Over the week-end I took time out to read Bridgewater’s report on the Chinese stock market crash. Usually I don’t have access to the world’s largest hedge fund’s research pieces, so when the FT published the full report (click here to read it), I jumped at the chance.
I was shocked at how worried Ray Dalio & Co. are about the Chinese stock market crash. From the report:
Our views about China have changed as a result of recent developments in the stock market. We previously conveyed our thinking about the debt and economic restructurings being negative for growth over the near term and positive for growth over the long term – i.e., that it is a necessary and delicate operation that can be well managed. While we had previously considered developments in the stock market to be supportive to growth, recent developments have led us to expect them to be negative for growth. While we would ordinarily consider the impact of the stock market bubble bursting to be a rather small net negative because the percentage of the population that is invested in the stock market and the percentage of household savings invested in stocks are both small, it appears the repercussions of the stock market’s declines will probably be greater.
Many investors are trying to reason away any worries about the Chinese stock market crash by claiming the Chinese stock market is still up on a year over year basis, so there is nothing to be concerned about. Not Bridgewater. They have taken the exact opposite tack. Ray Dalio thinks the stock market crash will have an exaggerated effect on the Chinese (and even the global) economy.
Because the forces on growth are coming from debt restructurings, economic restructurings, and real estate and stock market bubbles bursting all at the same time, we are now seeing mutually reinforcing negative forces on growth.
As you would expect from Bridgewater, the report is quite analytical. It is filled with numbers and historical data comparisons of previous similar events. Give it a read to decide if you buy Dalio’s argument.
Missing the real problem
I think the team at Bridgewater is overweighting the importance of the Chinese stock market crash while underweighting the signals other market instruments are sending. The Chinese stock market has definitely shit the bed from the highs, but the rally was rather preposterous in the first place.
I don’t know if I buy all of Bridgewater’s arguments about the damage done to the Chinese economy as a result of the bursting of the stock market bubble. There can be no denying there was some naive buying at the highs, but there has to be some accounting for the fact the stock market was only up there for a couple of months. Having a multi year bull market collapse is much different than some speculative spike coming back to earth.
Don’t get me wrong – I think the Chinese economy is worse than most market participants believe, but I am not staring at their stock market for clues. I view their stock market as more of a sideshow.
But not everyone ignored the Chinese stock market
Herein lies the real problem with the recent Chinese stock market rally (and collapse). Many astute investors took the recent rise in the Chinese stock market as a signal the Chinese economy was about to take off. Legendary trader Stanley Druckenmiller gave a lengthy interview with Bloomberg news where he outlined his belief of a coming global economic uptick that was in large part, simply a recognition that the Chinese stock market was reflecting what he believed to be an massive liquidity injection into the Chinese economy (Apr 27/15 – Druckenmiller says “Don’t fade the banana stand guy”)
“no, it’s not the data, I am watching the markets. And whenever I have seen a stock market explode with record volume and record breadth, and move to that degree, like **day follows night,** six to twelve months down the road you are out of that recession and into a full blown recovery. ”
Although Druck was wise enough to point out the fact the Chinese stock market was relatively undeveloped and maybe more probe to false signals, he was still setting himself up with pro-growth positions. For example he was buying oil on anticipation of a global economic uptick.
I am not picking on Druckenmiller as I have nothing but the upmost respect for him. I am merely trying to point out why this commodity rout has been so painful. Not only did the Chinese stock market rally trick millions of new Chinese retail investors, but it sent signals about a coming economic recovery that fooled many smart investors on this side of the world.
Part of the reason why Bridgewater’s report seems so alarmist is they were also most likely caught leaning the wrong way. When the Chinese stock market rally proved to be nothing more than a mirage of orgiastic speculation, the stark reality that the Chinese economy is still declining rapidly became abundantly clear.
Zerohedge recently reported that China’s electricity consumption grew at the slowest pace in 30 years:
Chinese iron ore has been in free fall:
It has been disappointment after disappointment. Meanwhile the Chinese economy is suffering from the weight of an ever rising currency, and it is drowning.
China is a disaster
My guess is the Chinese economy is even worse than Bridgewater and the other newly minted China bears believe. Apart from the Chinese stock market’s recent gyrations, all other market signals are screaming massive slow down. There is simply nothing pointing towards this slowdown showing signs of bottoming.
The recent acceleration of the commodity collapse was to some extent the hedge funds pitching their pro-growth bets. Bridgewater admits it point blank – they were caught flat footed by the speed of the Chinese stock market crash. Given their sombre assessment of the effects of this decline, you have to assume they are not positioning themselves for a solid global economic upswing. Now I am not naive enough to think Bridgewater published this piece before they unwound their position. There is no way they still have their selling ahead of them. Understanding Bridgewater’s argument is mainly helpful in determining why we declined, not whether it will continue or not.
As for where we go from here, it is all up to the Chinese. If they continue to allow their currency to rise, they will continue to import the world’s deflation and slowly strangle their economy into a recession. Everyone is focused on the Chinese stock market, but I think they are missing the more important market signals. I am watching iron ore, electricity consumption and all the commodities for clues when the Chinese economy will turn around. But most importantly, I believe their economy will not be able to turn around as long as the Yuan is rising. If I only had one indicator to base my forecast of the Chinese economy, it would be the WestPac Real Effective Traded Weight Yuan. In this day and age of prevalent over indebtedness with anemic growth, no country can afford to allow their currency to rise as quickly as the Yuan has done over the past year. The Chinese are hanging tough with their currency rise, trying to get themselves into the IMF’s reserve currency basket, but at what cost?
At the risk of being disrespectful of the world’s largest hedge fund, I humbly suggest you ignore the gyrations of the stock market, and instead focus your attention to the value of the Yuan. The Chinese government can fix this problem almost overnight with a devaluation combined with a fiscal policy stimulus. I know the bears will tell you that will not solve anything in the long run. Of course it won’t. But we all know what happens to us all in the long run. In the mean time, the devaluation solution will be used time and time again. The only question is timing. While we are waiting for the inevitable tapping out, the Chinese economy will only get worse. Hedge funds have just woken up to this fact, and they are piling on the short side of growth trades (or in some cases at least puking out their pro-growth trades). I don’t know about you, but I am not keen to assume it will all get worse from here. I have seen the world’s Central Banks’ fury when growth slows to levels where a deflationary vicious circle is at risk of taking hold. I have to think we are pretty close to some big changes in the world’s monetary order.
No more complaining about ‘paper selling’
Gold seems to be struggling to make a bottom. The rallies are still met with selling, and we don’t seem to be able to get any traction. I had to suffer through another of Sprott’s paper gold manipulation interviews this week-end (although Eric did have some other great bullish points, it is always frustrating when he trots out the manipulation argument). Instead of complaining about the ‘paper selling’, I am going to pull out the tuxedo baby to deal with the short sellers.
Thanks for reading,