If M1 is not visible, what should be looked at?

Key Conclusion: After June, the market has entered a phase of shrinking volume and stagnant rise. Although it aligns with our consistent judgment of a "volatile market foundation," we still feel uneasy. Currently, the tactical focus is on the rise in inflation, with limited positive data coming from the 0.2% month-on-month rebound in May PPI (previous value -0.2%), but year-on-year still at -1.4% (previous value -2.5%), indicating that the signs of reversal are not clear. The strategic focus is on the real estate issue. This round of real estate policies has identified the root cause correctly, and the direction of thinking is right. However, the negative growth of 4.2% in M1 in May, despite factors such as crackdown on shadow banking, reveals the weak reality and the ineffective policy transmission behind it, indicating that the adjustment in real estate and domestic demand is a cautious and verifying process. Perhaps the trend can only be clearly judged by the end of 2024 at the earliest. At the index level, the market is highly concerned about the historic low in May M1. Before 2014, the overall trend of the A-share market was basically consistent with the year-on-year growth rate of M1, known as the "M1 determines buying and selling." However, after 2016, the correlation between the two has decreased, and the effectiveness of pricing in the past 3 years has significantly declined. The crux lies in the fact that the year-on-year growth rate of M1 is fundamentally tied to the real estate cycle, a financial phenomenon, and the financial path of monetary injection-real estate sales-inflation transmission is no longer smooth under the background of economic transformation. Here, our more profound observation is that in recent years, the core of pricing A-share macro strategies may be gradually shifting from a financial perspective to a fiscal perspective. Currently, the emphasis is on "finance is the foundation and important pillar of national governance." We solemnly propose that the difference in expenditure growth between central and local governments (the difference in the growth rate of local and central government expenditures) may be a more effective leading indicator for the pricing of the CSI 300 (leading by 1-2 months). If this value expands, it is beneficial to the index, and vice versa. It implies observations on the process of local debt and the intensity of central transfer payments, and this indicator has shown a strong correlation with the index from 2017 to the present.

Regarding the recent high attention on the historic low of -4.2% negative growth in May M1, the key lies in the fact that M1 used to be a widely used macro indicator for trend analysis. Before 2014, the overall trend of the A-share market was basically consistent with the year-on-year growth rate of M1, and timing the A-share market based on the highs and lows of the year-on-year growth rate of M1 was known as the "M1 determines buying and selling." However, the synchronicity between the two has decreased since 2016, and the pricing effectiveness of the past 3 years has significantly declined. Here, our more profound observation is that in recent years, the core of pricing A-share macro strategies may be gradually shifting from a financial perspective to a fiscal perspective. After the emphasis on "finance is the foundation and important pillar of national governance" in 2022, we believe that the difference in expenditure growth between central and local governments (the difference in the growth rate of local and central government expenditures) may be a more effective leading indicator for the pricing of the CSI 300 (leading by 1-2 months). If this value expands, it is beneficial to the index, and vice versa. It implies observations on the process of local debt and the intensity of central transfer payments. This indicator has a strong correlation with the overall market index from 2017 to present.

• 1. Why was M1 able to determine buying and selling in the past? The essence of the year-on-year growth rate of M1 is highly tied to the real estate cycle, a financial phenomenon. Because the act of buying a house is the most direct way to generate M1 (residents' time deposits are converted into current deposits of real estate companies, further converted into current deposits of enterprises in the real estate chain through bank credit creation), we can see that the year-on-year growth rate of M1 and the year-on-year growth rate of commercial housing sales area have always maintained a good correlation. In recent years, the continuous decline and repeated underperformance of M1 growth rate are naturally closely related to the weakening of the real estate cycle. The root cause of the gradual decrease in the pricing effect of M1's buying and selling lies in the fact that, against the backdrop of economic structural transformation, the influence of real estate on China's macroeconomy is gradually declining. An indicator to observe this influence is the correlation between M1 and inflation. Before 2014, the fluctuation of the year-on-year growth rate of M1 and the year-on-year growth rate of CPI had a stable relationship, with M1 positively correlated with CPI lagging by 12 months, reflecting the lag effect of monetary injection on inflation. This indicated a stable relationship among the financial cycle, inflation cycle, and real estate cycle. However, after 2014, due to the advancement of high-quality development and the change in the status of real estate in the economy, the transmission path of monetary injection-real estate sales-inflation is no longer smooth.

