Straits Financial Chief Economist Commentary – March 2025

Summary :

• Over the past month, the world's largest geopolitical landscape has undergone significant changes. The ongoing US relationships with traditional allies, including the EU, the UK, and Canada, have shown severe cracks. The EU has embarked on rearmament , while Germany announced ambitious infrastructure and defense manufacturing investment plans. Deteriorating transatlantic relations imply substantially reduced external pressures on China, creating favorable conditions for further re-rating in Chinese assets, particularly H shares.

• The US economy, stock market, and dollar’s supremacy are inextricably linked to the post-Cold War international order. The theory of "American exceptionalism" has long been used to explain why the U.S. has outperformed global peers since 1990. However, we argue that this doctrine relies critically on two external obligations: safeguarding allied security and upholding free trade. The policies of Trump’s current administration directly challenge these pillars, posing risks to market sentiment, the dollar’s international credibility, and potentially increasing recessionary pressures in the US economy.

• EU nations, constrained by post-debt-crisis fiscal rules, currently have relatively low fiscal deficits and government debt-to-GDP ratios. Amid heightened security challenges, both the EU and Germany have significant room for new fiscal expansions and sovereign borrowing.

• The premium on U.S. assets driven by "American exceptionalism" now stands at historical highs, but  Trump’s policies  are weakening this advantage. Meanwhile, Europe’s planned fiscal stimulus and China’s chronically discounted asset prices may trigger global capital outflows from US dollar-denominated investments (especially overvalued US stocks) toward European and Asian markets, particularly China.

• While China’s Two Sessions fiscal stimulus and consumption subsidies appear below market expectations, Beijing has shown increased policy flexibility in recent years, such as implementing additional stimulus measures in Q3 of consecutive years.

• We remain cautious on US stocks under Trump’s administration, as significant downside risks remain. Geopolitical and capital reallocations may also lead to a depreciation in the US dollar.

• Our overall outlook remains positive on A-shares and HK shares, with HK-listed stocks slightly favored over A-shares. Near-term selling pressure due to below expectation policy announcement in Two Sessions should present buying opportunities.

• The latest geopolitical developments, particularly fracturing US-alliance trust and Europe’s military buildup, will likely boost demand for strategic minerals. Regional powers prioritizing self-defense and reserve accumulation could drive up the prices of non-ferrous metals, particularly those critical for military use.

Previous Views:

Our outlook on US stocks has shifted from optimistic to neutral, with a cautious stance.  While US equities continue to benefit from retail optimism and momentum-driven inflows, the Trump administration’s honeymoon period is drawing to a close. We maintain an optimistic stance overall on A-shares and Hong Kong stocks. Markets are expected to rebound from the early-year declines driven by concerns over Trump's China policies. The success of China's Deepseek AI model could potentially disrupt the AI narrative and profitability of US tech giants, while simultaneously boosting investor confidence in A-shares and Hong Kong stocks. Gold remains our preferred commodity due to its stability.

Views in March:

I. Deteriorating EU-American Relations: H shares Will Likely Be The Biggest Beneficiary

Over the past month, the world's largest geopolitical landscape has undergone significant changes. This transformation began with  the Trump administration's decision to bypass Ukraine and the EU by engaging in unilateral negotiations with the Russian government for a Ukraine-Russia ceasefire. Tense exchanges between Trump and Zelensky at the White House, along with the US unilateral termination of military and financial aid to Ukraine, have deeply strained relations with traditional allies such as the EU, UK, Canada, and other NATO countries Meanwhile, escalating trade frictions between the US, Mexico, and Canada have futher strained transatlantic alliances, causing cracks to widen rapidly within just a month.

This situation may lead to the following consequences:

1. The Rearmament of the EU and UK

The EU and UK  have long relied on US military security guarantees, but Trump’s policies and the unilateral withdrawal of Ukraine have raised serious concerns. This crisis has compelled them to consider re-arm and the development of independent defense industries. With the EU allocating €800 billion in “ReArm EU” investments and Germany's new chancellor planning €500 billion in infrastructure and manufacturing investments, Europe is poised to become a major military power in the future.  Additionally, a rearmed EU and UK would reclaim their geopolitical and diplomatic independence, moving beyond decades of U.S.-oriented foreign policy.

2. Significant Reduction in China's External Pressures

Rising Euro-American tensions are worsening the Ukraine crisis  and  increasing geopolitical risks with Russia. However, this shift implies that European nations, including Nordic and Canadian countries, may no longer  follow US containment policies against China and could take a more neutral stance. Meanwhile, US allies in the Asia-Pacific are becoming more cautious of Trump's foreign policy, further reducing pressure on China. Thus, this geopolitical shift  creates favorable conditions for the revaluation of Chinese assets.

3. ​Hong Kong Stock Market as a Primary Beneficiary

The EU's rearmament likely  marks a shift away from post-debt-crisis fiscal constraints, entering an era of accelerated fiscal expansion and investment. This is particularly beneficial for  European stocks, especially  those in military equipment and fixed asset investments.  Meanwhile, Hong Kong is poised to gain as the primary beneficiary in the Asia-Pacific region. Previous capital outflows due to Sino-Western tensions have depressed HKEX valuations, but the new geopolitical landscape now positions it as a "safe re-rating bet" asset due to its relatively low valuation. Additionally, some funds from traditional US allies may shift away from American markets and toward Chinese assets, boosting HKEX performance.

