Obtuse Optimism Is Slowly Giving Way To Harsh Realism On China’s Recovery: The Geopolitical — Stock Market Connection

Optimism about China is absurdly misplaced and find its analogue in the absurd bear market rallies that have plagued bears like myself since the summer. Both near-term and long-term optimism regarding China obtusely ignore the political and cultural winds that are turning China away from liberal capitalism and toward traditional left-wing statism. As news slowly filters out regarding the harsh price the Chinese people are paying for the unplanned and abrupt change in COVID policies I expect global markets to begin a plunge back to the October lows. That will likely coincide with earnings reports from technology companies later this month, but for now the bulls are in pitched battle with the bears and likely keep the markets above support levels. 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 one positive factor for US stocks. Inflation expectations are stabilizing based on measures of Treasuries and TIPS. Expect the S&P 500 to be range-bound over the next few days.

The bulls based much of their hope on a smooth Chinese reopening and point to resurgent commodities like copper, oil, zinc and tin as proof that activity is picking up. Hopes may rise in the grassmere but the reality is reopening coincides with Lunar New Year and a surge of travel among lockdown-weary Chinese. The result can only be a spreading of COVID among people lacking mRNA vaccines to those who aren’t even vaccinated at all. Singapore-based CNA notes “After a gruelling month in which cases surged nationwide, the government said it would step up efforts to quell "gloomy emotions" online about the outbreak. China's internet watchdog launched a campaign Wednesday to sponge out "fabricated patient experiences" online and "increase the rectification of epidemic-related online rumours”…Airfinity also estimated that more than 600,000 people have died from the disease since China abandoned the zero-COVID policy.”

Supply chains can’t open up meaningfully now under such conditions but demand for commodities reflects the forecasted upturn in the Chinese economy that will likely occur just as the true number of hospitalizations and deaths peak. So for now the global economy must deal with rising industrial metal and crude oil prices just when central bankers are trying to accelerate disinflation, while enduring the risk of a surge in new COVID variants from China. These inconvenient facts will enbolden the bears as earnings season peaks by late January.

Even worse is that the outlook for the Chinese recovery is exuberant and fanciful. Fitch notes “The recovery in China's consumption after the lifting of Covid-19 restrictions is likely to be bumpier than those in many other major economies due to the weak employment and income outlook, decreasing home prices, rising household leverage, and a lack of direct stimulus…the housing slowdown has undermined Chinese consumers’ wealth and willingness to spend as it has diminished home equity, which accounted for about 59% of Chinese urban household assets in 2019, according to a People’s Bank of China report. In December 2022, 64 of 70 major cities in China registered yoy declines in secondary home prices, and new home sales fell by 28.3% yoy in 2022…Rising household indebtedness has also impaired Chinese consumers’ purchasing power. The residential leverage ratio rose rapidly to 62.4% in 3Q2022 from 55.3% in 3Q2019, according to the National Institution for Finance & Development, while consumers in other re-opened economies, such as those in the US and Europe, had been deleveraging since the 2008 global financial crisis.”

And longer-term the damage done by Xi Jinping’s self-serving and moronic zero-COVID policies will fuel discontent and reactionary repression, eventually resurrecting the harsh leftist stance toward entrepreneurs and private firms that Xi imposed in 2021 before tamping down once the Chinese equity market started plunging in the fall of 2022. Such statism can only reverberate in the West where old-school politicians like Joe Biden feel the good vibrations of activist government and investors and businesses feel the pinch.

Yesterday I initiated a short-term swing trade in the levered ETF UPRO as I believed the markets would rally after touching support in the morning. I exited that position during the day, and consequently my current positions remain the same as yesterday morning, namely a large cash position, Goldman Sachs (GS), 3M (MMM), Pfizer (PFE), Starbucks (SBUX), and the ETF SPXU, all of which nets out to a large short position in equities.