• **2. After the significant decline in the effectiveness of M1, what will be used for buying and selling in the future? In the current transition from old to new drivers, the monetary narrative gradually loses its effectiveness as the real estate cycle declines, while the fiscal narrative gradually becomes the dominant force in the rise of new drivers. The so-called fiscal narrative uses fiscal (government bonds) rather than real estate as the carrier of money, converting money into demand, then transmitting it to inflation, thereby completing the economic cycle. Based on the allocation of fiscal power and responsibilities between the central and local governments, we construct an indicator to assess the strength of fiscal expenditure: the year-on-year growth rate of local fiscal expenditure minus the year-on-year growth rate of central government expenditure, referred to as the central-local fiscal expenditure growth rate difference. From a quantitative perspective, the correlation coefficient between the central-local fiscal expenditure growth rate difference and the CSI 300 (lagging by 3 months) was -19.92% before 2017 (2009-2017), showing a weak negative correlation, while after 2017 (2017 to present), the correlation coefficient increased to 63.08%, showing a strong positive correlation. This pattern implies that, compared to monetary policy and related indicators (M2, M1, etc.), the impact of fiscal policy on market pricing is gradually increasing. With the issuance of special government bonds and the implementation of debt-to-equity measures, the central-local fiscal expenditure growth rate difference may gradually rise, and the A-share market is expected to return to an upward cycle accordingly **

Has the M1 定买卖 strategy failed? - Pricing based on the difference in central and local expenditure growth rates is more effective

In May, M1 saw a year-on-year negative growth of 4.2%, hitting a historical low. Despite factors such as manual subsidies affecting this figure, the underlying reality of weakening real economic demand and hindered monetary policy transmission cannot be ignored. In the history of the A-share market, M1 was once widely used as a macro indicator for trend analysis. Before 2014, the overall trend of the A-share market was basically consistent with the year-on-year growth rate of M1. By timing the A-share market based on the highs and lows of M1's year-on-year growth rate, considerable profits could be obtained. This pattern was known as the "M1 定买卖" strategy. However, the synchronicity between the two decreased after the bull market and stock market crash in 2014-2015. From a quantitative perspective, we divided nearly twenty years of macroeconomics and the A-share market into the first ten years and the last ten years (with 2014 as the dividing point) for further study. The correlation coefficient between M1's year-on-year growth rate and the CSI 300 index was 44.06% before 2014 (2004-2014), while it was -22.39% after 2014 (2014-present).

This discussion raises the question of whether the M1 定买卖 strategy was a historical coincidence or if there is a coherent macro narrative behind it. We propose three points of understanding:

First, why was M1 able to determine buying and selling for a considerable period in the past? The year-on-year growth rate of M1 is fundamentally tied to the real estate cycle because property purchases are the most direct way to generate M1 (residents' time deposits are converted into current deposits for real estate companies, further transformed into current deposits for companies in the real estate chain through bank credit creation). Therefore, we can see that there has always been a good correlation between the year-on-year growth rates of M1 and the sales area of commercial housing. In recent years, the continuous decline and unpredictability of M1's growth rate are closely related to the weakening real estate cycle. From a quantitative perspective, the correlation coefficient between M1's year-on-year growth rate and the year-on-year growth rate of commercial housing sales area was 63.43% before 2014 (2004-2014) and still remains at 53.47% after 2014 (2014-present), indicating a robust correlation. The real estate cycle was the dominant force in China's economic cycle before 2014, as well as a core influencing factor in the A-share market cycle and profit cycle. This is a macro explanation for why M1 was able to determine buying and selling for a significant period in the past.

