U.S. inflation resilience is increasing, and the likelihood of stagflation has risen. On the demand side, China continues to experience contraction and urgently requires larger macroeconomic adjustments. However, both U.S. and Chinese capital markets have performed well recently, driven primarily by expectation-guided market movements. In the U.S., this is due to the market’s expectation that the Trump administration will support rising capital markets. Similarly, in China, these expectations have weakened short-selling pressures, leading to a sustained upward trend.
In such extreme market conditions driven by expectations, investors must closely monitor the gap between expectations and reality, as well as the policy measures used to bridge this gap. Both the U.S. and Chinese governments have nearly limitless policy space, but the actions they can take in the short term will certainly be carefully considered. Therefore, if the gap between expectations and reality becomes too large, policy adjustments will be made to bring expectations in line with reality. In the U.S., this has manifested as adjustments to rate cut expectations, while in China, it reflects control over the financial sector.
In such extreme market conditions, a cautious approach is required for major indices. In the U.S., excess returns are primarily driven by traditional sectors affected by interest rate cuts, such as manufacturing and real estate. In China, opportunities may arise in the banking sector, which has been gradually retreating.
U.S. and China Economic Data Released This Week
This week, both U.S. inflation and China’s major economic data were released on Friday, Beijing time. Specifically, U.S. CPI for July increased 2.7% year-on-year, in line with the previous value, while the core CPI rose 3.1%, with a month-on-month growth of 0.3%. Overall, the U.S. CPI growth was lower than expected. From the data, it is evident that tariffs had a smaller impact on commodity inflation than anticipated, while service inflation expanded beyond expectations. On one hand, this reflects that efficiency wages are supporting U.S. economic expansion, and on the other hand, it indicates that U.S. investments are driving economic growth.
The release of U.S. CPI data spurred a global market rally, but the narrative shifted significantly with the release of the PPI data. The PPI rose 3.3% year-on-year, exceeding expectations, and grew 1% from the previous month. The rapid pace of PPI growth in the U.S. economic environment will likely have downstream effects, partly dampening global rate cut expectations and pushing the U.S. stock market into a stagnation phase.
As we noted in our previous report, as data continues to be released leading into September, the likelihood of stagflation increases, and volatility in the U.S. stock market is expected to rise. This will present a significant challenge for traders, which is why we believe reducing positions is the correct strategy. Based on the PPI data, U.S. inflation is unlikely to decrease significantly in the near term. Technically, this makes it difficult for the Federal Reserve to implement significant rate cuts. Balancing the need to reduce restrictive interest rate effects while preventing further inflation will slow the pace of rate cuts and limit the space for them. As a result, the volatility phase in the entire capital market will likely persist.
China’s July Economic Data
On Friday, China’s major economic data was also released. Since the publication of China’s PMI data in July, all indicators have pointed to a rapid decline in China’s economic data. However, the market seems unaffected, with little retracement from 3400 to 3700 points. However, the banking sector, which had previously driven the stock market rally, has seen some pullback, suggesting that risks are accumulating.
Breaking down the July data, import and export figures still exceeded expectations, indicating strong momentum for at least the next 90 days. However, investment, consumption, real estate, and industrial production all dropped significantly compared to June. Notably, restaurant consumption grew by only 1.1% year-on-year, automobile consumption turned negative, and real estate investment continued its sharp decline. Some studies suggest that China’s economic growth rate could slow to around 4.7%.
In financial data, new loans turned negative for the first time in recent years. Financial regulators stated that this shift was mainly due to structural adjustment policies in the financial sector, but the trend is undeniably unusual. The overall decline in data reflects the significant impact of macroeconomic adjustments. The hidden debt replacement funds totaling two trillion yuan were nearly exhausted in the first half of the year, and the infrastructure growth driven by long-term special government bonds and new local bonds has notably slowed. The consumption of durable goods has peaked, and commodity consumption is rapidly declining. This indicates that economic demand is still contracting.
We believe that price controls are beneficial, but when faced with market contraction, even without direct price cuts, other measures will be taken to compete for market share. With no room for price hikes, it is difficult for companies to fundamentally alter their profit margins. Clearly, if macroeconomic adjustments are not strengthened, demand-side contraction may continue, which is not a positive sign for China’s economy. While an extreme scenario like last September is unlikely, the severe disconnect between reality and asset prices will only worsen market distortions, leaving all parties uncertain.
Market Outlook: U.S. and China Dynamics
After the release of U.S. PPI data, the market’s upward momentum has slowed, but China’s performance remains strong. U.S. indices are pricing in an increased likelihood of stagflation, while China is primarily trading on expectations of policy adjustments and the belief that the government will push asset prices higher.
Recently, China’s capital market, especially major indices and asset types like the 1000ETF, has risen rapidly, putting pressure on investors to follow suit. If they do not, they risk missing out on performance. Even with poor fundamental data, market participants seem to be scrambling for shares. The gap between asset price performance and fundamentals is widening, posing a challenge for China’s macroeconomic control — a challenge that has not been encountered before. We expect official statements on capital market stability to decrease in the near term.
Policy Space
From a policy perspective, in the U.S., as inflation resilience increases, market expectations for rate cuts by the Federal Reserve will gradually rise, which will dampen the performance of interest rate-sensitive assets. In the future, as the Trump administration’s influence over the Federal Reserve grows, Federal Reserve Chairman Jerome Powell may become the de facto “shadow czar” of the capital markets, with his words gaining more weight. In a recent interview, Powell expressed new economic policies: using tariff revenues to reduce national debt, which will lower interest rates in the government bond market, reduce deficits, and provide Trump with more room for fiscal stimulus, including expanding tax deductions for low-income groups and traditional manufacturing industries.
In other words, despite the stagflation scenario, U.S. fiscal stimulus space remains, and attention should be paid to this area of progress. If the Trump administration implements such measures, U.S. tariffs could become permanent, as even if the Democrats take office again, it will be difficult to reverse the low-income and traditional manufacturing tax deduction policies initiated by Trump.
In China, the policy space for both monetary and fiscal policies is still significant, but the primary issue lies in the economic development mindset. While supply is important, the long-standing issue of shrinking market demand requires a shift in thinking. Long-term, without a large market, how can one participate in future, fierce market competition? Since the Central Political Bureau meeting emphasized expanding domestic demand as a key economic task, China’s thinking is evolving, but the speed of change still lags behind the contraction in market demand.
Investment Strategy
For U.S. stocks, we continue to favor semiconductors, particularly AMD, real estate (Horton), and pharmaceuticals. In Hong Kong, the growth of U.S. dollar liquidity and the narrowing of the A+H stock premium are beneficial for the Hang Seng Technology index. In China, we favor AI-related software and machinery manufacturing sectors. Globally, we do not anticipate a one-way market next week, but the aforementioned sectors can be traded with a long bias for swing trading.