Chinese shares took to their senses, resuming their fall on Monday. The CSI 300 dropped 1.65% and is now down 6.2% since U.S. President Donald Trump broke the U.S.-China trade truce last weekend.
Expect this year's top performers to continue to underperform in the aggregate. They've now surrendered one-third of their huge 36.9% gains for this year and look set to give back more.
Chinese stocks nonsensically surged 3.6% on Friday. I suspect that China intervened in its capital markets to support stocks and its currency. But it can't keep that pretense up for long.
The Chinese yuan also rose Friday despite clearly bad economic news. The currency fell 0.8% on Monday and is now at its weakest level since the start of the year. Chinese shares are at their lowest level since last June, when the United States kicked off its round of tighter tariffs.
Strategists are attempting to make sense of the rapid developments of the last week. It's a very hard thing to do when the situation changes overnight.
Markets in Asia have been "far more complacent than other markets around the globe," Thomas Poullaouec, head of multi-asset solutions for Asia at T. Rowe Price, said ahead of the sanctions hitting. Drops of 5% to 10% are a "real possibility," he noted.
A sharp drop in Chinese stocks would lead to eventual stabilization and "a more conducive environment to buy back into," Poullaouec said.
"Emerging markets stand out as a potential opportunity to leverage on any resulting weakness from the trade-induced volatility," because their underlying strong economies remain great domestic stories, he said.
It was Chinese financial stocks that bore the brunt of Monday's selling. They're in the first line of fire, hit when trade is disrupted, as it will be. The FTSE China Financial index fell 1.9%, so expect similar weakness in the Global X MSCI China Financials ETF (CHIX) .
The lows of last June came as Chinese equities rose to an abnormally high equity risk premium of 7.5% when the first sanctions went into place. Chinese markets then strengthened as fears about the trade war waned, bringing the risk premium down to 6%.
So Much for Less Risk
It looked like Chinese stocks were getting less risky, reverting to levels at the start of this decade. But whether they merit a lower risk premium is all "now in question," the Asia equity team at Société Générale notes. Let's answer the question: They don't.
"As long as the uncertainty over additional tariffs remains, we would expect China to underperform," the SocGen team, led by Frank Benzimra, wrote in a report. They favor the lower-beta markets of South Asia, by which they basically mean India. They dub India a "strategic overweight" that should overperform.
I do think we'll see a trade deal, and when that's signed Chinese shares should rally again. But they're best left alone until we get an inkling that a deal is actually in the works. Meanwhile, the Chinese yuan, now at ¥6.88 to the U.S. dollar, appears headed well north of ¥6.9.
I'm betting it will take Trump to meet Chinese President Xi Jinping in person to provide the necessary momentum. That is a "strong possibility" at the G20 summit next month, White House economic adviser Larry Kudlow said on U.S. television on Sunday. He also said the prospects of Xi and Trump meeting in Osaka, where the G20 summit takes place on June 28-29, are "probably pretty good."
It's hardly a ringing endorsement. The Chinese negotiating team also has invited Treasury Secretary Steve Mnuchin and U.S. Trade Representative Robert Lighthizer back to Beijing. But that would be the 12th round of negotiations that have yielded exactly nothing up to now.
So we are treading water. Both sides appear to be digging in trenches for a protracted trade war that would match the Somme in stagnation and senseless damage.
War of Words
The Communist Party is deploying its full lexicon. It ridicules the U.S. efforts to play a "rollercoaster-style thriller game," as its mouthpiece the Global Times puts it. "China has made full preparations for all situations," using the sweeping language that the party loves.
The United States is "arrogant" and "irrational," while China is drawing on its tai chi reserves of inner strength so it can "crumble the U.S. provocations with stout endurance."
China will not accept any terms that "undermine national sovereignty and dignity," the People's Daily state-controlled newspaper said on Monday, combining both nationalist sentiment with the undercurrent that China is a past and present victim of unjust trade treaties.
The People's Daily also says China "has already made preparations to cope with all possible results." The United States, with its "reckless leap in the dark," has misjudged "China's strength, capability and willpower."
China has limited recourse to retaliate through its own tariffs. But it could instruct its state-owned enterprises to stop buying U.S. products, which would hit the agriculture and energy industries in particular.
I'm waiting for China to start retaliating by making life harder for U.S. companies doing business in China. This is a tricky tactic, because China also doesn't want to appear protectionist and wants to move forward with its economic opening. But permits and paperwork can become terribly hard to track down in the Communist bureaucracy if officials want to take action on a practical rather than national level.
Trump Blusters Back
The United States is also equally confident its troops will prevail.
"We are right where we want to be with China," Trump tweeted. He said the United States would take in "Tens of Billions of Dollars in Tariffs from China," although of course the tariffs are not paid by the Chinese government, but instead by importers into the United States, mainly American companies.
Lighthizer says Trump has now ordered the United States to prepare heftier 25% duties on another US$300 billion in Chinese goods. That's after U.S. tariffs went up on Friday to 25% from 10% on US$200 billion in Chinese imports. The total damage of all those tariffs would knock 1 percentage point off Chinese growth, SocGen figures.
Xi and Trump can't meet soon enough next month. Until then, maybe the smart money would stick to India.