Second, why has the M1 定买卖 strategy failed in recent years? The root cause of the declining pricing effectiveness of the M1 定买卖 strategy lies in the fact that, against the backdrop of economic structural transformation, the influence of real estate on China's macroeconomy is gradually diminishing. An observable indicator of this influence is the correlation between M1 and inflation Before 2014, there was a stable relationship between the year-on-year growth rates of M1 and CPI. M1 was positively correlated with CPI lagging by 12 months, reflecting the lag effect of monetary transmission to inflation. This indicated a stable relationship among the financial cycle, inflation cycle, and real estate cycle. However, after 2014, due to the advancement of high-quality development and changes in the status of real estate in the economy, the transmission path of monetary injection-real estate sales-inflation became less smooth. From a quantitative perspective, the correlation coefficient between the year-on-year growth rate of M1 and CPI lagging by 12 months was 46.41% before 2014 (2004-2014), while it was only -2.61% after 2014 (2014-present). One reason for the poor transmission of money to inflation is that the core lever of monetary injection, real estate, has entered a structural downturn phase (showing some recovery after the epidemic but quickly facing a more intense downturn), making monetary injection less effective in stimulating domestic demand and driving inflation upwards. As a result, the path of M1 transmission to the economic cycle and profit cycle has become ineffective, leading to a significant decrease in the explanatory power of M1 for the A-share market.

Thirdly, after the ineffectiveness of M1, what should be used for trading? In the current transition from old to new drivers, the monetary narrative gradually loses its effectiveness with the downturn of the real estate cycle, while the fiscal narrative gradually becomes the dominant force in the rise of new drivers. The so-called fiscal narrative uses fiscal (government bonds) rather than real estate as the carrier of money, transforming money into demand, which is then transmitted to inflation, thereby completing the economic cycle. Based on the allocation of fiscal power and responsibilities between the central and local governments, we have constructed an indicator to judge the strength of fiscal expenditure: the difference between the year-on-year growth rates of local fiscal expenditure and central government fiscal expenditure, referred to as the central-local fiscal expenditure growth rate difference. From a quantitative perspective, the correlation coefficient between the central-local fiscal expenditure growth rate difference and the CSI 300 (lagging by 3 months) was -19.92% before 2017 (2009-2017), showing a weak negative correlation, while it increased to 63.08% after 2017 (2017-present), showing a strong positive correlation. This pattern implies that compared to monetary policy and related indicators (M2, M1, etc.), the impact of fiscal policy on market pricing is gradually increasing. With the issuance of special government bonds and the implementation of debt-to-equity measures, the central-local fiscal expenditure growth rate difference may gradually rise, and the A-share market is expected to return to an upward cycle.

Internal Factors: Weak Monetary Credit Data in May, Inflation Data Basically Meeting Expectations, Macro Fundamentals Still in the Process of Bottoming Out and Shaking

This week, the main data released were related to inflation, social financing, and M2 in May. In terms of inflation data, CPI weakened while PPI turned positive month-on-month. The weakening of CPI indicates that current domestic demand still needs to be boosted, while the positive turn of PPI is influenced by the low base effect and is related to the stabilization of the real estate chain and the rebound of the black series driven by this round of energy-saving and carbon reduction policies. In terms of social financing and credit, the recent acceleration in government bond issuance was the main support for social financing in May, but credit data still shows weak demand from the residential and corporate sectors In terms of monetary data, the decline in M1 and M2 is mainly affected by the policy of prohibiting manual interest supplementation, which does not fully reflect the real economy. Overall, the previous economic model of strong supply and weak demand may be undergoing adjustments. Faced with continuous price declines and profit deceleration, the process of corporate supply expansion is gradually slowing down. Real estate remains an important factor dragging down the current economy, but with continuous efforts in real estate policies and accelerated local government bond issuance, the trend of marginal economic recovery may continue. Specifically:

