Negative Correlations, Positive Allocations

Economic

Summary:

The inverse correlation between bonds and stocks has returned, broadening potential for risk-adjusted returns in multi-asset portfolios.

If the prevailing theme in asset allocation since early 2023 has been that bonds are back, a nascent theme today is correlation: Specifically, the negative relationship between stocks and bonds has reemerged as inflation and economic growth moderate.

This is great news for multi-asset investors: It means they can increase and broaden their allocation to risk assets, seeking potentially higher returns with the potential for adding little to no additional volatility within the overall portfolio. Equities and bonds can complement each other in portfolio construction, and both are likely to benefit in our baseline economic outlook for a soft landing amid continued central bank rate cuts.

PIMCO’s multi-asset portfolios therefore focus both on equities, with a slight overweight in the U.S., and on fixed income – especially in high quality core bonds, which we believe offer notable risk-adjusted return potential. Strategic investments in options and real assets can help manage risks, and systematic equity trades may enhance returns and help mitigate risks.

Investors are also considering the potential impact of U.S. policy under the second Trump administration and a narrowly unified Republican Congress. Bond markets had largely anticipated the Trump victory, and given the prevailing economic landscape, we expect bond yields will remain in an attractive range amid the transition to new leadership in Washington. In equity allocations, investors may want to consider U.S. companies that don’t rely as heavily on imports (given potentially higher tariffs), as well as those likely to be buoyed by deregulation and more favorable tax policies. Finally, an allocation to inflation-linked bonds or other real assets could help hedge against the potential risks of increasing inflationary pressures arising from fiscal policy or tariffs.

In our view, staying invested in core, high-conviction trades within a well-balanced portfolio can help investors achieve target objectives while navigating unexpected twists ahead.

Equity markets in rate-cutting cycles

While this business cycle has experienced pandemic-related surprises, inflation has now moved down the list of concerns. The precise trajectory of monetary policy may vary, but the Federal Reserve and most major central banks have clearly indicated their intentions to lower interest rates toward neutral. (Learn more in our latest Cyclical Outlook, “Securing the Soft Landing”.)

How do rate cuts affect stocks? Basic principles of asset valuation teach that, all else equal, lower central bank rates (as proxies for “risk-free” rates) lead to higher equity prices. Yet all else is rarely equal, and our historical analysis shows that economic activity has been the dominant driver of equity returns during rate-cutting cycles. If an economy slides into recession, rate cuts alone may not prevent stock market losses. However, if economic activity stays buoyant, rate cuts have potential to boost stock valuations.

There is no guarantee, of course, that these historical patterns will continue, but they can offer a guide. In Figure 1, we focus on the performance of the MSCI USA Index, a broad measure of large and mid cap equities, six months before and after the Fed’s first rate cut in cycles from 1960 through 2020 (the most recent rate-cut cycle prior to the one that began this year). This dataset encompasses nine soft landings and 10 hard landings. In the median soft landing, U.S. equities rallied through the first Fed cut, but performance tapered off three months after the cuts began. In the median hard landing, U.S. equities declined both before and after the first cut, bottoming about three months after the cuts began.

Negative Correlations, Positive Allocations_1

In both hard and soft landings, the initial rate cut typically led to stronger equity performance, at least in the first month or so, as cuts generally boost sentiment and real economic activity. However, before long, equity markets usually start to reflect the prevailing macro environment.

Examining historical equity market performance by factor and sector in the six months after the first rate cut shows that, on average, growth outperformed value, large caps outperformed small caps, and dividend yield and quality offered positive returns overall. Homing in on the six rate-cutting cycles accompanied by soft landings since 1984, we find that later in the rate-cut cycle (approaching 12 months), small caps began to overtake large caps as economic growth accelerated. Additionally, technology, healthcare, and consumer staples generally outperformed, while energy, communications, and financials lagged.

Every cycle is different, as is the macro environment that accompanies it. However, the historical pattern suggests that an equity allocation today could effectively combine secular growth themes with more defensive, rate-sensitive beneficiaries, such as real estate investment trusts (REITs).

