Is Xi crazy?
Like a fox. China knows what it's doing.
All eyes are on D.C. plus the bond market. Is that where we really should focus? The lesson from 2013’s taper tantrum suggests not. The S&P 500 gained 4% back then, with choppiness along the way, in the four months after Bernanke uttered “taper” in early May and long yields peaked in early September. With the reality of full Democratic control of government plus a reconciliation vehicle already in place (no explicit GOP veto), risks of technical default are lower than past episodes legitimately borne out of legislative impasses in a split Congress. If there’s a fiscal accident, it’s on the Dems. Things look bleak for progressives as the weeks go by. The size of the reconciliation package is shrinking, as are the pay-fors and odds of a big corporate tax hike. Stocks stumbled in September, wiping out gains for the quarter, with cyclical Value and small caps starting to find favor. For quite some time, sector leadership has shifted in line with interest-rate movements. Two-week trajectories for Covid positivity are declining in 45 states, reopening stocks are trending up and favorable seasonality is just around the corner. But then there’s China.
Has China shot itself in its foot? Authorities there have taken on tech, gaming, crypto and now a mega-property developer. Chinese stocks have underperformed the MSCI World Index by 40 percentage points over the last six months, the worst performance in a decade. Its economy is underperforming and delays in export shipments are creating supply issues the world over. China also is spending $30 billion a month on semiconductor imports, more than it spends on imports of anything else, including crude oil. Meanwhile, the renminbi has transformed into a credible trade and reserve currency, outperforming all other major currencies over the past three, five and 10 years, Chinese government bonds are outperforming almost every other major government bond market year-to-date and the country’s trade surplus is at new highs even as global trade has collapsed. Following Huawei, China had no choice but to reduce its dependence on the dollar, meaning it must make the renminbi into a credible trade and reserve currency and the bond market into a credible haven for foreign savings. Gavekal Research thinks this may explain why Chinese policymakers sat on their hands while the West unleashed unprecedented stimulus in response to Covid. Xi is firmly in control and eyeing next October’s 20th Party Congress, where he’s almost certain to secure an unprecedented third term.
Is Xi crazy? Like a fox …. China’s current leaders were all raised in the Marxist church, where Gavekal notes the first tenet of faith is that history is not shaped by individuals or ideas, but by economic forces—and inflation is the most powerful of these. So, as inflation around the world accelerates, it makes sense for China’s leaders to worry about social stability, and to want to be seen to be doing more for the common man. Hence its crackdown on mega-companies and high-profile entrepreneurs and encouragement of smaller, China-oriented enterprises. The U.S., France, Germany, Japan and the U.K. aren’t the target. Indonesia, South Africa, Brazil, Russia and other emerging markets are. China wants to convince them its economy is built on solid foundations, so it’s highlighting its desire for common prosperity, which implies there is prosperity to be shared. Our government, meanwhile, talks of the need to “build back better,” which suggests the current situation suffers from major deficiencies, such that more trillions of dollars must be printed. What do common prosperity and “build back better” have in common? Inflation. One country is hell-bent on avoiding it and the other may be careening toward it.
- Manufacturing managing supply constraints ISM’s gauge for September surprised, rising a second straight month and signaling one of the strongest rates of expansion since 1983 with solid increases in production and new orders. Also, durable goods orders surged in August off an upwardly revised July, with capex-related components up significantly.
- Americans have cabin fever In a sign the economy may moving past delta variant fears, consumer spending rose broadly in August, led by outlays for food and beverages, as well as for services and housing-related goods. Only autos lagged. Recent high-frequency spending data—card transactions, airline traffic, OpenTable diners, mobility measures (eating out, shopping, etc.)—also have turned up.
- Housing, autos lining up for Q4 August pending home sales jumped amid rising inventories and moderating prices. Pending sales, which track contract signings rather than closings, tend to lead existing home sales data by a few months. Also, Q4 vehicle production is scheduled to increase, with estimates suggesting the auto recovery could boost Q4 GDP by 1.4 percentage points.
- Shoppers spend more because they’re paying more August PCE inflation jumped a more-than-expected 4.3% year-over-year and the core rate held at an elevated 3.6%, both 30-year highs. With energy prices spiking and mentions of S&P “shortages” hitting a record in September, even Fed officials are starting to admit “transitory” may last a long time.
- Usually, shopping makes us happy The Conference Board Consumer Confidence Index fell a third straight month to a 7-month low, with both the present situation and expectations components contributing as the outlook for household incomes deteriorated. Higher gas prices (more below) were partly to blame.
- The Mister loves his Tesla As oil prices flirt with multiyear highs, prices at the pump that normally start to slide after Labor Day remain elevated. Gasoline expenditures, the single largest household cost, have a strong inverse correlation with the U.S. presidential approval rating. Not surprisingly, President Biden’s favorability numbers keep plunging—the latest Gallup poll shows a majority (53%) disapprove of his performance, a first in his tenure.
The cure for higher prices is higher prices Spiking energy prices—oil at 7-year, natural gas at 10-year and coal at 14-year highs—and power shortages in Europe and China further complicate a macro outlook already showing signs of a slowdown. Assuming this situation drags out, Bank of America thinks final demand inevitably will crack, reverberating across the whole supply chain and playing the role of an automatic stabilizer that closes the gap between supply and demand, the way it always does.
Needs vs. wants After shortages of ships, labor and semiconductors, Gavekal views today’s energy shortages that have sent prices jumping as amplifying an investment environment that’s shifting from the “age of globalization” and “age of plenty” to the “age of regionalization” and “age of shortages.” For investors, that may mean shifting from things that were “nice to have” (video streaming services, luxury goods, social media) to things one “needs to have” (energy, food, autos).
Powell watch Bidding markets have lowered the Fed chair’s reappointment odds to 60% from 80% on Sen. Warren’s skewering opposition and the early retirements of hawks Rosengren and Kaplan (Fed presidents at the center of scrutiny over trading activity). Some on the Street think it could come down to whether Powell better serves Biden as a bargaining chip with progressives or, as a Republican appointed by Trump, cover against political risk associated with high inflation.