Geopolitical Developments: China Turns From Savior To Ogre While The Markets Grin And Bear It

The two-week soft slide in equity markets mirror pessimistic stories of vaccination stagnation in America but also reflect low volumes of trading, which may be due to a decline in global confidence. The dominant reason for such a decline is China’s manhandling of its private sector jewels. Global investors base their confidence in large part on China pulling up global GDP growth with 5-6% annual growth rates. That’s now at risk as Chinese entrepreneurs and CEOs grow risk-averse for fear of losing all to the proud but insecure leviathan that is the CCP. The volatility risk premium points to a higher market over the next few days, but my technical reading of key stocks in the S&P 500 is neutral. Yesterday's cross-asset action failed to build on the $US weakness, and brought just one positive factor for US stocks: oil's chart continues to signify global growth. On this options/futures expiration Friday, I expect the S&P 500 to be range-bound but volatile.

China was the undisputed global savior during the 2008-2009 Global Financial Crisis, and proved its mettle by surviving a financial debacle in 2015, maintaining high if declining growth rates right up until COVID. Even then China handle COVID well in comparison with most other nations, but that was because China’s high savings rate meant that turning on the monetary spigot was non-inflationary, as savings went into financial instruments that eventually buoyed business confidence and the amazing economic recovery from 2q2020 up until recent weeks. But now China’s financial excesses, its brutal takedown of its own high-flying companies, imperious geopolitical attitude in the South China Sea, disingenuous vaccine diplomacy linked to limited efficacy of its homegrown vaccines, are combining to make China an antagonist to the US and other nations, while its growth is in danger of falling to earth and well behind india.

The upshot of this is turmoil in China’s property market along with geopolitical malaise which combine to attenuate global investor confidence. Regarding the property market, Reuters notes “China's central bank highlighted in 2018 that companies including Evergrande might pose systemic risks to the nation's financial system…The leaked letter last year said Evergrande's liabilities involve more than 128 banks and over 121 non-banking institutions. JPMorgan estimated last week China Minsheng Bank (600016.SS) has the highest exposure to Evergrande…Late payments could trigger cross-defaults as many financial institutions have exposure to Evergrande via direct loans and indirect holdings through different financial instruments.,,In the dollar bond market, Evergrande accounts for 4% of Chinese real estate high-yields, according to DBS. Any defaults will also trigger sell-offs in the high-yield credit market…A collapse of Evergrande will have a large impact on the job market. It has 200,000 staff and hires 3.8 million people every year for project developments”

Cross-defaults are the bane of the global financial system, threatening China now but also Europe in the long-term because of Italy’s precarious economic, political and demographic situation. So contagion risk is real, and memories of the GFC’s virulent bout of contagion are keeping volumes low in equity markets.

The geopolitical malaise gripping the world can be largely traced to the CCP’s unwarranted aggression and bombastic approach to everything from cultural values to territorial claims of small reefs and rocks in the East Asian seas. China has fomented a Thucydides Trap by hinting that the worst instincts of the CCP might be resurrected, with global consequences. The world knows what Mao did to China and that leaders like Xi Jinping lived through such brutality, making them potential repeaters. But Mao ruled a somewhat autarkic China while Xi rules a globally integrated nation whom investors rely on. So the Thucydides Trap is real and consequential.

An example of this is the Washington Post story regarding Chinese academics in America. The Post reports “But a string of dismissed cases has amplified concerns among some lawmakers and activists about whether prosecutors have been overzealous in pursuing researchers of Chinese descent....The Justice Department separately dropped five other cases in a single day this summer, each involving Chinese nationals doing research in the United States and accused of falsely denying links to the Chinese military on visa applications. Officials said the dismissals were not for lack of evidence, but defense lawyers said the government overreached.”

The problem here is not governmental overreach or Americans being paranoid, but China’s ability to undermine the golden goose of American culture and scientific dominance, the university system. Even if the Justice Department caused its own debacle that simply makes it an example of the Thucydides Trap coming to fruition, a course set by the turn to conservatism by Xi Jinping. And it’s worse if the Chinese did actually engage in academic spycraft, since it’s only a matter of time before other nations are accused of doing the same.

Geopolitical antagonism redounds to trade relations, and now that Biden has the Trump experience as a case study, he is both capable and likely to exert more harmful measures against China than Trump did. With the CCP hurting its own companies, any hit to Chinese exports would send growth falling and pierce global investor confidence into a volatile bear market.

My current market positions are in Activision (ATVI), American Express (AXP), Amgen (AMGN), Gibraltar Industries (ROCK), Johnson & Johnson (JNJ), 3M (MMM), Pfizer (PFE) and a short position in the SPX (UPRO and SPXU).