Bond markets in rate-cutting cycles

Historical analysis also shows that bond returns have been positive during Fed rate-cutting cycles across a range of macroeconomic environments. Moreover, analysis indicates that the starting yields of high quality core fixed income securities are strongly correlated (r = 0.94) with five-year forward returns. Thus, today’s attractive starting yields bode well for fixed income investments.

As the Fed proceeds with rate cuts, bond investors may benefit from capital appreciation and earn more income than what money market funds provide. In multi-asset portfolios, conservative investors can seek higher risk-adjusted returns by stepping out of cash and onto the curve, while balanced portfolios can increase duration exposure. Of course, high quality bonds may also offer downside mitigation in the event of a hard landing.

Within fixed income, high quality credit and mortgages can enhance yields and serve as diversifiers. In particular, agency mortgage-backed securities (MBS) appear attractively valued, with spreads over U.S. Treasuries near historical highs, making them a liquid alternative to corporate credit. Historically, agency MBS have also provided attractive downside resilience for portfolios: During recessionary periods, they have delivered an average 12-month excess return of 0.91 percentage points above like-duration U.S. Treasuries, versus −0.41 percentage points for investment grade corporates.

Negative stock/bond correlation: portfolio implications

The stock/bond correlation tends to turn lower and then negative as inflation and GDP growth moderate, as is the case in the U.S. and many other major economies today. Analysis of monthly measures of stock/bond correlation data since 1960 tracked against inflation rates indicates a clear trend: When inflation is at or near central bank targets (around 2%), as has generally been the case in developed markets since the 1990s, the stock/bond correlation has been negative or very narrowly positive.

In practice, a low or negative stock/bond correlation means that the two asset classes can complement each other in multi-asset portfolios, enabling investors to broaden and diversify their exposures while targeting return objectives.

For instance, investors with a specific risk budget can own a greater range and number of risk assets while staying within their tolerance, while investors with a predefined asset allocation mix can target lower volatility, smaller drawdowns, and higher Sharpe ratios (a measure of risk-adjusted return).

In general, negative correlations can enable asset mixes that experience lower volatility than any individual asset, while still targeting attractive returns. A hypothetical efficient frontier exercise helps illustrate this (see Figure 2): When the stock/bond correlation is negative, there are regions along the lower-risk portions of the frontier where investors may target an asset mix that offers a somewhat higher potential return profile despite a drop in expected volatility.

Negative Correlations, Positive Allocations_2

A lower volatility from portfolio beta could also free up space for more exposure to alpha strategies, such as systematic equities – more on this later.

For multi-asset investors able to access leverage, negative stock/bond correlations could allow even higher total notional levels for a given risk target, as long as the portfolio returns exceed borrowing costs. The value of leverage in a diversified portfolio tends to be greater when correlations are negative.

A look at the historical extreme (“tail”) scenarios of negative returns in a simple multi-asset portfolio consisting of 60% stocks and 40% bonds further illustrates the beneficial characteristics of a negative stock/bond correlation (see Figure 3). Periods with positive stock/bond correlation have typically seen more severe (worse) left-tail outcomes for multi-asset portfolios than periods with negative correlations. This is true even though most recessions have had deeply negative stock/bond correlations, because equity drawdowns were partially offset by gains in the fixed income allocation.

Negative Correlations, Positive Allocations_3

Mitigating risks

While the opportunity set for multi-asset portfolios is rich, elevated risks related to public policy, geopolitics, and monetary policy mean that investors should consider designing portfolios capable of withstanding unlikely but extreme tail events. Even as one of the biggest global election years in history (by voting population) concludes, uncertainty remains about how policies could affect inflation, growth, and interest rates. Additionally, ongoing conflicts in the Middle East and between Russia and Ukraine, and potential for geopolitical unrest elsewhere, could roil markets.

