, U.S. stocks tend to show characteristics of large gains and small fluctuations. When the differential is below 400 basis points, U.S. stocks may show a decline, with gold performing modestly. In other words, gold may perform relatively better compared to U.S. stocks, but absolute returns may not be as good as in the previous two years.The dollar has stopped rising and the volatility has increased significantly. The short-term interest rate differential between the US and Japan has narrowed to around 400 basis points. The global stock market crash triggered by the reversal of interest rate differentials in August 2024 may just be a preview of what is to come in 2025.This article is reprinted from the "Dunhe Asset Management" WeChat public account; Edited by GMTEight: Huang Xiaodong.