If Jan Viebig, CIO of the ODDO BHF group, overweights Chinese stocks, he prefers American stocks and notes that investors have too little gold.
On the eve of the American elections, stock markets are at their highest and the process of disinflation is well underway. Is it time to change asset allocation? Should we hope for more than a short-term rally in China? What to expect from the American economy and stocks in 2025? Jan Viebig, Chief Investment Officer (CIO) of the ODDO BHF group, answers questions from Allnews.
Is China beginning the long-awaited recovery?
China is going through a multifaceted crisis. It first hits real estate, which represents 25% of GDP. The second problem concerns the indebtedness of local governments through their financing of these investment vehicles. This aspect is crucial because in China, growth is driven less by the central government and more by Local Government Financing Vehicles (LGFVs) which finance real estate development and other projects. ‘infrastructure. Local debt is considerable: it represents 50% of GDP. The problem lies in the ban on directly issuing credits which affects these financing vehicles. Chinese economic growth will therefore only reach 4.5 to 5% in 2024, below the authorities’ objective. To solve its problems, the recent stimulus measures taken by the government are going in the right direction. The Central Bank sharply cut interest rates, which produced a massive rally in Chinese stocks. The question is what’s next.
What are you waiting for?
The debate concerns the effect of the measures on consumption. The Minister of Finance has not quantified his support plan. Other governing bodies have not quantified it either. This is why, after a 30% rise, stocks lost almost half of their initial gains. The answer should emerge from the Standing Committee of the National People’s Assembly in early November. The market rise is a sign that the government’s action was correct and that it responded to China’s two major economic challenges. But today, no one can know the amount of the stimulus.
What is your weighting in Chinese stocks?
In recent months, we have increased the Chinese market in our allocation to emerging equities relative to its weighting in the MSCI Emerging Markets Index. In recent months, everyone invested heavily in Indian stocks and absolutely nothing in China. So we are very happy to have been increasing China for some time, but we are not changing our slight overweight due to the current extreme uncertainty.
“The problem with Chinese stocks is the very low return on equity of companies.”
Is this a short-term rally or the start of a structural rise?
There are many reasons to believe that this is a short-term rally until the government gives clear indications on the continuation of its plan. There is a second reason not to increase overweighting, namely the uncertainty over the outcome of the US presidential elections on November 5. If Donald Trump were to win, he would implement a program that plans to establish customs duties of 60% on Chinese imports. The impact will depend on the rate ultimately decided in Congress, but these tariffs would penalize not only the American economy, but also China and the EU.
Which Chinese stocks to buy in this context?
We are investors who favor quality stocks. The problem with Chinese stocks is the very low return on equity of companies. So it is not easy to identify good companies. The first idea targets tech giants, like Alibaba, Baidu and Tencent. If we got a real structural solution, which is by no means a given, investors would start buying banking stocks, consumer staples, consumer discretionary and cyclical companies. But it is too early to take action. Other investment avenues exist outside China if we believe in a recovery in future consumption, for example the European luxury industry.
Is a wealth effect on consumption possible if Chinese stocks recover strongly?
This wealth effect would be possible, but it would be significantly more modest than if it occurred in other countries, because stock ownership is significantly more modest in China than elsewhere. Most of the savings are instead invested in real estate. It is all the more important to get out of the real estate crisis. A real estate giant like Evergrande is $300 billion in debt, which exceeds the entire debt of a country like South Africa. The government is moving in the right direction, but it still needs to play to its biggest advantage, which is how much it is willing to spend to increase demand.
If the amount were already known, wouldn’t the market be significantly higher?
Yes. Foreign investors refer to the CSI 300 index, but I prefer the HSCE index, which represents Chinese stocks listed in Hong Kong. Despite its recent rise, this index remains very cheap, with a PER of 9.7 times, due to low return on equity. Many Chinese companies have destroyed value over a long period of time. The cost of equity has exceeded the return on equity. The cause is to be found in government interventions in the economy. The market also risks being heavily penalized by the increase in American customs duties if Donald Trump were elected president.
Specifically in the United States, what is your analysis of American actions on the eve of the elections?
We also invest long term in quality companies. With this approach, we find many more opportunities in the United States than in Europe and Asia, because the return on equity is significantly higher there. We are very positive on US stocks. In the MSCI World index, which contains securities from 23 countries, the 10 largest companies, in terms of market capitalization, are American. Their return on equity and their degree of innovation are higher, and their access to financing is even easier.