While the negative stock/bond correlation means portfolios may be better positioned to navigate downturns, it can’t prevent and may not mitigate all the risks of tail events. But investors have other strategies available, such as dedicated tail risk management. Active drawdown mitigation may include selectively using options when volatility is reasonably priced. The availability of volatility-selling strategies in recent years, including the rapid growth of options-selling ETFs, has increased the supply of volatility options, especially in the short end of the yield curve. This trend can make downside hedging more economical during opportune times.

We also believe it is prudent to hedge multi-asset portfolios against upside risks to inflation. Although restrictive central bank rates have brought inflation levels down close to targets, the long-term fiscal outlook in the U.S. includes continued high deficits, and geopolitical surprises could cause a spike in oil prices or snarl supply chains. Trade policies, such as tariffs, and deglobalization trends could also pressure inflation higher. We believe inflation-linked bonds (ILBs) remain an attractively priced hedge, offering compelling return potential as long-term real yields are currently near their highest levels in 15 years. Furthermore, long-term breakeven inflation rates are priced around or below the Fed’s target, reflecting little to no risk premia despite the recent memory of a sharp inflation spike.

Spotlight on structural alpha: equity factors

In any investing environment, it’s helpful to step back from the analysis of risks and opportunities to assess one’s investment process. At PIMCO, in addition to our investment views based on macro and bottom-up research, we use quantitative methods to help identify equity market inefficiencies and target structural alpha. Our process emphasizes diversification, minimizes concentration risk, and seeks to overcome behavioral biases.

First, we research and assign a composite score to a stock based on four key themes: momentum, growth, quality, and value. By integrating traditional metrics, such as earnings growth, with alternative data, such as insights from earnings transcripts and customer-supplier relationships, we aim to identify companies with potential for long-term outperformance.

The composite scores are then combined with considerations of risk and transaction costs to construct a highly diversified allocation that reflects conviction levels while adhering to various constraints. These include limits on active risk, market beta exposure, and concentration risk at the country, sector, and individual company levels, ensuring only modest deviations from the broad market.

With a systematic approach, rigorous research, and advanced analytical tools, including proprietary techniques, our strategies are designed to offer consistent excess return potential across different market conditions.

Takeaways

Investors can position multi-asset portfolios thoughtfully to seek to benefit from market trends while managing risks in an uncertain environment. As central banks continue to cut rates amid an outlook for a soft landing, both equities and bonds may do well. High quality core fixed income should be especially well-positioned.

A lower or negative stock/bond correlation allows for complementary and more diversified cross-asset positioning, especially for those with access to leverage. A robust options market can help investors hedge downside risks. Finally, making use of quantitative techniques and innovative tools can help smooth returns and lay the foundation for disciplined investing across market cycles.

To stay updated on all economic events of today, please check out our Economic calendar

Risk Warnings and Disclaimers

You understand and acknowledge that there is a high degree of risk involved in trading. Following any strategies or investment methods may lead to potential losses. The content on the site is provided by our contributors and analysts for information purposes only. You are solely responsible for determining whether any trading assets, securities, strategy, or any other product is suitable for investing based on your own investment objectives and financial situation.

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Saif

Economic

The U.S. economy added 227k jobs in November, in line with the consensus forecast calling for a gain of 218k. Payroll figures for the two prior months were revised higher by 56k.

Private payrolls rose 194k, with the largest gains seen in health care & social assistance (+72.3k), leisure & hospitality (+53k), professional & business services (+26k) and manufacturing (+22k). The gain in manufacturing were largely payback from the month prior following the resolution of the Boeing strike. The public sector added 33k new positions last month.

In the household survey, civilian employment (-355k) fell by considerably more than the labor force (-193k), which pushed the unemployment rate up to 4.2%. The labor force participation rate fell 0.1 percentage points to 62.5% – a six-month low.

Average hourly earnings (AHE) rose 0.4% month-on-month (m/m), matching October’s gain. On a twelve-month basis, AHE were up 4.0% (unchanged from October). Aggregate hours worked rose sharply, up 0.4% m/m.

