Rare Events Taking Hold: Macro View Looking for Upside By Reading The Chinese Fortune Cookie

Below excerpt is closing conclusion courtesy of Oct 28 edition of Rareview Macro LLC publication “Sight Beyond Sight”

Neil Azous, Rareview Macro LLC
Neil Azous, Rareview Macro LLC

The Federal Reserve (FED) will make its policy announcement tomorrow. The Bank of Japan (BoJ) will make its statement at the end of this week. The European Central Bank (ECB) meets next week. All three of them will be dovish at the end of the day.

Additionally, Jean Claude Juncker begins his presidency of the European Commission next week and that should embolden the call for fiscal help, which is required even more now that both Italy and France have changed their budget plans (see details below in Top Overnight Observations). There is no question that professionals we speak to are warming up to the idea of a larger fiscal announcement and this is tempering their bearish view on Europe to a degree.

Finally, with a positive US employment report, expectations of a Republican win in the US Mid-term Elections, and the positive seasonality associated with the start of a new month, it can be easily argued that the theme for the next two-weeks is global policy support.

The worst part of it is that everyone who was forced to reduce risk in October, and then missed the move back up, knows this is the market’s support structure regardless of the fact that QE finally ended yesterday.

This is not us being overly constructive on US equities or risk assets. After six weeks of one-way negative news flow and the sentiment shifting to extreme levels, there are now three weeks of events that should be supportive for risk. This is just the start of week number two in that period.

And that, combined with the lagging performance in the professional community, is enough to walk sentiment back even further, especially when countries like China and Sweden move out of nowhere to support the market on the upside.

MarketsMuse Editor: For the reader who requires further context re: above, the preface to above-noted thesis is…

Government Support Highlights the Upside Potential for the Next Two Weeks

  • China:  Invisible Hand at Work
  • Sweden:  Central Bank Defends a Key Engine of Cyclicality
  • Model Portfolio Update – October 24, 2014 COB:  +2.35% WTD, +3.08% MTD, +12.07% YTD

Government support for the markets was clearly visible overnight.

Firstly, the Shanghai Stock Exchange Composite Index (symbol: SHCOMP, +2.07%, 90.9% up-day), Shanghai Stock Exchange Property Index (symbol: SHPROP, +3.02%, 95.8% up-day ), Honk Kong Hang Seng Composite Index (symbol: HSI, +1.49%, 92% up-day), and Hong Kong Stock Exchange Hang Seng China Enterprises Index (symbol: HSCEI, +2.3%, 92.5% up-day) are all showing the largest back-to-back positive risk-adjusted returns across regions and assets.

  1.  It is rare that the onshore SHCOMP and SHPROP trade in tandem.
  1.  It is rare that the onshore SHCOMP and SHPROP show the largest back-to-back positive risk-adjusted returns on a cross-asset basis as opposed to just in the equity asset class.
  1.  It is rare that offshore HSI and HSCEI trade in tandem.
  1.  It is rare that the offshore HSI and HSCEI show large positive risk-adjusted returns to begin with. Additionally, these markets rarely act as overall leadership or trade in tandem like their onshore brethren.
  1.  It is extremely rare that all four indices or onshore/offshore markets show back-to-back moves in equities or trade in tandem. Remember, there is has been a big divide between onshore and offshore investor bases since August.
  1.  It is even rarer that all four show the largest back-to-back moves across all assets and regions.

What we are trying to say here is that all four of these markets have their own personality and separate trading patterns, and we cannot remember a time where they all moved in such a unified way relative to every other asset and region.

This profile is so rare, it forces us to dig deeper to work out what is going on.

