Why China’s Stimulus Isn’t Good News for the Market

There are two factors driving markets higher right now: Chinese stimulus and a re-think on the direction of US interest rates.

I’ve previously discussed how, in relation to the Aussie market, the resource sector has been holding up well. The big iron ore players, BHP and Rio, have been behind this solid performance. That’s despite China’s slowing economy and concerns that the trade war with the US will damage it even further.

The reason behind the strong performance is the expectation of additional stimulus spending. This week, Chinese authorities confirmed the expectation by announcing a number of measures.

A few days ago, the central planners approved more than $1 trillion in rail projects (a lazy US$150 billion). And just yesterday, China announced additional tax cuts and stimulus to help bolster its economy. From the Australian Financial Review:

China has put private sector tax cuts at the frontline of President Xi Jinping’s battle to combat a slowdown in the world’s second-largest economy with a package of rebates for millions of small companies that economists say is worth 2 trillion yuan ($410 billion).

China also outlined plans to make it easier for private companies to obtain financing and increase consumer spending as the economy faces its worst slowdown since the global economic crisis and uncertainty over threatened US tariffs.

The raft of measures and the joint appearance of officials from the country’s central bank and two other powerful ministries managing China’s economy buoyed markets in the region that were rattled by disappointing trade data 24 hours earlier.’

According to JP Morgan, the boost represents around 1.2% of GDP.

In other words, it’s a hefty jolt that China is providing.

Why the market has been rallying

Which is why the market has been rallying lately. After all, what’s good for China is good for Australia, at least in the short term. But now the news is out (rumour is now fact), in the next few days we’ll get to see just how confident investors are in the China growth story.

Right now, the evidence is mixed.

What do I mean by that?

I always look to the iron ore producers to tell me what the market thinks of China’s fixed asset/infrastructure growth profile. Fortescue Metals Group Ltd [ASX:FMG] is in an early upward trend (see below), after falling considerably. So this is a bullish sign. I’m tempted to buy!


FORTESCUE METAL GROUP 16-01-19

Source: Optuma

[Click to open in a new window]

But then I look at Rio’s share price, and hesitate. It peaked back in May/June. Subsequent rallies have failed to get back near the highs. If it turns down from here — amidst bullish news about more China stimulus — it’s an ominous sign.


RIO Tinto Limited 16-01-19

Source: Optuma

[Click to open in a new window]

You’ll need to see a few more weeks of price action to have a better idea of what’s going on. But right now, I can’t get too excited about China’s recent announcements.

The reason FMG looks good here is that it’s a relatively low quality iron ore producer. It’s much more susceptible to swings in demand. The market is betting that FMG will be the big beneficiary from China’s recent announcements.

But keep in mind that China’s iron ore imports dropped 1% in 2018, the first annual drop since 2010. And, despite the stimulus cuts, there is major concern about the longer term health and growth trajectory of China’s economy. That’s why they’re implementing these measures…it’s not because China is in rude health!

The other factor buoying markets right now is news out of the US Federal Reserve. Overnight, voting member and interest rate ‘hawk’ Esther George conceded that the Fed should pause its interest rate hikes.

George said ‘it might be a good time to pause our interest rate normalisation, study the incoming evidence and data, and verify our current location

Ya think so, Esther?!

The market (and Donald Trump) has put pressure on the Fed. Now they’re back peddling and trying to find out where they are on the map.

Let’s just ignore the Fed’s incompetence and the crazy notion that a handful of people can direct monetary policy for a hugely complex global economy, and focus on the facts.

The market tanked in the last quarter of 2018 on concerns that Fed tightening would slow the global economy. The Fed responded by pulling back on its expected interest rate tightening path. And it continues to communicate this cautious new stance.

As an investor or trader, you have to remember it’s not the news that is important, it’s the market’s reaction to the news. The bullish price action overnight (the S&P 500 was up 1%) tells you that the market is still receptive to bullish news. That is, all the recent good news wasn’t in the price.

But let’s see if there is follow through buying. Now that the news is out about China’s stimulus and the Fed pausing while it works out where it is exactly, we’ll get to see just how strong (or weak) this market is.

In my view, both these recent news items confirm that the global economy is in a spot of bother. We’re at the end of the business cycle and companies will find it much harder to grow earnings from here.

The recent rally merely reflects a change to short term positioning. Soon enough, I think you’ll see the bear market resume.

Regards,

Greg Canavan,
Editor, The Rum Rebellion


Greg Canavan approaches the investment world with an ‘ignorance is bliss’ philosophy. In a world where all the information is just a click away at all times, Greg believes we ingest too much of it. As a result, we forget how to think for ourselves, and let other people’s thoughts cloud our own. Or worse, we only seek out the voices who are confirming our biases and narrowminded views of the truth. Either situation is not ideal. With regards to investing, this makes us follow the masses rather than our own gut instincts. At The Rum Rebellion, fake news and unethical political persuasion are not in the least bit tolerated. It denounces the heavy amount of government influence which the public accommodates. Greg will help The Rum Rebellion readers block out all the nonsense and encourage personal responsibility…both in the financial and political world.


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