Key Implications

This morning’s release provided further evidence that October’s soft employment report was more to do with temporary effects stemming from hurricanes and labor disputes, and not a sudden deterioration in the labor market. Not only did job creation regain its vigor in November, but revisions to prior months were also a tad higher, and aggregate hours worked grew at the fastest pace in eight months.

Smoothing through the recent volatility, job gains have averaged 173k over the past three-months, or only a modest stepdown from the 186K averaged over the prior twelve-month period. But this likely overstates the degree of “strength” in the job market. A broader sweep of the data suggests that the labor market has already come back into better balance, and is no longer a meaningful source of inflationary pressure. Moreover, the fact that the labor force has contracted in each of the past two-months suggests that job seekers are starting to internalize the fact that jobs are becoming harder to come by – a further indication that the labor market is cooling. This should give policymakers the assurance they need to cut by another quarter-point later this month. But with inflation progress showing early signs of stalling and some of the incoming administration’s policy proposals (including the potential for tax cuts and tariffs) viewed as inflationary, the Fed is likely to proceed more cautiously with easing its policy rate in 2025

Source:Bank Financial Group

To stay updated on all economic events of today, please check out our Economic calendar

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SAXO

Economic

Energy

The AI revolution is a power-hungry one. The tech giants see that current electricity supply falls far short of what is required to power the massive new AI data centres they hope to build. They are already taking dramatic steps to secure stable, long-term power sources. Microsoft has contracted with Constellation Energy to reopen one of the old nuclear reactors at Three Mile Island. Google and Amazon are striking deals with US utilities and other providers to create small modular nuclear reactors (SMRs) for their planned AI data centres. But these are all long-term projects - for 2030 and beyond in the case of the latter two. What about the energy needs right here and now, as the AI arms race reaches new white-hot intensity already in 2025?

In 2025, US power prices spike higher in several populated US areas, as the largest tech companies scramble to lock in baseload electricity supplies for their precious AI data centres. This inspires popular outrage, as households see their utility bills skyrocket, aggravated by the huge spikes in power prices for electricity consumed at home during peak load periods in the evening. In response, many local authorities move in to protect political constituents, slapping huge taxes and even fines on the largest data centres in a move to subsidise lower power prices for households. The taxes incentivise investment in massive new solar farms with load balancing battery packs, but also dozens of new natural gas-driven power stations, even as the demand for ever more power continues to rise faster than supply. Rising power prices drive a new inflationary impulse.

Potential market impact

A massive boom in US investment in power infrastructure. Companies like Fluor rise on signing massive new construction deals. Tesla’s accelerating Megapack gets increasing attention. Long-term US natural gas prices more than double, a significant contributor to a more inflationary outlook.

To stay updated on all economic events of today, please check out our Economic calendar

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ING

Economic

Political

With Donald Trump soon making a return to the White House, the trade deficit with the EU is likely to come under renewed scrutiny. The President-elect has been vocal about what he perceives as unfair trade practices, particularly in the automotive and agricultural sectors. He has threatened to impose blanket tariffs ranging from 10% to 20% on all imports and to match tariffs raised by other countries to achieve a level playing field. But is the difference really that significant?

The differences in effective tariffs between the EU and the US

Effectively applied tariffs are not vastly different between the two countries, with the simple average standing at 3.95% for products from the US and 3.5% for EU products – but there are notable differences in certain sectors.

Trump has a point regarding tariffs on cars, agriculture, and food. For example, the EU tariff rate is 10% compared to 2.5% in the US for cars, and there is approximately a 3.5 percentage point difference for average tariffs on food and beverages. Additionally, tariffs on chemicals are on average 1ppt higher in the EU than in the US. However, the EU faces higher tariffs on commodities and transactions not classified elsewhere (miscellaneous or unspecified items) when exported to the US. Given this context, the EU might indeed face intense tariff threats and challenging negotiation rounds moving forward.

