In October last year, President Trump was snickering at how his precious "Trade Wars" was causing turmoil in the Chinese markets, as the S&P 500 was outperforming by 20%. Boasting only goes so far, if one does not understand the basics of Economics 101. The U.S. is not immune to a slowdown in China or any part of the Asian world, as that is the biggest consuming market, despite what Trump wants to or tries to make the American public think. Q4'18 was a slap in the fact for anyone who thought otherwise.
Shanghai stocks have been on a tear this year, rising 22%, compared to the 24% slump in 2018. So much for "getting" China to do a deal! Given the U.S. is obsessed with using the stock market performance as a benchmark for their negotiations, I am sure China had the winning hand over the last few rounds of talks. All China had to do was pump the system with 4.64 trillion yuan in liquidity (a record amount, by historical standards) to jump start its local stock market and boost asset prices; the ball is back in their court and Trump knows this -- especially going into re-elections, he "needs" to show a win, even if it is all just on paper.
China's February numbers look at lot less impressive. The monthly flow of credit stood at 703 billion renmibi vs. January's level of 4.64 trillion. The M1 money supply hardly moved, and total credit dropped 13.3% year over year. The million (or rather trillion, in this case) dollar question is, what is and will China do in March given the ginormous liquidity injection in January? January's action by the central banks was a complete u-turn from their policy of last year to de-lever.
All asset classes, including Equities, Commodities (Oil, Copper, Base Metals) and Bonds, have rallied this year; a pure beta market rally. Correlation is close to 1 as all move up in tandem, just like they moved lower in Q4'18. What this rally has achieved is that most have moved to fair value, given the extreme low levels in December'18. Long/short strategies do not work given the macro focus, it's either all in or out that have resulted in outperformance this year.
Central banks around the world have caved in their desire to rid the world of the excess stimulus in the system that had been pumped in since the Global Financial Crisis. Each time they try to take their foot off the pedal, investors panic, which scares the central banks who then decide to "ease off". The ECB and BOJ are clear examples of this. This cycle has been going on for the past 5 years. Central banks are living in constant fear of "popping the debt bubble". No one wants to be the first to do so. All hopes were placed in Fed Powell to be the superman to be able to get the U.S. economy out of its liquidity opioid addiction, but even he caved in this January when he decided to take a "patient" stance. The tricky bit is that the S&P 500 was at 2350 back then, today it is back up at 2800. So why wait now?
We know Q1'19 is going to be a shocker. The latest projection from Atlanta Fed's GDPNow forecasts shows a number closer to 0.5% growth! Last week the S&P 500 fell 3% and as the market breached close to 2700, Trump's tweet suggesting the market will have an enormous rally if a Trade deal is done with China, forced the algorithms and computer models to come back and buy the dip.
Machines are not cerebral, they just follow headlines and trends. We all know that even if a deal is done, how it is actually implemented and what it really changes is anyone's guess. It has masked a much bigger underlying problem. The global economy is swimming in a sea of debt and central banks better hold off on printing more, as it will be much harder to come out of it the next time things get out of control. The Fed will have to, at some point, get back to raising rates.
When there is such a big disconnect between real data (shockingly recessionary) and soft data (extreme bullishness), something does not add up. Liquidity can mask fundamentals, but only for so long. The market's extreme gyrations send shocking reminders of March 2009. These extreme up and down moves, strategy and asset allocation changing rapidly day-on-day with volatility bound to pick up, it is easy to get sucked into either the bull or bear case. The only way to navigate this is to take a view, as the market is not going to give you any evidence, or best just sit it out and wait until the horizon clears.
This Friday has the triple-witching expiration that will make the market a lot "cleaner," as less futures will be traded by market makers to flatten their exposure. It will be interesting to see if Fed Powell has the courage to steer slightly hawkish into next week's March FOMC meeting, especially as there is no need to be cautious, unless the Fed sees something the market is not aware of. As the old saying goes, "when the Fed panics, the markets panic more."