The Chinese stock market recently saw its biggest selloff in 8 years as the
dramatic 8.5% fall in Shanghai
"A" shares also rattled markets around the world.
For the past few weeks China has been balancing its desire to keep the equity
market from a complete meltdown, while still courting the international investment
community with hopes of being a dominant player in the capital and currency
markets.
But recently The International Monetary Fund (IMF) warned China's government
about its concern over limiting investors' freedom to take equity out of financial
markets. These concerns were raised when the IMF met with officials in to discuss
the chances of including the yuan in the fund's basket of currencies, also
known as Special Drawing Rights (SDR).
As China tries to balance the demise of its equity bubble while still keeping
the illusion of free markets intact, two delusional narratives have started
to circulate around Wall Street.
The first such Wall Street inspired delusion is that the collapsing Shanghai
stock market will have no effect on the underlying Chinese economy. However,
even though China's 260 million trading accounts may be a relatively small
percentage of its total population, it's also the richest and most productive
portion of its citizenry, which also happens to be equal to the entire U.S.
population in 1993. And Chinese GDP growth accounts for 1/3 of total global
growth. Therefore, we can already find the manifestation of slowing Chinese
growth from the nascent fall in equity prices.
For example, the profit of China's industrial firms dropped 0.3% in June from
a year earlier, that reversed a 0.6% rise in May and 2.6% gain in April. For
the first six months of 2015, industrial profits were 0.7% lower than a year
earlier.
In June, China's producer price index fell 4.8% on an annual basis, its 39th
straight month of declines. In fact, the economy is headed for its poorest
overall performance in a quarter of a century.
The second fallacy is Wall Street believes in the TV commercial that claims
what happens in Las Vegas stays in Vegas. Or, in this case, what happens to
the Chinese economy stays in China.
But the truth is the meltdown in China is already spreading all around the
Asia Pacific region. For example, Taiwan's year over year export growth has
hit multi-year lows due to collapsing trade with China.
But perhaps the biggest indicator of the magnitude of China's slowdown can
be found in the global commodities market. Most pundits are trying to link
the recent selloff in commodities strictly to the rising dollar as measured
by the Dollar Index (DXY). But that Index is actually down about 3% since March.
During which time the rout in precious and base metals, energy and agriculture
has greatly accelerated.
We see the Bloomberg Commodities index now at a thirteen year low. Copper
is down 28% for the year, tin is down 30%, and nickel is down 44%. And then
we have gold. Last week China dumped 4 tons on the market, causing the price
of the precious metal to fall almost 4% within a matter of seconds. This had
little to do with the value of the dollar on the DXY, but it was rather mostly
about the waning demand in China from its imploding economy and the need to
sell what you can when capital controls are in place.
Indeed, these commodity prices began to plunge concurrently with China's steep
drop in officially reported GDP growth from 12% in 2010, to just 7% today --
the real current growth rate in China is closer to 4% when measured by private
data. It is no coincidence that the price of copper dropped from $4.52, to
$2.37 during this same timeframe.
The true message of plunging commodity markets is that the Chinese government
wasted $20 trillion worth of credit digging holes to mollify the fallout from
the Great Recession of 2007; primarily creating a huge fixed asset bubble with
little economic viability. And then forced another $1.2 trillion in margin
debt to engender a consumption-based economy; primarily by creating a stock
market bubble after the fixed asset bubble strategy began to fail miserably.
So where does this leave the global economy now? US GDP is growing at a meager
1.5% for the first half of 2015. And the second half looks even worse, as an
organic U.S. slowdown meets cascading global trade. Adding to this malaise,
it appears as though the handful of U.S. stocks that have led the rally are
finally starting to join the hangover party. For instance, social media stocks
are now crashing harder than commodity prices, with Yelp recently falling 27%
in one day after dropping 60% YOY; Twitter has also tumbled 45% in the last
52 weeks; and Facebook recently dropping nearly 5% after reporting a miss in
the number of eyeballs staring at their cellphones checking the like box.
But here is the most important take; the arrogance that led the Fed to believe
it could save the world in 2008 by manipulating markets is causing Ms. Yellen
and co. to promulgate the idea that it can now raise rates into a global slow
down without negative repercussions -- thereby, demonstrating its success in
rescuing the economy from the Great Recession by proving interest rates can
now rise with impunity.
However, the truth is the Fed hasn't raised interest rates in a decade and
will probably never be able to move much off the zero bound range without totally
collapsing markets and the economy. I think the Fed is aware of this and that's
why it is continually finding excuses not to start a rate hiking cycle -- just
like it did yet again in the July meeting. Therefore, the real money to be
made is in fading the massively overcrowded trade that believes U.S. stocks
are immune from the worldwide economic slowdown and that the U.S. dollar will
be in a secular bull market.