4. Rising Risks for U.S. Stocks

 The US economy, stock market, and dollar dominance are intertwined with the post-Cold War international order. However, Trump's administration is undermining two pillars of this order: protecting allies’ security and maintaining global trade stability. While some damage (e.g., tariffs) may be reversible, others (e.g., lost trust from its allies) are irreversible. These risks threaten market sentiment, dollar credibility, and could materially increase recession odds for a highly interconnected and globally dependent US economy.

II. "American Exceptionalism" Faces the Most Severe Challenge Since the End of the Cold War

Since the early 1990s, after the Soviet Union’s dissolution, the US economy and stock market have consistently outperformed other major global economies. Despite experiencing two major shocks - the dot-com bubble burst and the 2008 financial crisis - the US economy and markets have rapidly recovered and reached new highs.

Investors often attribute this resilience to the concept of "American Exceptionalism." We maintain that the two most critical external obligations underpinning "American Exceptionalism" are the following:  (1) ensuring the security and freedom of its allies, and (2) safeguarding free international trade. Economically, this has enabled the dollar to function as a stable medium of international trade and reserve currency, while US assets (stocks and bonds) have become the top preferred global investment destination. From an asset pricing perspective, this has  led to historically high valuations for US equities compared to other markets (Figure 1).

The current Trump administration's policies have fundamentally shaken these pillars of American Exceptionalism. Notably: Unilaterally abandoning Ukraine despite EU/UK security concerns by cutting military aid while criticizing insufficient European defense spending.

From Europe's perspective, post EU debt crisis fiscal constraints have maintained relatively low fiscal deficits and government debt ratios (particularly in Germany) compared to the US and China (Figure 2). This creates significant fiscal space for renewed government borrowing and military modernization.

In terms of global asset allocation, three factors are particularly noteworthy: Historical price premiums for US assets have reached unprecedented levels under decades of American Exceptionalism. Trump's policies are currently threatening the structural foundations supporting these valuations. Europe is entering an expansionary phase of fiscal stimulus and investment, while Chinese assets have long been discounted. These dynamics may collectively prompt a shift in global capital allocation away from US assets, particularly overpriced US stocks, towards European and Asian assets, especially those in China.

III. China's "Two Sessions": Policy Emphasizes Flexibility

In early March, China convened its annual "Two Sessions." Based on the government work report released during the sessions, investors may feel slightly disappointed with the announced stimulus measures, which include:

1.      ​New local government special bonds of RMB4.4 trillion, an increase of RMB500 billion from 2024 but slightly below market expectations.

2.      ​Ultra-long-term special treasury bonds of RMB1.3 trillion, a RMB300-billion- increase from 2024, while market forecasts had anticipated RMB2 trillion.

3.      ​Subsidies for consumer goods and trade-in programs totaling RMB300 billion , compared to market expectations of around RMB500 billion.

While these figures appear below market expectations, China's fiscal policy has demonstrated increasing flexibility over the past two years, reducing the initial policy forecasts' significance. Investors therefore need not fixate on the initial fiscal targets outlined in the Two Sessions reports to the same extent as analyses of European or US budgets.

Nonetheless, this year’s fiscal stimulus will still be larger than last year’s, as evidenced by the concrete data in the work report. However, there is considerable debate over the actual impact of US new tariffs. A 20% incremental tariff is expected to lower China’s total exports by less than 3 percentage points, indicating that the risk remain manageable.

If additional sanctions target China’s exports or transshipment trade, or if the US economy enters a recession, the decline in exports could accelerate beyond current calculations. Since exports contributed for 1.5 percentage points of China’s 5% GDP growth in 2024, a significant decline in export contributions may require additional consumption support and expanded fiscal stimulus measures as outlined in the current work report. Nevertheless, China retains ample fiscal policy space. To achieve its 5% GDP growth target, especially amid significant downward pressure on exports, the government is likely to intensify fiscal stimulus measures in subsequent quarters.

IV. Market Strategy

We maintain a cautious outlook on US equities, as the S&P 500 has nearly lost its gains for the year. However, due to the Trump administration's policy agenda, we see substantial downside risks for U.S. stocks, reinforcing our relatively bearish outlook. The latest shifts in global capital allocation driven by geopolitical developments also signal a potential decline in the US dollar.

Regarding A-shares and H-shares, we remain moderately optimistic overall, with H-shares slightly outperforming A-shares. Chinese equities will benefit from both global asset revaluation-driven reallocation and improving domestic investor sentiment, leading to further valuation recovery.

For commodities, aside from gold, we also see positive implications from recent geopolitical developments on non-ferrous metals, particularly strategically significant minerals. The erosion of trust between the US and traditional allies, coupled with EU re-armament efforts and regional powers' military buildup priorities, will likely exert upward pressure on prices of non-ferrous metals - especially those with military strategic importances.