Geopolitical Developments: Eurasia Toys With Global Confidence And Now Investors Are Reacting By Buying US Markets

The extreme shift in risk-off sentiment is playing now to the benefit of equity markets. The rout in currencies has led investors back into US assets and now into the equity side as investors rationalize that the West will come back to normal eventually, so bottom-fishing is the call of the day. The volatility risk premium points to a higher market over the next few days, while my technical reading of key stocks in the S&P 500 is short-term bullish. Yesterday's cross-asset action brought several positive factors for US stocks. The US yield curve is falling and in the current context that is bullish. Inflation expectations are stabilizing based on measures of Treasuries and TIPS. But there were also several negative factors across global asset classes. Copper is pointing to declining global GDP expectations. The action in currencies signifies risk-off sentiment. Expect the S&P 500 to trade higher over the next few days.

The current bear market rally reflects higher confidence in the US and the West than in Eurasia, where malevolent and moronic policies are converging to drive down economic growth and raise inflation. The same macroeconomic situation pertains to the West but confidence is higher in the resilience of the West to maintain its liberal framework, which is pro-capitalist and thus favorable to financial markets. Consequently investors are more willing to risk their money in the expectations of a future bull market, even in the midst of a 4-month long rout. The rally in US treasuries reflects this liberal order where policymakers are expected not so much to be right or even smart, but to correct themselves when they are wrong and stupid, through the expression of both the democratic process and more profoundly, the interpretations of global investors. Contrast this with the rout in the Chinese yuan and other EM and Asian currencies, which speak to capital flight and growing pessimism about the long-term health of these nations.

China is a good case of Eurasian disdain for the liberal framework and the consequent tendency to toy with investors. Komarovsky’s maxim from the film version of Dr. Zhivago that the Bolsheviks didn’t trust anyone but merely found everyone useful applies to the modern Chinese Communist Party. The CCP talks about liberal ideas and implements them for clear and transparent goals, then reverts back to statist and anti-Western policies but keeps the implements and institutions in order to effect those policies while maintaining the veneer of conforming to the liberal order that investors need. Anti-corruption policies are the prime example of this practice, and they are turning what was optimism about a more stable China into pessimism about the “investability” of China, as JP Morgan inadvertently alerted to the entire financial world several weeks ago.

The Diplomat notes “Anti-corruption investigations in China (have been) punishing more than 4 million cadres and nearly 500 senior officials since Xi took office in 2012. The CCDI even has its own TV program called “Zero Tolerance,” an annual production popular with the public for showcasing the body’s work in tacking graft and exposing the corruption and opulence of high-ranking members in the party…Another highlight of the political discipline campaign was the expulsion of 63 military generals, the largest such anti-corruption effort targeting the military in China’s modern history…The expansion of the CCDI and NSC’s operations abroad also accompanied a shift in the emphasis of the campaign. The CCDI has targeted bureaucratic inefficiency and performance-related issues, such as the failure to meet key performance indicators, unaccountability to constituents, and the lack of compliance with directives issued by the party center. For example, in January 2022, the Zhengzhou city party chief, Xu Liyi, and 89 other officials were disciplined for their poor handling of the Henan floods, which claimed the lives of 380 people in the city…Lastly, public perception of the anti-corruption campaign has been largely supportive of Xi’s efforts. Combined with corruption within the CCP, the rising inequality in incomes in China is likely to generate support for the campaign as it moves forward. As the 20th Party Congress approaches, the anti-corruption drive shows no signs of slowing, indicating Xi’s resolve to maintain his authority over the party and demonstrating his willingness to shape the future of the CCP in his image.“

As long as Xi Jinping can rest on the confidence of the Chinese people he will continue such practices. But capital flight and the scorching effect of his COVID lockdowns are draining such confidence, and lay the seeds for eventual change in China either to the Russian or the liberal order. This is one reason I expect rallies like today to be short-lived and pessimism to return shortly, driving global equity markets to deeper lows.

Yesterday I added modestly to my holdings of UPRO, both in an intraday trade and a subsequent position near the close of trading. Consequently my current positions include a large but smaller cash position, Goldman Sachs (GS), 3M (MMM), Pfizer (PFE), Starbucks (SBUX), Titan Machinery (TITN) and the levered ETF UPRO.