The “on the surface” observations include:

  1.  China International Capital Corporation said the PBoC added funds via a Medium-term Financing Mechanism in mid-October, not the Standing Lending Facility (SLF) that many reported. The funds involved were between CNY300-400 billion, higher than the CNY200 billion discussed in the market last week. Like the reported SLF, the funds carry a term of 3-months but can be rolled over, with the interest rate reset upon maturity. Banks can apply for the funds using bonds as collateral and are required for rural and small business lending. Banking sources said the central bank has asked banks to lower lending rates, which is the condition for rolling over these funds, and said this is “a clear indication of a targeted interest rate cut”.  (Sina.com)
  1.  China CNR Corp and CSR Corp, the country’s two largest train makers, are being merged under orders from the State Council to promote exports of high-speed rail locomotives.
  1.  China is preparing to approve a second list of cities to be declared Free Trade Zones, a year after the Shanghai Free Trade Zone was launched as part of Beijing’s reform efforts.
  1.  Fitch Ratings has affirmed the Long-Term Foreign and Local Currency Issuer Default Ratings (IDRs) on China National Petroleum Corporation (CNPC), CNPC Finance (HK) Limited (CPFHK) and PetroChina Company Limited (Petrochina) at ‘A+’. These are the major integrated energy companies and were welcomed given the lower price of crude oil.

The “under the surface” observation or the “Rareview” includes these two points:

  1.  The Communist Party of China (CPC) Central Committee has on Tuesday published the full text of the decision on comprehensively advancing the rule of law. The decision was adopted at the fourth plenary session of the 18th CPC Central Committee on Thursday. The full text (160,000 characters) and an explanation to the decision (9700 characters), delivered by President Xi Jinping at the session, was also published.
  2. The consensus amongst the private think tanks was that President Xi Jinping suffered some setbacks, especially with regard to not being able to finally conclude the takedown of the former politburo standing committee member Zhou Yongkang. The takeaway was that the power struggle at the top will continue and inevitably that will weigh on sentiment going forward.
  3.  Today, it was announced that a senior Chinese military officer (i.e. a “Tiger”) accused of graft will be prosecuted in court and he has also been expelled from the Communist Party and the military. Xu Caihou, once one of the country’s most senior officers, was court-martialed in June. He confessed he was guilty of taking “massive” bribes. (Xinhua). This is a signal that Zhou remains in the line of sight and it is just a matter of time before the remaining power is consolidated.
  4. The trading unit of the state-run China National Petroleum Corp. has bought 36 cargos of crude oil in the open market so far in October, the largest purchase ever made in a single month. The 36 cargoes were bought by China National United Oil Corp., or Chinaoil, and are equal to 18 million barrels of crude, and they came from the UAE and Oman. China’s last big purchase in the Singaporean market was 16 cargos in April, with its buying rate averaging just three cargos a month from June to September. (Sources: Singapore-based traders, Platts, WSJ)
  5.  Add in ongoing speculation that China’s strategic stockpiling reserve for Copper has also been supporting the market.

As we said yesterday,we are a devoted China watcher and anecdotally, our view is that negative sentiment is at an extreme level right now. Between the movements in the various stock markets, crude oil and copper coming on the day of the 4th Plenum formal communique, one could easily argue this was not coincidental and this was the work of the “invisible hand” (i.e. the Government).

Historically, we have always viewed South Korea, Germany, and Sweden as the world’s three main engines of cyclicality. So when one of these countries – Sweden – abruptly changes course, or surprisingly accelerate the path they are already on beyond market expectations, we pay careful attention. This is especially true when it is likely to be a precursor for other countries following in their footsteps (i.e. Switzerland).

We would encourage you to read the full list of bullet points in the Data & News sections below but the summary is that Sweden’s Central Bank – the Riksbank – statement after its aggressive rate cut (i.e. 25 bps vs. 12 bps price in) also saw it push back out its view for first rate hike until mid-2016 (from prior end-2015). The Riksbank effectively cut rates more than expected, significantly lowered the interest rate path, reduced its inflation forecast, raised the possibility of currency intervention, and did so in unanimous fashion, which is very rare for that central bank.

To read the remainder of this edition of Sight Beyond Sight, free trial subscription (no credit card info is required) can be secured directly from Rareview Macro website by clicking on this link.