• In terms of inflation data, in May, the national consumer price index (CPI) year-on-year was 0.3% (previously 0.3%), month-on-month was -0.1% (previously 0.1%); the national industrial producer price index (PPI) year-on-year was -1.4% (previously -2.5%), month-on-month was 0.2% (previously -0.2%). Overall, the weakening CPI and the positive month-on-month change in PPI indicate that current domestic demand still needs to be boosted. The weakening CPI indicates the need for demand stimulation, while the positive PPI change is influenced by both a low base effect and the marginal stabilization of the real estate chain, as well as the current round of energy-saving and carbon reduction policies driving the recovery of the black series. In terms of CPI, looking at specific items, pork prices rose, while durable consumer goods, rental housing rents, and alcohol prices fell. In May, the year-on-year increase in pork CPI was 4.6% (previously 1.4%), which was the main driving factor for the increase in food CPI. The rise in pork prices is partly due to the gradual manifestation of the effect of previous capacity reduction in the pig industry, and may also be a short-term disturbance due to factors such as secondary fattening and stocking pressure; the decrease in durable consumer goods, rental housing rents, and alcohol prices indicates that the practice of "exchanging price for quantity" continues under insufficient demand, and the intensifying price war in the automobile sector is also a significant factor dragging down durable goods prices. As for PPI, the low base effect is the main driver of the year-on-year rebound in PPI, with the carry-over effect rising by 0.9 percentage points. In addition, the black series priced based on domestic demand is starting to turn positive, with coal mining and washing industries increasing by 0.5% and 0.8% respectively on a monthly basis. Looking ahead, on June 7th, the State Council meeting pointed out, "Efforts should be made to ensure that the policies already introduced take effect, and continue to study new inventory reduction and market stabilization policies." With the continuous efforts in real estate policies and the accelerated issuance of local government bonds, the trend of marginal economic recovery may continue, driving the stabilization of black series prices and thereby supporting the upward trend in inflation data.

• In terms of social financing, the growth rate of social financing in May rebounded to 8.4%, with new social financing reaching 2.07 trillion yuan, an increase of 0.51 trillion yuan year-on-year. Breaking it down, government bonds increased by 1.22 trillion yuan, an increase of 668.2 billion yuan year-on-year. The recent acceleration in government bond issuance is the main support for social financing in May; loans increased by 406.2 billion yuan year-on-year, which is the main drag on social financing in May. Structurally, in May, long-term loans to enterprises decreased by 269.8 billion yuan year-on-year, while the net financing of PSL+ policy bank bonds increased by 46.4 billion yuan year-on-year, reflecting the slow growth in loan demand for infrastructure and major projects. Short-term loans and long-term loans to residents combined decreased by 291.5 billion yuan year-on-year, mainly affected by weak financing demand and a cold real estate market, showing that significant changes in short and long-term loans to residents reflect residents' active optimization of their balance sheets and their willingness to deleverage. The stimulus for housing and other consumer goods consumption needs to be further increased in the future. Looking ahead, as government bond issuance accelerates and a new round of real estate policies proposed by the State Council continues to exert force, it may continue to provide support for social financing growth.

• In terms of monetary data, the year-on-year growth rate of M2 in May was 7.0%, a decrease of 0.2 percentage points from the previous month; the year-on-year growth rate of M1 was -4.2%, a decrease of 2.8 percentage points from the previous month. The reason behind this is that the policy of prohibiting informal interest payments may lead to a decrease in the scale of corporate loans and deposits, with enterprises turning to fund products to seek higher returns. This trend is reflected in the increase in non-bank deposits and the decrease in corporate deposits. The chain reaction triggered by the early repayment of private sector loans is as follows: early repayment by the private sector leads to a decrease in M1 and M2, as it restricts the purchasing power of residents and the current deposits of enterprises (affecting M1), while forcing commercial banks to shrink their balance sheets, reduce lending to the non-bank sector, thereby reducing resident and non-bank deposits (affecting M2). Overall, the credit and social financing data in May are mainly influenced by short-term policies and cannot fully reflect the operation of the real economy. Looking ahead, there is still room for monetary policy adjustments. Pan Gongsheng, the Governor of the People's Bank of China, stated at the press conference on the economic theme of the Second Session of the Fourteenth National People's Congress that the average reserve requirement ratio for the entire Chinese banking industry is 7%, and there is still room for reserve requirement ratio cuts in the future. With the additional support of structural monetary policy tools, under multiple signals, it is expected to drive credit indicators represented by M1, M2, and social financing to stabilize and improve.

Author: Lin Rongxiong, Source: Lin Rongxiong Strategy Salon, Original Title: "If M1 is not visible, what should we look at?"

Lin Rongxiong S1450520010001

Zou Zhuoqing S1450524060001