China Priming the Pump

Does anyone actually believe when things get hairy that central banks will just let it play out?  You have a little slowdown in China and the PBOC is already on their 3rd RRR cut.  I am sure the authorities at the top are urging banks to lend to stop the slowdown.  Never forget one thing:  central banks are turtles and patient when the economy is booming.  they are impatient and micro managers when the economy slows down.  There is an asymmetric response to a cyclical economy, which leads to long up cycles and short but violent down cycles.  

It isn't trade wars that is causing the Chinese slowdown.  It was the PBOC trying to keep up with the Fed in the tightening cycle, and realizing that China's economy is much more sensitive to monetary policy than the US.  The Chinese have built up such a huge debt pile, much of it nonperforming and junk, that any increase in interest rates causes immediate weakness in the economy.  The Chinese government has done a masterful job of keeping the USDCNY exchange rate stable despite all the money printing they have done to keep the financial system intact.  It has taken a draconian approach to capital outflows, essentially making it impossible for any significant sums of hard currency to be taken out of China.  And no, the yuan is not a hard currency.  It is about as soft as Charmin when it comes to currencies.  The dual currency system of internal CNY and external CNH has been used to keep inflating the debt bubble in China, forestalling any financial crisis, while keeping the supply of CNH limited in order to keep the yuan looking strong to the rest of the world.  That way, China can maintain its purchasing power when buying commodities overseas, and give the appearance of the yuan as a legitimate currency for foreigners to exchange their dollars for.  

Anyway, only in a tightly controlled economy can such huge financial distortions and incessant can kicking last for so long, without any serious repercussions.  Yet.  It will happen, because eventually the Chinese will lose faith in the value of their currency, much like Turkey, Argentina, and Brazil.  Sure, those other countries don't have the command economies and government capable of neutering the masses.  But the Chinese government will eventually realize that the costs of keeping the time bomb from blowing up outweigh the cost of the sharp, short term pain from a one time massive hurricane to clear out the debt overhang.  

As the global economy slowly heads towards recession, the US looks stronger and stronger by comparison.  The money flows go from Europe/Japan/emerging markets towards the US.  That helps to keep US stocks fairly immune to the global weakness.  But it doesn't make the fundamentals in the US any better.  With a stronger dollar coming from these money flows, the large caps suffer as much of their earnings come from overseas.  Eventually, the fundamental realities will hit the S&P 500 and bring it down like the rest of the world.  Trade wars and tariffs are not going to be the trigger.  What is the trigger is global economy ex US going back to its natural rate of growth, and perhaps overshoot lower.  

All the tax cuts and government spending bill has caused is taken investment money dedicated to corporate/mortgage fixed income/loans and shifted it to T-bills and T-notes.  The result is an increase in corporate bond spreads, which is unusual when the economy is in an up cycle.  There is less liquidity sloshing around in the investment world, leaving financial markets more vulnerable when investors want to sell in mass.  The corporate stock buyback window is now closed for the next several weeks, so the stock market is on its own.  It could get ugly if investors decide to de risk after putting on a lot of risk over the past 2 months.  

I missed the short on this down move, but based on all the trade war headlines, when that fades away, there should be a rally just around the corner which should provide a decent risk/reward short entry in early July.