We live in a world where central banks really do not allow markets to reflect their "true" fundamentals and keep pumping money into the system via various channels -- claiming it is necessary for day to day operation, but it is another form of Quantitative Easing. Every time we get bad economic data, the next day if the bank injects the system with cash, how are investors and markets supposed to trade the fundamentals?
Last Wednesday, the Peoples Bank of China (PBOC) pumped a total of 200 billion yuan (about $28 billion) into the market via the medium-term lending facility (MLF). The MLF tool was devised in 2014 to allow commercial and policy banks maintain liquidity by allowing them to borrow from the central bank using securities as collateral. Fed Chair Jerome Powell announced similar measures for its own U.S. repo market, extending T-bill buying through the first quarter of 2020 and daily allowances of up to $75 billion through November 4. One wonders where the markets and respectively exposed equities would be if these central bankers had not intervened last few weeks. Or how bad things are underneath the surface for them to do so without officially changing their policy.
As the U.S./Sino Trade War has been building over the past 18 months, policymakers are worried that liquidity constraints have made banks less willing to lend money to companies. This latest move by China came just two days before China released its latest Q3 GDP figures. As one would expect, they came in lower than forecast -- at 6% vs consensus of 6.1%. It is not the actual number, as we know how efficient China is at fudging the real data, but the trend has been weakening significantly since last year.
This is perfect timing, as the Chinese markets ($FXI) and China-exposed equities rallied hard the last week. Counterintuitive? This came as a total surprise, as usually the PBOC injects as older lending facilities mature -- but last week, there were none maturing.
The situation is dire in China. It is evidenced in all the data, ranging from CPI (showing massively high food price inflation) and PPI (severe deflationary trends as industrial raw material prices are falling). Judging by global trade volumes, South Korea and Japanese export trends, there is no doubt that global growth has fallen off a cliff. China knows it and right now they are stuck in a battle to not be bullied by President Trump and buy time until the election next year. They will do what it takes, rather than acquiesce to his demands of changing their domestic policy agenda, alter their IP and Property Theft laws and disallow foreign subsidies to allow for more global competition. Trump is asking China to change the bedrock of its expansion strategy, and that will never happen.
These Trade Wars are set to go on and on until either side gives in. Trump knows full well that if he does not get a real deal, and if he makes a fake deal, the markets will blow up in his face. If so, he will lose his re-election prospects. So, his plan is to keep things dragging on and tweeting every 2 days saying "talks are progressing well" so that the computer algorithms keep supporting the market all the way until November 2020.
After re-election, if he gets re-elected miraculously as the American public is clearly lost, he will then go guns blazing at China -- and crash markets even, as it will no longer be his agenda.
There are talks that over the next two weeks China is going to release updates about its outlook and GDP guidance. We all know Q4 2019 will be sub-6% growth, judging by how bad September and October trends were. It will be interesting to see how the macro data evolves in addition to how much liquidity China injects stealthily. We all know what happened in Q1 2019, when markets rallied 20% from their lows as China injected a total of 1.1 trillion yuan in one week in January alone to prop up the markets. At the end of Q1 2019, markets retraced all their gains and fell right back down by August 2019.
Such is the game of investing these days. It is all foul play by central banks. The good old days when investing was about studying the balance sheets and fundamental earnings trends is long gone. These past few years, and certainly this year, it is all about liquidity. Central banks have dug such a big debt hole that the only way for the world to grow is to print even more money and borrow more.
Perhaps the millennial traders are right after all -- this is a buy on the dip market, as no central bank can ever let this bubble burst. However, I am a student of Physics and firm believer that Boyle's law will supersede these central bank financial engineering tactics (pressure exerted by a given mass of gas is inversely proportional to the volume it occupies). It takes time, but one can't refute basic universal laws.
Commodities like copper and oil are actually trading on their true fundamentals. They are weak and staying low, as there is just too much supply and lack of demand. Equities can be manipulated and rallied 8%-10% over the last week, despite no changes in fundamentals or their actual commodity drivers. This is the art of central banks pumping money into the system, it finds its way back into risk assets, the cheap seats first.
No one knows what is going on in China behind the scenes, but this liquidity injection needs to be monitored as this operation can mask the true underlying behaviour for a lot longer than one can stay sane -- or liquid even. Stay tuned.