Key dynamics play this week

Here’s one massive key point for you.

Chinese property accounts for roughly 28% of their GDP.

Over the last twenty to thirty years, China has become extremely land and property focused - which means much of the Chinese population now bases their wealth on the land beneath their feet and the houses they live in.

Naturally, this is not too dissimilar to anywhere else in the world, but there is a major distinction… The extent of the debt gorge to get to the situation they’re in now.

Meet Evergrande.

They’re China’s second largest property developer and are currently facing some serious, serious stress. Their share price is down over 90% from the highs in 2017 and their bonds are also facing a risk of default (in fact, they were suspended on the 16th of September, an activity that is best described as ‘restructuring’... or as this analyst likes to say, ‘please stop selling’).

Is it China’s Lehman moment?

We aren’t so sure, since we do not yet know the unknowns, or the opaque factors that might yet come to light. These issues only tend to come to light when the Emperor and His New Clothes have had their bluff called.

In market terms, this is when everything turns highly illiquid, and participants become almost paranoid. And that paranoia shows itself by assets selling off at a big discount to the initial bid by the holder (think 2007/8 and how cheap mortgage books were offered to the market at).

But why should you care?

Well, if the situation does become contagious and we start to see serious stress put across multiple firms in China, the interconnected nature of the global economy is likely going to hit foreign assets too.

As mentioned in the intro, we have seen a pretty range bound market for USD… But that could certainly change.

Above, is the dollar index

And it’s looking pretty bullish from a technical perspective with the market trading above the 50, 100 and 200 daily moving averages, and well above its multi year support at 88.00/90.00.

But we like to back our view up with the macro.

The purest asset to express a view of severe global stress is to be long USD.

Howard Marks, the famous hedgefund manager, said in a note in July that indices were not overvalued relative to interest rates.

Do you agree?

We certainly do.

But why?

Consider the rate of interest as the ‘risk free rate’ of investing (really we’re talking about bond yields here). In other words, if you put your money into a bank account at 2%, you’re going to get a 2% return on your money.

If that ‘risk free rate’ increases, investors are less inclined to put their cash into equities, since there is now a greater ‘risk’ of making as much of a return, and the opposite occurs when this rate lowers.

So we look to what the Fed will do at the FOMC meeting to obtain a view on where the balance going forward will lie. This time round, we’re coming out of the Jackson Hole meeting, where the Fed were expected to signify when bond purchase reduction (tapering) would begin.

They didn’t, so now we are looking to this meeting to see what their next move will be.

Traders will be looking for a hint as to when the Fed will indeed move on tapering, whether the dot plots (expectations for an interest rate move in the future) will shift and the more narrative driven topic; what the labour market will look like going forward.

If we see a hawkish Fed (they want to raise rates), it’s likely we see a growth stock heavy index like the NASDAQ sell off. Conversely, if they are dovish, you would expect the opposite. change.

The global supply chain is still in complete disarray, with ships backed up at ports (Maersk says that 10% of all shipping capacity is currently sat outside ports across the globe waiting to unload), and there are signs it’s starting to weigh on economic activity.

Global economic growth slowed in August to the lowest level since January on the back of supply delays and sharply rising prices.

All of which leads to higher costs for firms and fears that their profits will be squeezed… Companies such as Unilever have really struggled to adapt. Originally they expected to pass the costs on to customers, but the pace of change has proved challenging

Chief Executive Alan Jope said the lag between the impact of commodity costs and the benefits of increased product prices had created "a higher than normal range of likely year end margin outcomes." (Business Speak for ‘we don’t know how much money we’ll make, if any’).

Their shares are currently trading at $54.41 & well below the 100, 50 & 20 Daily Moving Averages

The next obvious support is the February ‘21 low around $52, followed by the May ‘20 low at $50.

If sentiment really sours, those Covid lows at $44 could even come into play…