June 19, 2018

While the sell-off in currencies of emerging markets with insufficient foreign exchange (forex) reserves and wide current account deficits – like the Argentine peso and the Turkish lira – is still picking up steam, there is relative calm in China, where the yuan is trading well off its recent multi-year lows. On the surface, the yuan has plenty of forex reserves (over $3 trillion) and its current account has been in surplus for over 20 years; but under the surface, it very well may have some more serious issues.

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary

The natural question is: If there is no need for external financing, why did China lose $1 trillion in forex reserves between mid-2014 and mid-2016 before briefly arresting that decline (which has now resumed)?

I think America’s escalating trade war with China is more dangerous for China than it is for the U.S. Still, in a bad trade war there are no real winners, just various degrees of losers. While I agree with President Trump that the U.S. has been taken advantage of by China in bilateral trade, I am not sure the Chinese are the kind of people to be slapped on the front page of the Wall Street Journal with $50 billion worth of tariff packages. This is as far from the “saving face” modus operandi of Chinese diplomacy as it gets.

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

The point is: Trade war could escalate dramatically, which neither Mr. Trump nor Mr. Xi should want.

In 2002, Ben Bernanke, then a Governor of the Federal Reserve, helped celebrate the 90th birthday of Milton Friedman. Here is a notable line from his prepared comments:

“Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton … Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.”

I doubt Ben Bernanke was referring only to the monetary policy mistakes of the Federal Reserve in 1929 and subsequent years, when the central bank tightened monetary policy at a time when they should have been doing the opposite. He most likely was referring as well to the Smoot Hawley Tariff Act of 1930, which collapsed global trade. At the time of the enactment of the tariff, U.S. unemployment was only 8%. At the time of its repeal a couple of years later, the unemployment rate was 25%.

I doubt that a sitting U.S. President who wants to “Make America Great Again” wants to repeat that Great Depression’s economic record, but neither did Senator Reed Smoot or Congressman Willis Hawley who sponsored the tariff act. The point is: Unintended consequences happen and given the precarious situation in China, they may happen again in the latest tariff imbroglio. President Trump is like the man at the wheel of a kerosene truck, whose brakes are not entirely in order, speeding towards the bonfire burning in the Chinese financial system. While it is possible that he would be able to stop at the very moment before reaching the point of no return, it is also possible that he has underestimated the momentum of his payload of $375.2 billion in bilateral trade imbalance that is likely to hit another record high in 2018.

There is a bonfire burning in the Chinese financial system because the bulk of rampant dollar borrowing in emerging markets in the last 10 years has come from China, due to the sheer size of the Chinese economy, which was $11.94 trillion in 2017, and as such the second largest in the world. Furthermore, unlike in India where GDP growth is driven by self-sustainable internal domestic demand, in China GDP growth is driven by accelerating borrowing (see chart below) and aggressive mercantilist tactics.

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

If a trade war were to escalate, the fragile balance in the Chinese economy could be tipped and we may very well experience a second Asian Crisis. The important difference here would be that China’s GDP is many times larger than the total GDP of all countries involved in the first Asian Crisis in 1997-1998 (when China’s GDP was barely above $1 trillion).

While the sell-off in the Turkish lira and Argentine peso is certainly gathering headlines at the moment, it is hard for the Chinese yuan to get the same attention as there are still plenty of forex reserves to maintain the dirty yuan peg and stop the yuan from depreciating further. One could say that because of the bigger war chest of the People’s Bank of China, the yuan is not necessarily the same timely market indicator as other emerging markets currencies whose central banks are in considerably less fortunate positions.

The key here remains forex reserve outflows, in which a pick up similar to what we saw in 2015 after the crash of the Shanghai Composite (and faster than the present pace) would be the major red flag.

Other Market-Driven Indicators

The Shanghai Composite Index closed last week at 3022. It sure looks to have experienced a bad “crack” in 2018. I have previously referred to the rally off the January 2016 lows of 2650 as “the mother of all dead cat bounces,” or MOADCB, a bear market rally that could not recover in two years what it lost in a single month (January 2016). The index is now unwinding that MOADCB rather expeditiously.

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

I am aware that the Shanghai Composite is not as good a reflection of the Chinese economy as India’s SENSEX is for the economy of India, as China’s economic growth does not necessarily translate into profit growth due to the much bigger government intervention in the economy in the best interest of “social stability,” as the Chinese like to say. Still, the troubling developments in the Shanghai Composite cannot be ignored when forex reserve flows have resumed and there is a rather unconventional man at the wheel of a kerosene truck headed for the blazing bonfire of the Chinese financial system.

This year promises to be a more different year for financial markets than 2017, as it is driven by unilateralist “Make America Great Again” policies that frankly have resulted from the failure of the multilateralist approach of several previous administrations.

