Summary: Adversity will take China's 2025-2035 plans, which are all about technology, moving up the value chain and developing tech infrastructure, and bring them forward
The current focus going into Q3 is the staggering disconnect between the damage that we have seen globally from Covid-19 – economically, socially, politically and from a humanitarian perspective – and the market response.
While the economic contractions, close-to-standstill activity and job losses across so many metrics have seen multi-decade records broken (i.e. unemployment or economic growth), listed asset classes have only soared higher. Some indices, such as the NASDAQ, have hit all-time highs.
As an experienced volatility trader (codename Vega) made clear on a recent macro group call: “make no mistake, this is the worst economic time of your life”, so perhaps we shouldn’t use the level of the equity market as a barometer for the system’s underlying health, fractures and potential breaks. It’s worth noting that this was someone who made +50% in Q1 – they are very cognisant of the disconnect between asset prices and the underlying fundamentals in the economy.
There will be some natural low-hanging fruit and pent-up demand as the world reopens fully, but there will also be risks: from second-wave infections, further lockdowns and more. As cited often on the Macro Dragon, my take is that the probability of another co-ordinated global shutdown is almost 0% – the costs economically, politically and from a stability standpoint are just too high for almost all countries.
What we can say with high probability is that the monetary and fiscal policies of the world will keep the accelerator pushed down on loose and accommodative policies for a long time. Liquidity is currently the primary driver in regards to the ascent of listed asset prices, with fundamentals gagged and bound in the boot of the car. At some point this will reverse, but it could be 6-18 months or even years away. After Abenomics, the Nikkei went up circa +150% over 3 years.
The key global backdrop on all this however – predominantly brought to light by the Trump administration, but now globally in vogue and almost certain to continue even in a Biden presidency – is localisation, the inverse of globalisation.
China is facing the perfect storm of adversity and challenges, including the costs of Covid-19, US-China relations deteriorating, the west backing Hong Kong over Beijing and, still to come, a global backlash that is only set to increase once the Covid dust settles on who is to blame for all this (think Occupy Wall Street x 1,000).
Adversity, though, will only make a country more resilient and innovative, forcing it to tap into its true potential. Trump and Covid-19 are going to be the best things that have happened to China – a function of which will spill net positive to the rest of the world – in that it will accelerate Beijing’s plans to go from being export dependent to domestic-consumer driven. It will take China’s 2025-2035 plans, which are all about technology, moving up the value chain and developing tech infrastructure, and bring them forward. Finally, it will open China’s markets and accelerate reform which has been held back by export dependency.
Overall, localisation will raise global competition. Globalisation lowers global competition: why innovate, when you can just find a lower-cost producer?
The likely net result of a more localised and domestic-consumer-driven China is:
There will be a huge opportunity cost for the countries that choose to ignore dealing with 1.4 billion consumers and an economy that will become the largest in the world in most people’s lifetime. This opportunity cost will be an opportunity boon to others – such as Germany and the eurozone as a whole – who will capitalise by pivoting further towards China.
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Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
Commodities poised for rebound. The "Year of the Metal" boosts gold and silver, copper awaits rate cuts. Grains may recover, natural gas stabilises. Gold targets $2,300-$2,500/oz, copper's breakout could signal growth.