Geopolitical Developments: Short-Term Exuberance Is Long-Term Irrationality

The move up in Tesla and the S&P 500 is likely to diverge soon, as the markets look increasingly exuberant despite broader political and economic trends. The volatility risk premium points to a higher market over the next few days (though volume may be light since the VRP could easily reverse and catch investors offside), while my technical reading of key stocks in the S&P 500 is bullish. Yesterday's cross-asset action brought one positive factor for US stocks. The US yield curve is falling and in the current context that is bullish. Expect the S&P 500 to rise modestly over the next few days.

Confidence is high right now because the profit trajectory out of COVID is still intact, but the ominous rise in COVID across the world combined with rising inflation expectations and ever more debt-fueled government spending are long-term negatives. I’ve been calling for higher highs but I see those highs as only marginal now, given the increasingly poor long-term outlook.

Chinese statism is increasingly pertinent to both geopolitical trajectories and the markets. As George Magnus notes in Project Syndicate, the WTO is at risk of being perverted by China to allow more statism and less free trade. In the new book “In China and the WTO: Why Multilateralism Still Matters” written by Columbia Law School’s Petros C. Mavroidis and André Sapir of the Université Libre de Bruxelles, Magnus notes the authors “bring years of experience and sterling reputations in trade law and economics, respectively, to a crucial issue: Is China’s state capitalism compatible with its membership in one of the world’s most important – but also threatened – international institutions?... The only recourse for the rest of the world, as Mavroidis and Sapir see it, is to try induce a change in behavior, at least as far as trade policy is concerned, by reaffirming a commitment to multilateralism that includes China. For example, applying new rules across the board incrementally (following a pattern applied in the past to Eastern European countries, Japan, India, and Brazil) could enable compromise in contentious areas, or at least provide a basis for dialogue and engagement…It is laudable and necessary to explore possibilities for collaboration between China and liberal democracies within the WTO, not least because the institution’s survival depends on such progress. With their deep understanding of the power, scope, and mechanics of multilateralism in trade, the authors make a good case for what needs to be done. What remains in doubt is whether there is the political will to do it. For now, at least, any openness to compromise is being drowned by a cacophony of sanctions, appeals to national security, and other concerns.”

Since Biden is continuing the Trump line on protectionism, and the Progressives have moved Biden toward statist experiments in public services and welfare, there is little chance the WTO stays oriented towards free-trade. The WTO is more likely to evolve rather than China. And that corresponds with China’s plans in Central Asia, where two of its immediate conduits are incapable of executing the original Chinese model of poverty alleviation, namely capitalist development. Pakistan and Afghanistan don’t have China’s history of a “year zero” where markets were abolished and history discarded. These nations can’t alleviate poverty like China did, namely to allow pure innovation zones under foreign corporate control and the allowance of local competition with little cultural or economic regulation in towns and small cities. Such policies have already been tried and found wanting since they are not conducive to the cultural and tribal goals and rivalries that dominate these nations. But they can become even more statist, which would make it easier for the Chinese Communist Party to manipulate, which is particularly important since Western China is the CCP’s weak point due to ethnic diversity.

A world with less free trade and more statism is bad for profit margins and confidence, and consequently the long-term is looking precarious for markets. So while we make new highs this week I believe it’s critical to have large cash balances so that one can opportunistically trade on both the long and short side, as governments start playing havoc with the markets.

My current market positions include a large cash position, and the following holdings: Activision (ATVI), Amgen (AMGN), Apple (AAPL), Johnson & Johnson (JNJ), 3M (MMM), Pfizer (PFE) and a small net short position in S&P 500 (the levered inverse ETF SPXU).