The hits keep on coming: China loosened zero-covid policy today. It wasn’t a full restriction. People still have to quarantine, but they can do it partially at home. The airlines won’t be punished if a coronavirus-positive person flies in on their plane. The shift signals there should eventually be a reopening though. There are some immediate positive impacts. Sanya stopped screening secondary contacts and released all secondary contacts from quarantine.
That’s not the only change. The more prominent news in the finance section today was Hangzhou loosening housing restrictions. Policies put in place back in 2016 are being eased, such as allowing someone who doesn’t own a home in Hangzhou to qualify as a “first time buyer” in the city. This suggests policy easing won’t stop with coronavirus policy.
Commodities popped on the news, but more so the China'-centric commodities such as iron ore. I’m keeping an eye on copper because it is still repeating the 2011-2012 topping analog, in fact this bounce is in perfect keeping with it:
The U.S. dollar cratered versus the Korean won. Going by the chart alone, one can make a strong case for the dollar bull market being finished. One doesn’t want to chase a move like this, but there’s certainly reason for taking a bullish interpretation here, ignoring macro. Since macro is a bit slower to adjust, I can’t brush the chart signal aside.
At the end of October, I laid out the case for emerging markets and gold in The Bull and Bear Case for Two Important Assets. I correctly identified the turning points, but I saw the bearish case as more likely. The bullish case is the one that unfolded. As I said, I still wouldn’t chase here. Pullbacks are likely.
Charts such as copper still make me hesitant about the rally, but on measures such as valuation there’s really no argument for U.S. stocks broadly speaking versus emerging markets. The latter are cheaper.
How will the U.S. market react? It depends. If these moves are a nascent bull run, it doesn’t look good for inflation readings. An expanding global economy is bearish for the U.S. dollar. On the other hand, an expanding global economy will be bullish in general.
Whenever I run into these either/or scenarios, I zoom out. For stocks, I go back to Hussman’s model. If the economy picks up steam, wage inflation will kick in, interest rates will rise, profit margins will return to Earth and financial assets are still wildly overvalued. If nothing else, the public will vote for a far-left or far-right candidate who will either tax the rich or blow up the current system.
If there is significant inflation or deflation, U.S. stocks are in major trouble. Even if they’re not in trouble, foreign stocks are far cheaper at the aggregate level.
Today
I will be closely watching energy. I still have the DRIP position for the portfolio. When I saw this morning’s oil price I said to myself, “That’s it, I’m probably going to cash.” Then I saw the news and thought, “I’m certainly going to cash.” And then I looked at SPDR Energy (XLE): there’s no breakout yet. This can absolutely change in minutes after the open. I have seen this happen before where the market doesn’t wake up until regular trading hours.
The horizontal line is at $93.48. This chart should breakout. I expect it will breakout. I assume I’m going to close DRIP this morning. (AS I’m typing, XLE is trying to get there.) If this chart doesn’t breakout, that is a very significant piece of information. As significant as my article on emerging markets and gold a couple of weeks ago. It’s also a critical factor for the stock market. My bull case for stocks requires two things: lower inflation and lower commodity prices. If XLE breaks out, the broader stock market rally could quickly run out of steam.
On Inflation
Finally, a few words on inflation. I have seen many comments along the lines of inflation numbers are fake, inflation is still 7 percent and so on. First, it doesn’t matter if inflation numbers are wrong. The economy and markets reflect whatever is the real inflation rate.
Second, the market cares about where inflation is going, not where it has been. Inflation in the past year is 7.7 percent. Inflation has been running at 5.5 percent in the past four months. If housing and rents start falling in Q1 or Q2 2023, this number will be cut in half all else being equal.
Third, the market cares about surprises. Markets can reprice quickly. Everyone knows the CPI was 7.7 percent in the past year. When did the market bottom? Looking at the S&P 500 Index, it started bottoming in June 2022. What month had the highest month-on-month inflation reading? June 2022. It wasn’t announced until July, but the market “knew.” The market has only closed below the June low on 5 days. All the activity from June until now is a complex double bottom of a massive bull market correction if stocks keep rising. I still think this is a bear market, but what’s been going on since June is a test of the lows, not a significant breakdown to new lows. Higher inflation needs a catalyst. Maybe China provides it, maybe not.
I expect inflation will come down because the Federal Reserve will keep hiking until it breaks something. If a China reopening boosts the global economy, then the Federal Reserve has more room for rate hikes. That should prove bearish for U.S. stocks or at least argues for owning emerging markets and commodities if this never was a bear market. Or owning the DJIA over the Nasdaq. Alternatively, inflation is done and morphs into deflation next year, this year was a warmup to the main event.