Back to 2015?

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July 13, 2020
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There were shades of 2015 in the Chinese markets this week as margin financing came roaring back in for China’s re-boot of the ‘can’t lose’ mentality recently adopted by the RobinHood day traders in the US – and still frankly running in the US tech space. Our favourite anecdote of the week is of the Hong Kong based, but ethnically Chinese, graphic designer who, personally now 21x leveraged believes it is still safe because the Grandmas haven’t bought in yet and thus he is staying long until his Grandma gets involved (!) Perhaps we need Bloomberg to bring out “the China Granny Indicator’?

To some extent this is based on a perception that ‘The National Team’ are back in supporting the Chinese Equity Markets, which is a variation on the Powell Put we discussed last week; if monetary authorities are under-writing financial market downside – quite possibly as part of a bigger geo-political standoff – then why not go leveraged long? Certainly this has spilled over into Hong Kong, where, as discussed we do believe that the mainland is intent on promoting the HK financial markets as part of their longer term strategic plans. Hong Kong exchange for example is up 30% or more in the last few weeks.

The usual suspects have been trying to rev up excitement over a breaking of the Hong Kong Dollar peg in the wake of the new Security Law, but to little effect in the real world. An amusing headline from Bloomberg about a ‘sudden bout of weakness’ actually described a drop from 7.750 to the $ to ….7.7525. We are used to FX traders getting excited about the second decimal place, but the third? Meanwhile, the offshore Yuan, or CNY as it is known, has strengthened back to the 7.0 level. Indeed, the other chart we are watching closely is the US dollar, which continues to weaken across the board, This is obviously seen as a positive for emerging markets generally – not least because of the easing of any debt pressure

In the US we are going into earnings season and it remains to be seen if the markets will shrug off bad numbers due to Covid as a ‘one off’. This nevertheless represents some imminent idiosyncratic risk that professional investors are likely to have been hedging and or diversifying away. We are not so confident about the day traders however, and while the Vix continues to mirror the Covid death rate chart, it could see its own second spike if there are some big margin calls.

Short Term Uncertainties

Covid-19 is back as an uncertainty, if not as an actual medical threat, although for now the markets are being more sanguine than the population at large. We have previously suggested that for those in the west wanting to think how the UK in particular will emerge from lock-down we can perhaps look to Hong Kong as something of a lead indicator, given it was hit early and also shut down early. Here there is good news and if not bad, then somewhat depressing, news, which tells us more about human behaviour than medical science.

On the positive side, the people of Hong Kong have moved back to a reasonable level of new normal. Bars are open, restaurants and cafes are functioning, as are shops, gyms and public transport. The attempts at command and control over every aspect of behaviour have been observed where sensible and practical, quietly ignored otherwise. Masks though are everywhere, except that is where they might actually be needed from a medical perspective, ie indoors! Interesting that Matthew Parris in the Times made a similar point about Spain (paywall I’m afraid). People will happily sit in an office, or chatting in a bar or a cafe and then, as they get up to go outside, put a mask on! It has become a curious form of Social Signalling.

If that were the only downside, we could be relaxed, apart from wondering what under this weird logic prevents us wearing masks for ever. However, the depressing aspect is the permanent paranoia resulting from Governments somehow thinking that lockdown and distancing will eliminate the virus. Hong Kong has had less than 1500 cases and only 7 deaths, but a recent spike of 28 more cases, 16 of which were locally transmitted. has prompted the schools to be shut (again) and calls by the so called medical experts for the whole city to stay locked up at home again. Corporates are if anything even more paranoid; indeed, on the basis of one single super-market worker in Quarry Bay near my old office being tested positive, the whole of my former company has been told to work from home for a week! Meetings and restaurant bookings are cancelled again and the economy thrown back into uncertainty.

This then is the problem we discussed last week in terms of behavioural science; context and ‘framing’ have left ‘authorities’ believing they have a mandate to shut down business on the basis of a small number of positive tests – not even hospitalisation, let alone death – from a virus that we now know to be not only far from as contagious but far from as lethal as we believed in might be three months ago. Moreover in the case of the imported cases – the 12 of the 28 – these will have been caught at the border under the still incredible restrictive quarantine arrangements, which require everyone, even if tested clear, to quarantine at home for 2 weeks on arrival. Those cases will have been put in compulsory hospital-like quarantine for a minimum fourteen days, after which two separate clear tests are required. These travel restrictions have basically paralysed much of Hong Kong’s business activity as a regional hub and continue to do economic damage far beyond the health risks involved.

Some more framing context for Covid-19

There are increasing numbers of high quality data sites around Covid coming across our radar and we like this one from InProportion2 which shows not only the context of the UK compared to Sweden (there are also some good comparisons between Sweden and Scotland), but also Japan. Neither of them had a serious lockdown, yet the differences in death rates are obvious. Sweden has come in for a lot of out of context criticism for not following the herd in abandoning the concept of herd immunity and yet the situation in Japan is even more telling. While the government has been aggressive in track and trace it has not curtailed economic activity with lockdown in the way that the west has, making it somewhat awkward for those claiming that this was ‘the only way’.

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Meanwhile, this Swiss site provides what seems to us at least to be a comprehensive, yet entirely understandable and bias free overview of the current situation with plenty of useful links to provide back up evidence. For example, it points out that 75% of Swedish deaths were in care homes and also the evidence that the effectiveness of masks in healthy and asymptomatic individuals remains questionable. This at a time when the ‘official’ view has suddenly decided that masks should become more or less compulsory. They also raise some important points about vaccines – something that our narrative alert system detects is being pushed heavily right now by Big Pharma.

Medium Term Risks

Some of the biggest risks to western markets over the next couple of quarters are likely to be around the cut and thrust of the US Presidential Election as the politicisation of the virus combines with the escalation of the China Cold War. On the former, it is clear that the Democrat strategy is to maximise the bad economic and policy aspects of the virus – and hence the blame – in order for Joe Biden to win without actually having to say anything. This will unfortunately drive a Covid fear narrative in the US at least until the end of the year. On the latter, it is clear that de-coupling with China is now a central strategy for the US whoever wins. What is less clear however, is how successful they will be in taking the rest of the world with them. For all their public statements, other western politicians are acutely aware that this is as much about preservation of the US top dog status as anything else. Europe in particular is unconvinced and the emergence of a Eurasian economic bloc still looks more likely than not. Emerging markets meanwhile are considering the contrast between US economic ‘aid’ from the World Bank that pursues an aggressive ‘green’ agenda – no coal fired power stations, but an NGO will provide you with a solar panel for your subsistence farm – and the infrastructure building attractions of the One Belt One Road system and the Asian Infrastructure Investment Bank.

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The X Factor

This was not about Left versus Right, it was about a generational shift, from the Boomers to Gen X. This will then also move the children of the Boomers - the Millennials - down in favour of the next generation, the Zoomers of Gen Z. The economy and the markets will now shift in line with their traits and behaviours.

Pause, Rewind, Repay

The upcoming Election has been an excuse for markets to hit pause. Experience tells us that the best way to trade the 'reaction' is usually to fade it, as it will reflect pre-positioning around risk and that the initial sell-off or rally is not the start of a new directional trend. We suspect with Hedge Fund 'year end' coming up soon at Thanksgiving that traders will be flattening books, while asset allocators and lo0ng term investors, while perhaps putting some precautionary cash back in to existing trades, will wait for more clarity.

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