To All SNS Members:

 

Most attention this week has been focused on the equity markets, primarily in the US.  By most analyst readings, these have moved into the "correction" status, having fallen more than 10% off recent highs.  Every analyst has a theory, and no doubt many describe at least partial contributors to this event. 

 

I thought it would be helpful to share our view, given the number of requests coming to us in the last few days.

 

First, it is worth re-stating that we look for patterns, often that others may not be seeing, and also that we look at market fundamentals differently than, for instance, Wall St.  Certainly, anyone interested has already read pages about that view: fear of increasing inflation, interest rates, deficits and debt. 

 

To cover these quickly: the inflation figures seem off, since they come to a large degree from auto pricing, which went up in December, even as sales dropped (a surprise).  Inflation fears came mostly from a wage increase beyond expectations for one month, and seemed coupled with the new Fed chief's announcement that it was staying on track with the Yellen program of three raises during the year (a few analysts suggested four).  The latter is a smart and healthy long term plan to get the Fed out of a zero-zone where there is no room for large-scale economic control (backed against zero rates), and the former is a bit more meaningful as the result of the lowest unemployment rate in many years.  Even so, this is not a cause for panic.

 

If we put deficits and debt into one discussion, it is true that the GOP perfidy on this issue is palpable, embarrassing and frightening: having presided over the GFC, and then fought the repair team over every spending bill, we now have something like $2.5T from Trump's State of the Union speech coming out on top of a $400B new debt burden from this week's budget bill.  The opiod crisis has nothing on the current administration's addiction to cutting revenues and spending wildly.  As when Reagan tried this approach, it will hemorrhage money. 

 

Having sad this, I do think Trump has the right ideas in re-sourcing US jobs back from China and Asia, and how to do it.  Unfortunately, it appears someone got to him around the time of the WEF, and that he caved on China in his SoU speech.

 

With the above issues addressed, I'd like to suggest that most of the ideas above, and those one hears in the media, are addressing what we might call "triggers," vs. the fundamental problems.  Once the basics are at risk, any trigger will do.

 

Here are my major concerns about the fundamentals behind the market moves:

1. Correction.  The US markets are overpriced, with P/E ratios about double what they have been over a long historic run.  Even in the sunniest scenarios, we are due for a correction, and old hands know that having controlled falls is much better than the alternative.  Life goes on as usual, and we all avoid a larger crash.

 

2. Central Banks.  SNS brought the term Currency Wars back about a decade ago, when China's flagrant manipulation of the yuan forced all of its trading partners to start cheapening their own currencies. These Quantitative Easing programs were thinly-veiled competitive responses to keep exports flowing, currencies competitive, and trade balances in line. Unfortunately, QE had other effects as well, not the least of which was to flood the world with hot money, even while interest rates approached zero. The second - order result of the Chinese Communist Party's currency manipulations was to flood the world with "hot money," at a time when the GFC had shown that too much global liquidity could (and did) create a market vulnerability that any trigger might set off.

 

From a larger overview, it is obvious that one way to "goose" global equity markets is to make more money available; the outcomes of market rise are almost inevitable. Add liquidity, equity markets go up, as people take that easy money and put it into stocks. The result is today's market peaks.

 

The EU's announcement last week (through Mario Draghi) that it was not ready to stop QE, contrary to prior plans, underlines the problem; and US Treasury chief Steve Mnuchin's "jawboning" down of the US dollar at the samet time, had a similar effect.  Mnuchin, at least, was transparent about his motive: he, like Trump, US trade chief Lighthizer, and Commerce Secretary Ross, are sick of widening trade imbalances with China.

 

That was the same day that the US China trade imbalance hit a new and impressive high.

 

3. Chinese Anti-Trump Proganda.  Building up to the WEF and the SoU speeches, China mounted a massive global propaganda campaign in an attempt to force Trump to drop his intended tariffs and sanctions against China.  The purpose was to allow China to continue to steal IP and jobs, build domestic champions, subsidize their products in global markets, and harm or destroy the companies and national economies who made those inventions.

 

The theme of this propaganda campaign was ironic: Stop Trump From Starting a Trade War With China.  Since China has been fighting an aggressive trade war against the US since at least 2003, this was really a ploy to let them continue the battle, but to disarm the enemy.

 

The larger, and unintended effect, may have also been to frighten global investors, already on edge from high prices, that a global trade war was a) bad for their own countries, already victims of China's asymmetric trade practices, and b) bad for the investors. The campaign was massive, and may have had this effect.

 

4. Contrary to what Chinese leaders announced in bragging about their markets' stability during the World Economic Forum, it appears that the first markets to fall were Chinese, beginning in Shenzhen and moving quickly to Shanghai and Hong Kong on Jan. 25th.  US markets began their real declines around a day later, and went into more serious rates of fall around Feb. 1.

 

And now we reach the most interesting, fundamental issue.  Today, it is difficult, if not impossible, to find out who owns US stocks.  At INVNT/IP, we looked long ago at Chinese threats of selling US Treasuries, and decided it was meaningless; at most, we might see a few bad quarters, even if they dumped everything.

 

On the other hand, how much Chinese money is in US equities today? 

 

Last week, just before the Shenzhen crash, the Communist Party suspended trading in seven major firms, including HNA, owner of Hainan Airlines, and the shell used by the Party to accumulate $40-$50B in international hotel and related foreign assets just a year ago.   A month ago, HNA failed to make a debt payment, announced it was in a cash crisis, and its state-controlled bank stated it was an unreliable credit risk. 

 

That same bank gave HNA $3.2B a few days ago, and revised its view to positive outlook. 

We were the first to announce the Chinese domestic crash, back in January of 2015.  We think that these current delistings and cash infusions by the state into failing champions are part of that larger story.  All of this brings up the final question:

 

If the state is terrified, what would it do with prior knowledge of a crash in managing its foreign assets?  Get out before the word got out?

 

And what of so-called private Chinese companies, and individuals?  If they think their markets are crashing, and or the domestic economy failing, would they pull their money out of foreign, as well as domestic, equity markets?  Would they have to, just to cover positions?

 

Summary: the US economy is in good shape, and, if Trump follows through on his plans to use economic tariffs to stop illegal Chinese trading practices, the US economy will do much better. The markets, will correct, as they should, even if Chinese contributions are a drag; ultimately, global investors will go to the safe haven.

 

Today, too many analysts ignore China, its policies, and their effect, and rely on the old slide rules of yesterday.  But today, what China does, no matter the ethics or legalities, has to be taken into account, and usually in the first order.
 
China is in serious trouble, not the US.
 

Your comments are always appreciated,

Sincerely,
Mark Anderson
CEO
Strategic News Service

 

For further reference:

 

https://www.bloomberg.com/quote/SHCOMP:IND

https://www.bloomberg.com/quote/SZCOMP:IND

https://www.bloomberg.com/quote/HSI:IND

https://www.bloomberg.com/quote/HSI:IND

https://www.bloomberg.com/quote/SZCOMP:IND

https://www.bloomberg.com/quote/SHCOMP:IND

 

P.s. Notice the clear indication of government intervention in the Shanghai markets, last url.