Effectively applied tariff rates on goods trade between the EU and the US (in %)

Source: WITS database for 2022, ING

The US is the EU’s top export partner

In 2023, the US emerged as the leading destination for EU exports, accounting for 19.7% of the EU’s total exports outside the bloc, followed by the UK at 13.1%. When it comes to imports, the US was the second-largest source (after China), providing 13.8% of the EU’s total extra-EU imports; China accounted for 20.6%.

On balance, trade with the US has evolved positively for the EU over the last decade. It peaked in 2021 at 1.1% of the EU’s GDP, as seen in the chart below. Despite a slight decline from 2022 onwards – partly due to increased energy imports – the EU maintained the highest trade surplus with the US in goods trade, amounting to EUR156.7bn (0.9% of GDP) in 2023.

Evolution of EU goods trade with US as a % of GDP

Trade of the EU vis-a-vis the US (% of GDP)

Source: Eurostat, ING Research calculations

Ireland has the largest relative export exposure to the US

Not all EU policymakers need to be equally concerned about US trade dependencies, though. There are significant differences in trade exposure among member countries and sectors. Nations with strong chemical and pharmaceutical sectors, such as Ireland and Belgium, or robust machinery and transport sectors, like Slovakia and Germany, lead the way in terms of trade exposure. Ireland and Belgium's overall exports to the US are particularly high at 10.1% and 5.6% of their GDP respectively, compared to the overall EU export exposure of 2.9% of GDP.

On the import side, the Netherlands and Belgium, with their major Atlantic ports, import mainly energy and chemical products from the US. Their total imports are valued at 7.1% and 6.1% of their GDP respectively, compared to the overall EU import exposure of 2% of GDP.

Largest EU-US trade dependencies in 2023

EUs export & import flows to the US in 2023 (% of a county's GDP)

Source: Eurostat, ING Research calculations

US dependencies are large, but strategic dependencies balance in favour of the EU

Some EU countries therefore have more significant levels of exposure, particularly in the chemical and transport sectors – but the EU still holds an advantage. These exports include strategically important products, i.e., goods that cannot be easily replaced due to limited supply, high dependency from the importing countries, specialised production, and stringent quality requirements.

In 2022, the EU traded 122 strategically important products, representing 4.9% of its overall imports. Yet, the bloc is strategically dependent on the US only for eight products, six of which are chemicals (see the chart below). For instance, the EU relies heavily on beryllium (HS 811212), a metal classified as a Critical Raw Material by the European Commission. Beryllium is essential for defence, transportation, and energy applications. The EU sources 60% of its beryllium from the US, which holds the majority of global resources in a Utah mountain deposit, making substitution difficult.

The US, on the other hand, relies on the EU for 32 strategically important import products, mainly in the chemical and pharmaceutical sectors. This dependency balance favours the EU and will provide it with some leverage in negotiations with the incoming Trump administration.

Strategic interdependencies between the EU and the US

Source: Lefebvre and Wibaux (2024), data for 2022

Trump trade pressure and a potential response

It's no secret that Trump is disgruntled by the EU's trade surplus and has the region in his sights when considering additional tariffs. But the President-elect deems himself something of a dealmaker, and that could make it crucial for the EU to identify areas for concessions and deals. What are the EU’s options?

Europe could increase its purchase of US products, such as further boosting LNG imports. While the promise to ramp up LNG imports from the US was perceived as a gesture to appease Trump during his first term without the expectation of significant impact, the energy crisis has made those imports more valuable for the EU. In terms of defence, the EU could propose increasing its defence spending to 3% of GDP, with a commitment to purchasing more from US companies. Additionally, the EU could open up defence funding initiatives to non-EU companies, as is currently being discussed. Increasing those purchases might be an easy way to reduce the bilateral trade surplus to some extent. Buying more from the US is likely to be a key point in the upcoming trade negotiations.

The EU could target US products by imposing retaliatory tariffs. The Commission is said to have already prepared a list of goods which would be subject to additional tariffs.

