Ebullient Balloons Of Optimism Will Soon Crash To Earth as China Continues To Ignore Its Past Mistakes: The Geopolitical — Stock Market Connection

Chinese balloons are causing ructions in Washington, DC but the ballooning Chinese equity market has been a boon to US equities and may now be trending lower. For now the bulls are keyed off Fedspeak but more important is the trajectory of the $US and bond prices, which are highly dependent on the actions of the PBOC and by extension, the Chinese economy. Both logic and anecdotal evidence from major newspapers suggest the Chinese economy has major obstacles ahead of it. The bulls are ignoring these obvious headwinds and set to retest 4200 on the S&P unless more Fed speakers try to tamp it down. That’s unlikely and consequently 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 brought one positive factor for US stocks. Inflation expectations are stabilizing based on measures of Treasuries and TIPS. But there were also several negative factors across global asset classes. The action in currencies signifies $US strength. The US yield curve is rising and in the current context that is bearish. Expect the S&P 500 to be range-bound over the next few days.

Key to market exuberance and optimism regarding our geopolitical trajectory is the economic resurgence of China. Should China’s reopening lead to healthy growth rates and allow smooth deleveraging from real estate and diversion into productive enterprises, then China will become a better exporter and its consumers will spend more and up goes the global economy. And should China achieve healthy growth rates Xi Jinping will simultaneously have more confidence in his support from the masses and less insecurity about having to take dramatic foreign policy actions a la Putin in Ukraine. The bulls argue that even if all this doesn’t come to pass, much worse will happen if China doesn’t retrieve healthy growth. Consequently every positive data point and every move higher in the Shanghai Composite have an outsized effect on equity markets around the world.

I see this as highly risky and unfit for purpose because Central Banks around the world are either trying to take risk off the table or getting closer to that position. The world is over-leveraged and labor productivity too stagnant to validate continued risk-taking. The result has been inflation and geopolitical mistakes such that the years 2020-2022 are ones which no one anywhere in the world feels any nostalgia for. Consequently it’s imperative to get China right in order to determine whether the current market a trading range rather than a bear market rally.

The SCMP notes “China’s ‘disappearing market confidence’ presents major test for the Communist Party. China’s top leadership has been at pains to talk up its support for the private economy, but scepticism remains among entrepreneurs. In some cases, tension between the strategic goals of Beijing and interests of local authorities is undermining business confidence…Despite pledges from China that it is determined to restore business confidence, scepticism remains about the government’s sincerity following the controversial deployments of apparatchiks to private firms by local authorities.”

This is predictable and sensible of Chinese businesspeople, since Xi Jinping has shown his cards in his leftist cultural beliefs and ruthlessness toward productive people who have grown the Chinese economy. Those Chinese with wealth know this and their actions speak clearly to the lack of confidence that Xi Jinping will navigate the economy to resurgence. Reuters notes “With its tax-friendly regime and seen as politically stable, Singapore has long been a haven for ultra-rich foreigners…But it has seen a fresh influx of wealth since 2021 after it became one of the first Asian cities to significantly ease pandemic restrictions and as many Chinese became disillusioned with their country's draconian Covid policies…We just lost patience over time," he said, describing the lengthy quarantines he had to endure when travelling between Hong Kong and mainland China. Political turmoil in Hong Kong has also been disheartening, he added.”

As China fails to hit robust growth rates we will see earnings estimates come down even further than present levels. Already some analysts are proactively publishing negative earnings growth through 2024 while the market is keying off 3% growth based the majority of analysts. Once negative earnings are baked into analyst estimates the markets will retest the October lows and the next question will be how much lower can markets go.

My current positions include a significant cash position, 3M (MMM), Pfizer (PFE) and the inverse levered ETF SPXU, which nets out to a significant short position.