We’re Only Halfway

Wednesday, 24 June 2020
Melbourne, Australia
By Greg Canavan

The market had a brief blip yesterday.

President Trump’s trade adviser Peter Navarro commented in a media interview that the trade deal with China was over.

US futures plunged. The ASX saw gains turn to losses immediately.

But Navarro quickly took his comments back. And soon after Trump tweeted:

The China Trade Deal is fully intact. Hopefully they will continue to live up to the terms of the Agreement!

The market promptly turned back up.

The ASX 200 finished up around 0.2% on the day.

Overnight, the S&P 500 rose 0.4%, while the NASDAQ rallied 0.75%.

Gold futures closed just below multiyear highs.

Liquidity drowns fear.

So what’s going on with the China trade deal announcement?

Well, let’s look at Navarro’s comments in context. He was in conversation with Fox News’ Martha MacCallum. From Foxnews.com:

“Do you think that the president — he obviously really wanted to hang on to this trade deal as much as possible and he wanted them [China] to make good on the promises because there had been progress made on that trade deal,” MacCallum told Navarro. “But given everything that’s happened … is that over?”

“It’s over,” Navarro responded.

“Here’s, I think, the turning point,” he explained. “They came here on January 15th to sign that trade deal, and that was a full two months after they knew the virus [coronavirus] was out and about.

“It was a time when they had already sent hundreds of thousands of people to this country to spread that virus, and it was just minutes after wheels up when that plane [with the Chinese delegation] took off that we began to hear about this pandemic.”

In a statement late Monday, Navarro said: “My comments have been taken wildly out of context. They had nothing at all to do with the Phase I trade deal, which continues in place.  I was simply speaking to the lack of trust we now have of the Chinese Communist Party after they lied about the origins of the China virus and foisted a pandemic upon the world.”

Hmmm…

So the trade deal is still on. But the US has a complete lack of trust in China. If China reneges on any part of the deal, the US will hit back hard.

But will Trump do this in an election year?

Is playing hardball with China a better election platform that keeping the Dow Jones elevated?

In my view, it’s about the only thing Trump would sacrifice the Dow for.

A lack of trust of China isn’t just confined to the Trump administration. Australians are finally waking up to the China threat too. As today’s Australian reports:

Australians’ trust in China to act responsibly in the world has collapsed, fuelling a grassroots push for the nation to reduce its economic reliance on the superpower.

The annual Lowy Institute Poll suggests strong public endorsement for Scott Morrison’s increasingly hard line approach to dealing with China, with fewer than one in four Australians trusting the country to do the right thing in world affairs, down 29 points in just two years.

Confidence in China’s President Xi Jinping also plunged to 22 per cent, while 94 per cent of respondents said Australia should “reduce our economic dependence on China”, the most emphatic consensus on an issue in the survey’s 16-year history.

This shift in Western sentiment towards China has massive long-term economic implications. China will no longer be the ‘world’s manufacturer’. There will be a trend towards lower Chinese trade surpluses, which means it will accumulate less US dollars and less foreign exchange reserves.

Without an increase in reserves, it will find it increasingly difficult to pull the credit lever for growth. Already this year it intends to generate total credit growth of nearly 20%. Yet economic growth forecasts are for 2.5%…and that’s at the higher end.

Australia is at high risk from this long-term economic shift. The days of selling high priced iron ore to China and leveraging it into property gains is over. That doesn’t mean we won’t continue to try doing it. But it’s becoming an increasingly risky play.

Even the government has finally worked it out. They have put former Fortescue chief (oh, the irony) Nev Power in charge of what’s called the National COVID-19 Coordination Commission to, among other things; look at ways of lowering energy costs to underpin a manufacturing revival in Australia.

In other words, a long-term plan to reduce our reliance on China.

Of course, such a shift is going to take a long time to play out. But it’s something you need to start thinking about and make sure your portfolio is positioned correctly for it. I’m in the process of doing that for Crisis & Opportunity subscribers.

More immediately, though, the market doesn’t care about any of this. As long as liquidity is plentiful, concerns about major risks like China’s looming trade troubles don’t get a look in.

Central bankers are, once again, the only game in town. Check out the following chart. At the end of May, global central banks’ balance sheets had exploded 35% in year-on-year growth.

The Insider

Source: Yardeni Research

And keep in mind that China’s central bank has not expanded its balance sheet at all lately. Its State directed commercial banks are doing the job. Total bank loan growth is currently running at 13.2% per annum.

Throw that into the mix and you have a massive increase in global liquidity. Perhaps the largest ever in such a short space of time.

It will be interesting to see how the market reacts when the rate of growth inevitably slows. It’s not going to be pretty.

This is a good time to remind you: 2020 is only halfway over…

Cheers,
Greg