Geopolitical Developments: The Delicate Nature Of China Is A Key Reason The Bear Market Rally Will Unwind As Summer Closes

Conspicuously absent from the recent equity rally off the June lows is the participation of Chinese equities, which had boldly rallied in the late Spring against the prevailing gloom but then suddenly lost steam in July. Last night’s trading was particularly bad as a near-term support point was breached, and the undeniable implication of this divergence is the souring of Chinese investor confidence. I expect this mood change to redound to the detriment of global equity markets as investors slake off their travel grievances and focus on the parlous geopolitical state of Eurasia. The volatility risk premium is pointing to a range-bound market over the next few days, while my technical reading of key stocks in the S&P 500 is neutral. Yesterday's cross-asset action brought several positive factors for US stocks. The US yield curve is bull flattening. Inflation expectations are stabilizing based on measures of Treasuries and TIPS. Expect the S&P 500 to consolidate over the next few days before heading lower as we approach mid-month.

Key to the bullish case is China growing at something between zero and the official target of 5.5%. Already the CCP is walking back that target as mere “guidance” with no penalties on anyone for missing it. The bulls can’t take heart from that, but are effectively betting that peak pessimism is past us, since the fragility of the property sector has yet to yield mass discontent, bank collapses or calls for Xi Jinping’s ouster.

The problem is the mood has soured, as Chinese are increasingly speaking out against unrealistic policies and the negative effect of empty exhortations on business confidence. As Fitch notes: “A rise in the number of Chinese homebuyers ceasing mortgage payments on properties where construction has been suspended for a prolonged period could weaken banks’ asset quality…Authorities are likely to step in to curb mortgage defaults from spreading more widely and to larger cities, but a failure of policy intervention to restore homebuyer confidence could test the banking system’s resilience and heighten liquidity pressure at developers. Household leverage stood at 62% of GDP and 112% of household disposable income at end-2021, which was modest by global standards. A recent rapid rise in debt may have stretched household balance sheets for certain segments of the population, but we do not believe a major deterioration in household debt serviceability was the driving factor in the mortgage boycott…However, should defaults escalate, there could be broad and serious economic and social implications. ”

I see the Pelosi visit to Taiwan adding to increasing disgust at the CCP, founded on its self-serving COVID policies from the outset of the epidemic through to the present. The Chinese are rightfully rebuked for their debt policies with subcontinental nations Sri Lanka and Pakistan, and for their tacit support of Russia which has led those nations to financial disaster. With people around the world disgusted with the ongoing disruptions from COVID the stage is set for increasing discontent within China against Xi Jinping as he seeks to mold one billion people is his image. Any further discontent along the lines of mortgage boycotts will drive the bulls to the shelter of cash and invigorate the bears, sending the market to new lows.

My current positions are a moderate but relatively large cash position, Goldman Sachs (GS), 3M (MMM), Pfizer (PFE), Starbucks (SBUX), Titan Machinery (TITN) and the levered ETFs UPRO and SPXU.