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The China Conundrum

December 4 to 8, 2023


The China Conundrum

December 4 to 8, 2023

Weekly Commentary

Market Recap

  • Equity markets posted modest gains this week alongside more encouraging U.S. inflation data and amid a wave of Canadian bank earnings.
  • The S&P 500 gained 0.8%, with banks jumping more than 4%. The TSX rose 1.7%, led by materials and health care.
  • The banks had a fine week overall, up 1.9%, as the sector rolled out a wide range of Q4 earnings hits and missed, which included a handful of dividend increases.


The recent bond rally has its roots in the U.S. Federal Reserve’s (Fed) rate announcement last month, when they adjusted their commentary on which way rates are heading by implying that they’d prefer not to raise them any further. We don’t necessarily need to see actual rate cuts in order for bonds to outperform cash and GICs—we just need investors to believe that the trend is toward lower rates rather than higher. Which point along the yield curve you’ll want to own will depend on where you think the economy is going. This year, High Yield outperformed everything else because of the fact that the economy was resilient; higher-risk credit tends to do well when spreads are shrinking and it’s supported by a strong consumer. As we approach 2024, every economic datapoint is suggesting that GDP numbers should be a little softer and that the consumer will weaken, especially with a slowdown in global growth and a recession potentially on the horizon. That tells us that it may be time to consider reducing the riskiness of your bond portfolio, shifting to exposures that will benefit from the change in the interest rate environment. This means higher-quality core bonds rather than High Yield or Emerging Market Debt (EMD). We haven’t implemented this trade in our portfolios just yet because we’re expecting the year-end rally to continue. But in the new year, I anticipate we’ll adjust our fixed income sleeve based on how the consumer plays out over the rest of 2023, reducing our higher-risk exposures in favour of core bonds.

Bottom Line: Going forward, our preference is to stick to quality bonds and keep our risk on the equity side of the portfolio.


Speaking of equities: our call is for a rally to end the year, which is based on the big pullback in the fall, seasonality factors, and the Fed’s aforementioned adjustment in rate expectations. We still see an excess of consumer savings, and that should support holiday spending. We’re not necessarily changing that call for 2024, but it will depend on a few factors. Real-time data on holiday spending is starting to come in—for instance, Black Friday numbers appear to be pretty good. If the numbers continue to be strong, then we may extend our optimism about the consumer into the first quarter of 2024 or even beyond. That said, we also have to keep an eye on savings, because consumers may have overspent; credit card debt will be harder to manage with high interest rates, so some households may get their first statement back after the holiday season, see how much they owe, and decide to tighten their belts. My suspicion is that we’ll take some equity risk off the table as we head into the new year, but how much will depend on the data we’re seeing. Central banks will also play a role: rate cuts are good if the economy is good, but cuts are bad if the economy is bad.

Bottom Line: Our outlook for equities in 2024 will depend on the state of the consumer, so we’ll be closely monitoring that data throughout the holiday season.


China has lagged behind expectations all year, and we still have concerns in the short term; the crisis in the property sector has sapped consumer confidence and negatively affected spending. But is China dead in the water? Absolutely not. We continue to believe that China is a growth engine that will continue to chug higher over the long term, and as the world’s second-largest economy, it would be unadvisable to avoid it. The trick is timing: in most areas, you want to get there early, but China doesn’t have the best track record on implementation. As such, we’d like to see some concrete developments before jumping in, including more aggressive action on stimulus, more stability in the property sector, and flows going back into the market. That said, we still like broader Emerging Markets (EM) ex-China—that’s why we’re neutral on EM as a whole rather than underweight due to the China exposure.

Bottom Line: Depressed valuations may offer an attractive entry point into China, but we’d like to see some concrete steps before diving in.


For a detailed breakdown of our portfolio positioning, check out the latest BMO GAM House View Report, titled Stocking Up for a Hiday Rally.


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