By Michael Every of Rabobank
Right Out of the Red
It’s all about China again today in markets – and what we are seeing in some corners is just a reflection of what we could potentially see in many others ahead.
Chinese and Hong Kong stocks tumbled yesterday, while the Nasdaq Golden Dragon sub-sector trading Chinese tech did too, now down 15% since Thursday, the most since 2008. CNY hardly moved, however. After all, why should a currency and the structure of its economy have any relationship? (Which says so much about said structure.) US 10-year yields dipped as low as 1.22% on the general red before remembering “This is ‘Murica!” and adding white and blue to close back at the merely depressing 1.28% level.
That Chinese sell-off was obviously prompted by the official crack-down on edu-tech, which came on the back of one on fin-tech, and then one on tech in general. And on property. And food delivery, with Meituan stock tumbling 15% after Beijing regulators forced the firm to ensure all of its delivery drivers were paid the minimum wage.
Key snippets from a Bloomberg article on the topic, which says the crackdown “has shocked even some of the most seasoned China watchers, prompting a rethink of how far Xi Jinping’s Communist Party is willing to go as it tightens its grip on the world’s second-largest economy” include: “Everybody’s in the Crosshairs”; and “Even when you think China risk is priced…it can get worse.” The first question in response is “Who thought this was priced, and how so?” The second key question should be “Where next?”, which to answer requires understanding “Why now?” or, if you work on Wall Street, “Why is this is happening?”
Here are the arguments from the most-to-least commonly heard:
The need to bring down the cost of living to head off a demographic crisis. Lower education costs make it cheaper to have more children - presuming people don’t just face the inconvenience of finding and then paying tutors on the black market given the social pressure on children to pass the gaokao university exam. Logically, lower housing prices could help too – but raising mortgage rates (as in Shanghai on Friday) takes money out of pockets; so much household wealth is stored in housing there is no tolerance for asset-price declines; and without asset price appreciation, why hold property at all? It’s a delicate balancing act – and with a long list of other areas that will need to be addressed too;
Social justice/inequality. China is trying to narrow wealth and income gaps from the structural side? If so, this is likely to be a zero-sum game, and tends to rock boats, as we already see;
A crack-down on Western-style exuberance. Day-to-day functioning of markets is fine; day-to-day trading and banking is fine; but the mutated Western hyper-capitalism all about disruption, agglomeration, and immiseration (and diversity and saving the planet) is not wanted. Which is a shock for a West that has forgotten what it used to be like until recently; or
More broadly, is Beijing deciding one particular color of cat has caught all the mice required?
This is not an attempt to prescribe an answer for readers. But one needs to have a view in order to predict where this stops (out). “Risk is priced” Wall Street is unlikely to be the source of that wisdom based on its track record and its theme song of “Money makes the world go round”. Indeed, I already saw the first reference to these shock out-of-the-red crackdowns being a good, lower entry point. As quoted yesterday, “Rarely is the question asked, is our Wall Street learning?”
If one wants a better guide to what this could yet mean, I suggest looking to the geopolitical environment: yesterday’s US-China diplomatic meeting went about as badly as the previous one in Alaska.
US Deputy Secretary of State Sherman came to China with the ostensible message that US “extreme competition” also wants to ensure “guard rails” to prevent things “veering off” into “conflict”. China responded with accusations of being treated as an “imaginary enemy” and US “coercive diplomacy”, rejected all calls to decouple cooperation on the climate from other issues, and handed over two lists of demands for the US to meet before relations can be reset. As journalist Stuart Lau of Politico puts it, the key messages from China were:
“Ideological: US shall not challenge/overthrow China’s communist system;
Economic: US shall not obstruct China’s development by sanctions/tariffs;
Sovereignty: US shall not infringe on its rights in HK, Xinjiang, Tibet, and Taiwan
If one subscribes to the view that the US will accede on all of the above --and hence to accepting the end of its role as global hegemon-- then by all means structure one’s portfolio/trades/supply chain risk accordingly. If one does not, then the same advice applies, but somewhat differently - because both sides would need to adjust policy, as we may already be seeing. In short, if the big picture doesn’t change then expect further surprises to appear out of the red, and out of the red-white-and-blue too.
Or, just hum “Money makes the world go round” until the next “Whocouldanooed?” surprise emerges as a “better entry point”.