By Simon White, macro strategist for Bloomberg’s Markets Live blog
Stocks in the US will remain mired in a bear market as long as China’s slowdown frustrates a strong rebound for the tech sector.
After a hiatus for most of this century, macro-driven markets, along with volatility, are back. To understand them, it’s now more essential than ever to have a joined-up, holistic view of the world. Butterflies are flapping their wings everywhere, and those reverberations are being felt in diverse, complex and constantly-changing ways.
One of the biggest butterflies in macro terms is China. Understanding the dynamics at play for the country’s economy is key to understanding when the equity bear market will end.
China faces economic pain on three fronts -- from its policy of seeking to eradicate Covid, the collapse in its property sector and also the growing risk posed by debt deflation.
While hopes continue to be dashed for a definitive end to China’s Zero-Covid policy, the slump in the country’s property market is arguably a more serious problem. Home sales are plummeting, rents are falling, residential building activity is contracting and high-yield real-estate debt has cratered 80% from its peak.
Local governments in China often use land as collateral for the debt they issue. With $8 trillion of such liabilities outstanding, falling land values - unless they recover - threaten to condemn China to years of debt-deflation and economic malaise, akin to what Japan experienced after its property bubble burst in the late 1980s.
China’s growth slowdown is a serious problem and can be seen most starkly in increased capital outflows. This might seem counter-intuitive given that China has been running huge trade surpluses. But domestic policies ensuring the household sector subsidizes the export-facing state-owned-enterprise sector means running those surpluses comes at a cost to overall growth.
Capital votes with its feet, even in a country with a nominally-closed capital account. We can infer capital is leaving China at an increasing rate as FX reserves are not rising, despite the huge inflows from exports.
The yuan has been weakening to alleviate some of the domestic credit destruction that comes with capital outflow. But it has not been enough. Liquidity conditions in China are tepid at best, especially with policy makers still reluctant to resort to so-called “flood-like” stimulus so as to avoid re-inflating the shadow-banking sector.
This brings us back to US tech. Real M1 growth – one of the broadest and best indicators of China growth – tends to lead US tech earnings by one year. It therefore follows that its current inability to properly recover represents a formidable headwind to a turnaround for US tech stocks.
It would be easy to make the case that US tech shouldn’t be too dependent on China. After all, three of the biggest tech firms – Amazon, Alphabet and Meta – do not have a significant presence in the country. But there are plenty of other US tech firms that do derive a significant amount of their revenue from China, such as Tesla, Nvidia and Apple.
In fact, altogether, almost an eighth of S&P 500 tech firms’ revenue comes from China, an amount substantially higher than any other sector. Tech firms’ revenue from China alone accounts for almost 1.5% of all of the S&P 500’s $15.7 trillion in revenues.
Risks to those sales streams look set to mount in the coming months and years as the US clamps down on the export of technology to China, most notably via the recent ban on semiconductors materials and know-how. Even so, the dial is unlikely to shift enough in the near term to make China unimportant to the performance of US tech firms.
Furthermore, capital controls make it difficult for foreign firms to get capital out of China when growth, and therefore revenues, are weak. That cash is often considered to be “stranded” and thus not able to boost earnings back in the company’s home country (even if it is considered a worthwhile risk to win the premium granted in one’s share price for having sales in such a huge market).
Stocks therefore are likely stuck in a bear market until tech – accounting for a quarter of the S&P’s market cap – makes a comeback. And that’s not likely until China emerges from its pandemic-induced growth stupor and manages to avoid a debt-deflation. Macro investing may be back, but no one said it would be easy.