The EU could use the Anti-Coercion Instrument (ACI), its “new weapon to protect trade” by launching countermeasures against a non-EU country if negotiations fail. These could include trade, investment or funding restrictions.

Regardless, the EU will go to the World Trade Organisation to prove its case. However, even though WTO panels have found US practices to be unfair and have authorised retaliatory measures in the past, these rulings have not resulted in significant changes. So, while we believe that the EU will try to stand up against Trump, this might be easier said than done. This is especially true given the differing interests of its member states, which were recently highlighted in the vote on additional tariffs on electric cars made in China.

A long-term threat to European economic growth?

What about the economic impact on Europe? Protectionism is generally bad news for economies, especially export-oriented ones. Yet long before tariffs come into effect, the uncertainty surrounding protectionist trade policy will have an economic impact on sentiment, potentially resulting in delayed investments and hiring.

In the longer term, this may strain trade relations between the EU and the US, further eroding the EU’s struggling manufacturing sector. And as we've written previously, Trump’s second term in office hits the European economy at a much less convenient moment than the first. Back in 2017, the European economy was relatively strong. This time around, it is experiencing anaemic growth and is struggling with a loss of competitiveness. A looming new trade war could push the eurozone economy from sluggish growth into recession. As a result, growth is expected to remain low in 2025 and 2026.

To stay updated on all economic events of today, please check out our Economic calendar

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ACY

Economic

Dollar Resilience Amid Trade Tensions

The U.S. dollar has rebounded strongly, driven by President-elect Donald Trump’s renewed focus on trade policies. His threats to impose tariffs on BRICS nations attempting to reduce their reliance on the U.S. dollar underscore a return to protectionist strategies. This rhetoric, while not immediately actionable, signals a firm stance that may influence trade relations and the dollar's trajectory heading into 2025.

Eurozone Challenges: Politics and Monetary Policy

In Europe, the euro faces pressure as political uncertainty in France mounts. The National Rally party’s push for a no-confidence vote over budget disagreements has created friction with the French government. At the same time, the European Central Bank (ECB) is poised to cut rates by 25 basis points, reflecting a cautious approach to managing disinflation and weakening growth indicators. A larger rate cut, while discussed, seems unlikely for now.

December’s Financial Pulse Policies, Politics, and Market Trends_2

Inflation and Growth in Focus

Inflation in the Eurozone has consistently surprised to the downside, with forecasts now suggesting the ECB’s 2% target could be achieved sooner than anticipated, possibly by mid-2025. Growth, however, remains fragile, with mixed signals from recent data. While consumer confidence and wage growth offer some optimism, investment remains subdued, and broader economic recovery hinges on sustained demand.

The divergence in policy approaches among global central banks is becoming increasingly evident. The Bank of Japan’s hawkish tone , coupled with Trump’s trade measures, contrasts sharply with the ECB’s gradual easing. These shifts underscore the complexities of navigating interconnected economies where domestic policies ripple across borders.

As markets process these developments, a delicate balance between caution and opportunity emerges. Whether it’s the U.S. dollar’s resilience, the euro’s political headwinds, or the ECB’s evolving strategy, stakeholders must remain agile to navigate this period of economic recalibration.

To stay updated on all economic events of today, please check out our Economic calendar

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UBS

Economic

For much of this year investors have had to navigate an uncertain macroeconomic environment. Market sentiment has shifted in response to geopolitical conflicts, election results, the turn of the global interest rate cycle and more.

Through these testing times, China is a wildcard. Until the surprise round of easing measures in September, many believed Beijing had not been doing enough to support the country’s slowing economy. The broad set of supportive measures were more comprehensive in scope and expectations, and in dramatic fashion, it sent the markets into a remarkable rally.

Going into the National People’s Congress (NPC) Standing Committee meeting in November, markets were volatile but hopeful for more. However, while the policy direction is clearer than ever, the lack of new borrowing or spending measures to boost consumption or the property market disappointed investors and sent markets lower. External factors such as possible higher tariffs from the newly elected US administration also had a compounding adverse effect.

