(Public) Moderately Loose? No, I'm Not Talking About The Oil Market. Buckle Up, It's About To Get Real.
What China wants, what China gets.
Editor’s Note: This article was first published to paying subscribers on Dec 9, 2024.
Early this morning, China's Politburo announced a meaningful strategic economic policy shift. The most important change was in monetary policy.
Source: Bloomberg
In particular, the wording change was from "prudent" to "moderately loose", a term they have not used since the 2008 to 2010 great financial crisis. This sudden strategic change was something many of the close China watchers saw coming.
Since we started writing about China back in October, we have been repeatedly disappointed by their fiscal stimulus announcements. Please see the following 3 articles we wrote on this:
(Public) China's Incredibly Out-Of-Touch Stimulus Policy
(MEMO) Memo - Observations From China And The Investment Implications
(WCTW) This Feels Pretty Serious
In our last China update, I wrote the following:
When the Obvious Comes
There will be a day when the obvious comes. If my thinking is correct on this, China will eventually announce meaningful fiscal stimulus. And when it does, commodities across the globe will shine again. Natural gas will shine via global LNG prices. Coal prices will balloon. Oil will shoot higher just as non-OPEC supplies start to peak. And the pain of the commodity investor will pay off.
But when is that obvious moment going to come?
I don't know the precise timeline. But if I had to guess, I think it will be after Q1. Unless China announces more meaningful stimulus announcements by year-end, the recent announcements will fizzle, and economic growth will worsen again.
I don't think it will be long. And when the economic data worsens in the face of all the current stimulus announcements, policymakers will turn from "out-of-touch" to "I am f***ing desperate". That's when you know the tide has turned. Until then, position accordingly.
What's particularly interesting about the timing of the latest announcement is that if you have followed China's economic data, they have already worsened. China is still experiencing deflation, its bond yields are plunging matching that of Japan's post-bubble era, and consumer confidence remains extremely low. Despite all the rhetoric during the October announcement, the economic momentum we saw already fizzled and businesses remain on the sidelines due to uncertainty.
Thankfully, Chinese policymakers did not wait another quarter before realizing the announcements so far are lackluster. The reality is that without more fiscal stimulus announcements, China's economy will continue to falter. While it won't fall apart, the lack of growth in itself could spiral the economy into a lost decade (or longer).
What changed?
Aside from the obvious monetary policy stance change to "moderately loose", the most meaningful part of the announcement came from President Xi Jinping himself. He said:
We must affirm the confidence to win while doing next year's economic work.
China's current development faces many uncertainties and challenges, which must be given high attention.
We must be fully prepared to achieve next year's economic and social development targets.
In my view, most of the other statements are rhetoric, but the most important word here is "confidence", and I think that in itself is the seismic change we need to see. Now that he's put himself front and centered on the incoming Chinese stimulus policy, confidence is what he wants to see and confidence is what he will get.
Before we delve deeper into what changed, it's important to understand the importance of "face" in Chinese culture. When a Chinese leader announces that he will do something, especially in the case of Xi, who forced the Chinese communist party to adopt "Xi Jinping Thought" akin to Mao's thoughts. Failure is not an option.
And because failure is not an option, every setback in economic data will just imply even more stimulus ahead. It's a bit similar to the "Fed put" we saw back in 2010. If the data worsens, the Fed will stimulate more. If the data gets better, the Fed will stay on the sidelines. China won't be any different.
In particular, I've repeatedly pointed out that China's big problem today is credibility and this is echoed in the dismal business and consumer confidence. People do not believe that China has the guts or the willingness to revive the economy. Following the stupidity of zero COVID policy, people distrust the government, so it's no surprise that when I went back to Shanghai in October, people were despondent on the latest fiscal economic policies.
"Nothing's changed" was the tone I got, and I suspect it's still an uphill battle from here.
But if Xi wants confidence, he will get confidence. Given how low bond yields are and how low inflation is today, China can stimulate without worrying about inflation skyrocketing back. I suspect it will find itself in the same predicament as the US post the Great Financial Crisis. Despite 3 iterations of QE infinity, inflation never came back, and China is likely in the same situation.
What does this mean in terms of investing?
Value, cyclical, and inflation are back.
This is it. This is like the Pfizer vaccine moment back in 2020. The China rhetoric has changed. It's not your complacent China anymore. The fact that this announcement came well in advance of what I expected tells me that these guys are watching the data closely. This is a bit like OPEC+ acting well in advance of any storage builds after the 2020 debacle. China is doing something similar. And for Xi to announce that he wants to see confidence return is the signal shift we needed.
Meanwhile, the timing of all this couldn't have come at a better time. Just last week Friday, I wrote my MEMO titled, "No one gives a shit." Everyone is practically giving up on value and energy investing (myself included), but things have changed now.
I strongly believe that China's oil demand growth next year will likely surprise to the upside. With the consensus only expecting demand growth of ~260k to ~350k b/d, we think the upside is closer to ~600k to ~700k b/d. The delta here coupled with non-OPEC supplies peaking means that OPEC+ will be able to return spare capacity.
Even if we assume no production loss from Iran, we see an oil market in deficit next year. OPEC+ can bring on production on its current schedule (starting in April and lasting well into 2026).
In fact, I will go as far as saying that it almost doesn't matter what non-OPEC supplies do at this point. There's no scenario where supplies surprise to the upside that will kill the oil market. The only thing that can deter the bulls is a material demand drop, and with this China announcement, we see this possibility as extremely low.
With oil prices more likely to surprise to the upside than the downside, this will have important ramifications on inflation going forward. If you couple what we see in the oil market with what Trump is expected to do for the US economy, inflation will rise from the dead. This will force the Fed to put on the brakes again after conducting ~100 basis points of cuts in 2025. Markets are forward looking so it will start to sell growth names and buy value names well ahead of that.
Valuations for growth stocks are already stretched and with investors around the world clamoring for US equities, I can't help but feel the turning point is here.
Conclusion
This is the obvious moment. China's monetary policy stance change was the cake, and Xi's comment was the icing on the cake. With non-OPEC supplies already expected to disappoint to the downside, oil market balances will be closer to a deficit than a surplus. Consensus is already expecting the worst for the oil market, and with supply surprise upside out of the question, the demand side concerns have been greatly alleviated.
I think value, cyclicals, and inflation are back in favor now. Invest accordingly.
Analyst's Disclosure: I/we have a beneficial long position in the shares of BABA either through stock ownership, options, or other derivatives.