As the S&P 500 ground all the way back up to 3000 yesterday, completely erasing the losses after Friday's sham of a deal, the bulls were clearly in charge, taking control of the market. It seemed quite at odds with the economic data that came out earlier in the day, with China CPI (Consumer Price Index) showing signs of stark inflation and PPI (Purchasing Price Index) that of deflation -- a toxic combination for yuan and Chinese-economy-exposed entities in general. As the U.S. market opened, futures kept rising slowly throughout the day, as bonds and gold got sold; a risk-on day.
It was interesting to note this theme prevalent in the sectors as well, as banks, helped by JP Morgan's (JPM) better-than-expected numbers, moved higher along with retail, materials and industrials. The losers were utilities and consumer staples, which have been the darlings of the market this year -- bond proxies. So, what happened to cause this sudden burst of enthusiasm?
October options in Volatility ($VIX), yes that old chestnut, expire today. It may seem entirely unimportant to the average equity trader, as most don't even look at Volatility, but do not realize how much of an impact it has on the broader $SPY index.
Given its statistically relevant inverse correlation, as $VIX goes down, the $SPY moves higher. As options expire, the volatility traders need to sell their front-month contract exposure to buy the next month contracts (usual portfolio protection dynamics), causing a selloff in volatility. This gives the illusion of a rise in markets that is not fundamental or macroeconomic-related, or some magical bull market notion. It is purely technical.
I hate to say it, but this market is more about technicals these days than fundamentals, given the size of computer-trading-oriented passive investment funds. This trend is evident in the past six expirations, which are worth monitoring, as this market rally will fizzle out once this support is gone.
Now time for facts. Wednesday morning, Bloomberg reported that auto sales in China have fallen for the 15th month out of 16 months, the "worst slump in a generation," which is an integral part of the automobile industry.
The auto industry, weighed down by the global economy, reported that the market fell 6.6% to 1.81 million total units. General Motors (GM) said deliveries into China were down 18% in the third quarter. Golden week, the seven-day-long holiday, is traditionally a peak for home sales. This year, according to Bloomberg, sales plummeted showing one of the worse golden week holidays in years. Sales of new homes in Beijing dropped to their lowest level since 2014. This is a highly speculative market, but when trends are negative, the buyers disappear. There is a real slowdown and it is undeniable.
We all know how easily China can fabricate its "official" data, judging by how consistently stable, down to one-tenth of a percentage, even, the GDP numbers are at around 6%. One needs to stop looking at official figures and look at random manufacturing and industry trend data to get a better read of the real situation that is being masked.
The yuan has devalued 6% against the U.S. dollar since April, and about 10% since the middle of 2018, which is quite significant. Surely capital flight must be picking up. China has painstakingly taken measures to avoid capital outflows lest the problem spiral out of control. But China's official data does not show any capital flight. What gives?
A recent Wall Street Journal article suggests locals are using a back-door exit that is easily hidden. It suggests when looking at China's fund flows, the number to track is China's "error and omissions" line under the Balance of Payments; which shows undocumented capital flight across China's borders. This trend has been significantly negative since 2014, but in 1H19 it hit a record high of $131 billion, much larger than the 1H average during the last big outflows of $80 billion in 2015 and 2016.
Capital outflows are twice as large today than the previous time China devalued. Judging by China's falling credit impulse, the global growth mechanism has shut down. And this is being felt across the globe. China's growth has been one of the primary factors influencing global economic growth trends. When it slows down, everything comes to a standstill.
To make matters worse, China has Wednesday morning urged the U.S. government to take back their support for pro-democracy protesters in Hong Kong, warning that it would retaliate. it is China's problem, not the world's. And the Phase 1 substantial deal seems to only be in Trump's mind, as China denies Trump's claims that it is buying $40 billion-$50 billion in agricultural products today. Seriously, one cannot make this up even if one tried! It will only do so if tariffs are rolled back. Trump was gracious enough not to increase them to 30%, but 25% are still in place. Of course, China won't give in without getting something in return.
Technicals aside, fundamentals do matter. The former just exacerbates the situation, given the flow of herd mentality chasing the action, but the latter will always come back to haunt investors.