Greater policy support is needed

Because policies have an outsized impact on Chinese markets and its economy, we too believe that more should be done – and, crucially, that more will be done. Not only is more needed on both the fiscal and monetary fronts, we believe that fundamental changes to protect consumers, investors and businesses in the areas of property rights, shareholder rights, deregulation and capital market liberalization would go a long way in reviving overall confidence. Despite the near-term stimulus letdown, we think greater policy support is still on its way given the forward guidance in the past few months; Beijing might also be holding off until there is more data on incremental improvement in the economy as well as more details on the US tariff strategy.

Timing of the stimulus aside, it is important to look at the big picture. China has made significant progress in its structural transition away from the old economic model by derisking the property market and strengthening competitiveness in many manufacturing and exports sectors. While the road ahead might still be bumpy, the right stimulus could prevent China from entering a deflationary spiral, smooth the transition process, and accelerate the timeline of the recovery. We are seeing the first signs that the stimulus measures are having a positive impact on certain sectors: retail sales picked up in October. A full recovery, however, will take time.

Taken together, we believe the most challenging period for China’s transition is likely behind us. For the Central Economic Work Conference (CEWC) in December we expect to hear more on Beijing raising the deficit, expanding the special local government and ultralong treasury bonds, increasing central transfers to local governments, as well as more support directed at consumption, the property market and infrastructure.

Markets are inherently forward-looking, and we think a more decisive stimulus response and a turnaround for the markets in the next 12-18 months could be in the cards, bringing along new alpha opportunities for the long term in the various asset classes, and especially for an active multi-asset strategy.

Policy pivot lifts sentiment for China equities

At this policy pivot juncture, there are plenty of opportunities to invest in China equities, given the number of high quality companies with attractive valuations. Despite the threat of more US tariffs and sanctions, Chinese companies have demonstrated resilience under such pressure. We particularly like companies that have a growing presence in foreign markets.

With earnings growth generally healthy, we believe that companies that focus on returning value to investors via dividend payout and share buybacks should also do well. While an uncertain stimulus timeline had again made some offshore investors think twice before getting back into China equities, onshore investors are more optimistic.

China fixed income is so much more than the property market

Before the September rally, Greater China USD high yield credits had already recovered from late last year and earned a spot among the best performing asset classes year-to-date in fixed income. Market sentiment on China had been overly bearish last year, which kept China USD high yield valuations trading at extremely low levels. However, as investors realized that most defaults have already happened a strong rally ensued earlier this year.

The Asian and China USD high yield markets have experienced a significant structural change over the past four years, with the weighting of China real estate sector in JP Morgan Asian high yield index dropping from 38% to 7% as of today.1 The market is therefore more diversified than before. At the same time, the default cycle in China and rest of Asia looks to be peaking. We think that this creates a solid foundation for both asset classes to continue to perform into next year. Credit selection is critical here; generating alpha and adding value require a close look at the credit issue and issuer. For Greater China credits, we currently prefer high yield over investment grade because there are more potential credit alpha opportunities.

A long/short approach to potentially capitalize on divergent returns

Our longer-term view of China is constructive, but the country’s transition could bring more market volatility. Stock performance could become more divergent, even within the same sector, which a long/short investment approach could potentially capitalize on.

While we don’t have a sector preference, we like market leaders that have reinforced their leadership position in the past cycle through improved financials, better sales, and larger market shares. These companies tend to deliver solid returns to shareholders, and they have the potential to consolidate the industry they are in.

Going forward, artificial intelligence, state-owned enterprises, and energy transition will likely continue to be our main investment themes, giving us many interesting alpha ideas in our long and short books.

The China wildcard

As global markets become more concentrated and unpredictable, diversification has again been brought to the fore as the central tenet of investment practice. China could be the wildcard in a diversified approach.

