China released its third-quarter numbers on Friday morning. Q3 GDP came in at 6.5% year-over-year vs. estimates of 6.5% expected and prior estimates of 6.7%. September Industrial Production came in low, at 5.8% vs. 6% expected. Retail sales, however, beat estimates, reported at 9.2% vs 9% consensus, and fixed asset investment also beat at 5.4% vs 5.3% assumed. China's inflationary measures came in a tad higher, with headline CPI in September rising to 2.5% y-o-y. All in all, numbers showed a slowing down in the Chinese economy with a bit of inflation pick up (stagflation), but is it worthy of the 30% collapse in local markets over the past three months? Who do we trust, the traders or the officials?
China's GDP growth has been rather boring over the last three or so years, pinned to the magical 6.5% number, deviating by a mere 0.1-0.2% above and below (on an official basis). Studying the broader macro indicators provides a much-better representation of the health of the overall economy and how it deviates from the mean.
The non-official Chinese Business Conditions Index survey shows that companies are facing extreme difficulties and worried about the future. Central banks take their foot off the pedal when the GDP shoots closer to 7% (last year after the 19th National Party Congress meeting) and ramp up stimulus as it threatens to break below 6%. That has been the norm for the past few years. Given the escalation of trade wars with the U.S., most are wondering if we are entering a new paradigm. Can or will China shore up its growth by accumulating more debt, when its sole purpose over the past year has been to deleverage its economy and rid itself of extreme debt? It is a two-way tug of war between growth and stability.
There is no doubt that the Chinese data has been disappointing over the past five months. Financial regulators have been trying to stimulate the economy through fiscal and monetary measures via reserve requirement ratio (RRR) cuts and by boosting infrastructure spending -- allowing banks to lend more, but to specific parts of the economy.
There has been a lot of verbal intervention, but markets have not taken comfort in their words and are fixated on the level of the yuan, which is currently trading closer to 7 yuan to the dollar than ever before. As the U.S. steps up pressure on China, the yuan falls, which mitigates some of the trade tariffs against the country -- frustrating Trump even more. Breaking the key 7-yuan level could cause a nasty selloff similar to ones seen in January 2016, but is the market already pricing that in? Will the cavalry step in to provide support if it does break?
As we near U.S. mid-term elections, we wait to see what surprise announcements Trump has in store for us to shore up support and claim a "victory." Perhaps even an agreement of sorts with China close to or around the elections? One party caves in and that is all the support the market needs for investors to go back to fundamentals, which are actually quite robust, judging by the Q3 earnings reporting season so far. Valuations aside, fear has set in and stocks will continue being whipsawed between the low and high end of the past months' trading ranges until some clarity is found.
Traders are focused on U.S. 10-year bond yields, whether they can breach 3.21% sustainably or not. If so, it would mean a new leg lower in equities, as the higher interest rate environment will curb any future growth. The FOMC minutes released by the Fed on Wednesday were slightly hawkish, as they did not nudge away from their "gradual rate hike path," but prefaced every comment with a warning about uncertainty of the future in emerging markets and trade wars. It could not have been a more hedged, two-sided commentary, leaving room for interpretation but not taking a firm view on either side.
The Fed is now in "data-dependent" mode, as it should be. It will react as and when to the data when it is released and not cave in to political games and pressure. Central Bank independence is vital for an economy, and Fed Chair Powell seems to be maintaining that. If there is contagion from emerging markets into U.S., the Fed will have the justification to ease and provide support. Financial conditions have tightened, but data remains robust.
FX markets and commodity markets have been behaving quite logically and trading on "real" fundamentals. The market seems to be in a stale mate status quo. Q3 earnings is upon us, and earnings are quite supportive, but investors are too scared to focus on fundamentals, for fear of the macro picture.
For markets to move sustainably higher, we need some resolution on the U.S./China and USD trade, so that people can start looking at earnings growth and valuations. For the moment, traders are trigger happy -- ready to hit the button to buy or sell if it breaks either side of the 7 level on the yuan vs. dollar, or 3.2% yield on 10-year bonds, or 2750 on the S&P 500.
Unfortunately, the market will give no clues as to which way it is headed, judging by the fickle nature of this week's price action. One has to take a view with all the facts at hand. Back to fundamentals.