About The Author

Ivan Martchev
INVESTMENT STRATEGIST

Ivan Martchev is an investment strategist with Navellier.  Previously, Ivan served as editorial director at InvestorPlace Media. Ivan was editor of Louis Rukeyser’s Mutual Funds and associate editor of Personal Finance. Ivan is also co-author of The Silk Road to Riches (Financial Times Press). The book provided analysis of geopolitical issues and investment strategy in natural resources and emerging markets with an emphasis on Asia. The book also correctly predicted the collapse in the U.S. real estate market, the rise of precious metals, and the resulting increased investor interest in emerging markets. Ivan’s commentaries have been published by MSNBC, The Motley Fool, MarketWatch, and others. *All content of “Global Mail” represents the opinion of Ivan Martchev*

Disclosures

Although information in these reports has been obtained from and is based upon sources that Navellier believes to be reliable, Navellier does not guarantee its accuracy and it may be incomplete or condensed. All opinions and estimates constitute Navellier’s judgment as of the date the report was created and are subject to change without notice. These reports are for informational purposes only and are not intended as an offer or solicitation for the purchase or sale of a security. Any decision to purchase securities mentioned in these reports must take into account existing public information on such securities or any registered prospectus.

Past performance is no indication of future results. Investment in securities involves significant risk and has the potential for partial or complete loss of funds invested. It should not be assumed that any securities recommendations made by Navellier. in the future will be profitable or equal the performance of securities made in this report.

Dividend payments are not guaranteed. The amount of a dividend payment, if any, can vary over time and issuers may reduce dividends paid on securities in the event of a recession or adverse event affecting a specific industry or issuer.

None of the stock information, data, and company information presented herein constitutes a recommendation by Navellier or a solicitation of any offer to buy or sell any securities. Any specific securities identified and described do not represent all of the securities purchased, sold, or recommended for advisory clients. The reader should not assume that investments in the securities identified and discussed were or will be profitable.

Information presented is general information that does not take into account your individual circumstances, financial situation, or needs, nor does it present a personalized recommendation to you. Individual stocks presented may not be suitable for you. Investment in securities involves significant risk and has the potential for partial or complete loss of funds invested. Investment in fixed income securities has the potential for the investment return and principal value of an investment to fluctuate so that an investor’s holdings, when redeemed, may be worth less than their original cost.

One cannot invest directly in an index. Results presented include the reinvestment of all dividends and other earnings.

Past performance is no indication of future results.

FEDERAL TAX ADVICE DISCLAIMER: As required by U.S. Treasury Regulations, you are informed that, to the extent this presentation includes any federal tax advice, the presentation is not intended or written by Navellier to be used, and cannot be used, for the purpose of avoiding federal tax penalties. Navellier does not advise on any income tax requirements or issues. Use of any information presented by Navellier is for general information only and does not represent tax advice either express or implied. You are encouraged to seek professional tax advice for income tax questions and assistance.

IMPORTANT NEWSLETTER DISCLOSURE: The hypothetical performance results for investment newsletters that are authored or edited by Louis Navellier, including Louis Navellier’s Growth Investor, Louis Navellier’s Breakthrough Stocks, Louis Navellier’s Accelerated Profits, and Louis Navellier’s Platinum Club, are not based on any actual securities trading, portfolio, or accounts, and the newsletters’ reported hypothetical performances should be considered mere “paper” or proforma hypothetical performance results and are not actual performance of real world trades.  Navellier & Associates, Inc. does not have any relation to or affiliation with the owner of these newsletters. There are material differences between Navellier Investment Products’ portfolios and the InvestorPlace Media, LLC newsletter portfolios authored by Louis Navellier. The InvestorPlace Media, LLC newsletters contain hypothetical performance that do not include transaction costs, advisory fees, or other fees a client might incur if actual investments and trades were being made by an investor. As a result, newsletter performance should not be used to evaluate Navellier Investment services which are separate and different from the newsletters. The owner of the newsletters is InvestorPlace Media, LLC and any questions concerning the newsletters, including any newsletter advertising or hypothetical Newsletter performance claims, (which are calculated solely by Investor Place Media and not Navellier) should be referred to InvestorPlace Media, LLC at (800) 718-8289.

Please note that Navellier & Associates and the Navellier Private Client Group are managed completely independent of the newsletters owned and published by InvestorPlace Media, LLC and written and edited by Louis Navellier, and investment performance of the newsletters should in no way be considered indicative of potential future investment performance for any Navellier & Associates separately managed account portfolio. Potential investors should consult with their financial advisor before investing in any Navellier Investment Product.

Navellier claims compliance with Global Investment Performance Standards (GIPS). To receive a complete list and descriptions of Navellier’s composites and/or a presentation that adheres to the GIPS standards, please contact Navellier or click here. It should not be assumed that any securities recommendations made by Navellier & Associates, Inc. in the future will be profitable or equal the performance of securities made in this report. Request here a list of recommendations made by Navellier & Associates, Inc. for the preceding twelve months, please contact Tim Hope at (775) 785-9416.

Marketmail Archives