To stay updated on all economic events of today, please check out our Economic calendar

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Owen Li

Economic

The OPEC+ "precautionary" decision to postpone crude production hikes until after the first quarter bides the group time to assess developments in global demand, European growth and the U.S. economy, according to the coalition's chair, Saudi Energy Minister Abdulaziz bin Salman.

On Thursday, the oil producers' alliance agreed to extend several output cuts, with the timeline to start gradually unwinding a 2.2-million-barrels-per-day voluntary decline undertaken by a subset of OPEC+ members pushed back by three months to April.

Several group members are delivering a second voluntary production decline, while the coalition as a whole is also restricting production under its formal policy — both now set to stretch until Dec. 31, 2026, rather than the previously penciled end of 2025.

Speaking to CNBC's Dan Murphy on Friday, the Saudi energy minister said OPEC+ had to undertake a "reality check" and reconcile supply-demand signals with market sentiment and attend to "the fundamentals, yet put together something that mitigate these negative sentiments within, of course, the contours of what OPEC+ can do."

Barclays analysts partly echoed the minister's feelings, saying the alliance "maintained a cautious stance" and suggesting "market share concerns among members are likely exaggerated."

OPEC+ faces a spate of variables affecting the supply-demand picture and geopolitical uncertainties, ranging from economic growth amid lowering inflation to conflict in the oil-rich Middle Eastern region and the January White House return of President-elect Donald Trump — a long-time champion of the U.S. oil industry, who applied protectionist tariffs on China and sanctioned Iran for its nuclear program during his first presidential mandate.

"There are so many other things, you know, growth in China, what is happening in Europe, growth in Europe … what is happening in the U.S. economy, such as interest rate, inflation," the Saudi energy minister said Friday.

"But honestly, the primary cause for moving, or shifting, the bringing of these ballots is [supply-demand] fundamentals. It's not a good idea to bring volumes in the first quarter."

The first quarter typically sees inventory build-ups due to lower demand for transport fuels.

OPEC+ member compliance

In a Friday note, analysts at HSBC assessed that the Thursday OPEC+ agreement is "marginally supportive" for supply-demand balances, reducing the projected market surplus in 2025 to just 0.2 million barrels per day, if the oil producers' alliance proceeds with hiking production in April.

"Another delay, which we would not rule out, would leave the market broadly in balance next year," they said. "While OPEC+'s decision to hold off strengthens fundamentals in the near term, it could be seen as an implicit admission that demand is sluggish."

Demand has been at the forefront of OPEC+ considerations, with the OPEC's November Monthly Oil Market Report seeing 1.54 million barrels-per-day of year-on-year growth in 2025.

The Paris-based International Energy Agency, meanwhile, last month forecast that world oil demand will expand by 920,000 barrels per day this year and just under 1 million barrels per day in 2025.

Market concerns have especially lingered over the outlook of the world's largest crude importer, China, whose convalescent economy has received a governmental boost in recent months by way of stimulus measures.

Abdulaziz bin Salman said OPEC+ had "not necessarily" lost confidence in global crude appetite or in recoveries in China, but admitted that "what is not helpful was the fact that some [OPEC+] countries were not attending to their commitments properly."

OPEC+ has increasingly cracked down on member compliance with individual quotas — which has in the past included the likes of Iraq, Kazakhstan and Russia — and requires overproducers to make up excess barrels with additional cuts. The deadline for these compensations is now the end of June 2026.

Oil prices have retreated despite the three-pronged extension to production hikes, with the Ice Brent contract with February expiry trading at $71.40 per barrel at 2:46 p.m. London time, down by 0.96% from the Thursday close. Front-month January Nymex WTI futures dipped to $67.63 per barrel, lower by 0.98% from the previous day's settlement price.

"While prices are likely to stay volatile in the near term, we expect falling inventories this year and a closely balanced market next year, in contrast to market expectations for a strongly oversupplied market, to support prices over the coming months," UBS Strategist Giovanni Staunovo said in a Friday note.