“If the U.S. market is expensive, the equal-weighted benchmark is no more expensive than its long-term historical average.”
Don’t you fear a recession in the United States?
A recession will occur sooner or later, but it is very unlikely in the next 12 months for three reasons. The first is due to the recent steepening of the yield curve, after having been inverted for a long time. It should continue to steepen with future cuts in short-term rates. We expect four or five Fed rate cuts between now and June 2025. Monetary policy is currently very tight. Short-term rates are above the neutral rate. In the event of an economic slowdown, rates would decrease towards this neutral rate, which stands at 2.9%.
What are the other reasons?
The job market is very strong. The unemployment rate is 4.1% and job creation is exceptionally strong. We consider Sahm’s law, which takes as a criterion for anticipating the start of a recession an increase in the unemployment rate of at least 0.5 points in three months. This rule shows that a recession is unlikely. There is also no wave of layoffs in companies.
Couldn’t the employment figures be revised sharply downward?
Even a revision of 0.2 or 0.3 points in the unemployment rate, which would be considerable, would not change our view. The unemployment rate is near the lowest in the last 50 years. The third reason is linked to the evolution of leading indicators, such as the PMI (54.3), which signals continued growth. In the second quarter, GDP increased by 2.8%. A slowdown is likely, but not a recession.
Isn’t the contraction in the money supply a bad sign?
For years, monetary growth has increased significantly because the Fed has massively injected liquidity during each crisis. This is why monetary aggregates are clearly too high today, as in Europe. All economists agree in calling for a reduction in the money supply, because banks are excessively accumulating reserves at the central bank. This will not lead the economy into a recession. A contraction in GDP could only occur if banks did not have enough money to grant credit. We are very far from it.
What are your inflation forecasts?
Monetary policies remain restrictive. Key rates are significantly above the neutral rate. This means that the economy and inflation will slow down. After an inflationary shock, the last phase of falling inflation is the most difficult. Its evolution will depend on the evolution of employment, wages and geopolitical risks. You should know that a fifth of oil passes through the Strait of Hormuz. It would be possible to imagine that Iran would cause turbulence that would cause the price of oil to explode. The probability of such an event, however, is very low. Finally, depending on the American economic policy that will be implemented next year, inflation could decrease more slowly than expected. The imposition of tariffs, for example, would reinforce the rise in American prices. I expect an inflation rate of 2.5% in 2025 (up from 2.4% in September 2024), but uncertainty is quite high. The markets are rather optimistic about this.
What is the best asset class for the next 12 months?
Stocks are the best asset class. We overweight them in our allocation. Some segments of the US market are expensive, but quality stocks, with a high return on equity, are preferred. If the U.S. market is expensive, the equal-weighted benchmark is no more expensive than its long-term historical average. Small and mid-caps are the most attractive. Their discount compared to large caps is at its highest since 2008. The environment is therefore favorable to stock-picking after months of domination by the “magnificent 7”.
Would you avoid the Magnificent 7?
No. It would be stupid to underweight the knowledge economy in the long term. But it is not certain that Nvidia or Microsoft will outperform in the short term. Portfolios must be diversified in favor of other values.
Could a tragedy occur on the French debt?
There are two big risks in Europe: France and Germany, each for different reasons. France must reduce a public deficit which could rise to 7% of GDP. The government’s measures are in the right direction, but they will slow growth. The situation in France corresponds to what economic textbooks describe when the debt reaches 110 to 120% of GDP. Long-term economic growth will now be lower than its historical potential. In Germany too, but due to the effects of demographic aging and massive delays in infrastructure investments (railways, schools, bridges). The Council of Elders believes that over the next ten years, the annual growth rate will reach only one third of past growth. In addition, companies no longer invest in Germany, in particular because of energy costs which correspond to 2 or 3 times those they encounter in the United States. Germany is finally suffering from a decline in the competitiveness of its automobile industry, a pillar of the German economy, which will have an impact on growth for several years.
Should we have more cash or gold to protect ourselves?
From a long-term perspective, it is recommended to hold a proportion of 9.9% of your stock holdings in gold. If you have 50% of your wealth in stocks, you should hold 5% in gold. The investor should hold a significant portion of gold, regardless of its short-term level. If it is at its highest, this is due to particularly high geopolitical risks. Most of our clients have too little gold in their portfolios at the moment.
