Juggling Dynamite

The International Monetary Fund warned this month that the downdraft in China’s real estate sector has contagion implications globally:

In the near term, the sharp adjustment in China’s heavily indebted property sector and the resulting slowdown in economic activity will likely spill over to the region, particularly to commodity exporters with close trade links to China. Beyond this, an aging population and slowing productivity growth will further temper growth over the medium-term in China, amid rising risks of geoeconomic fragmentation, and bear upon prospects in the rest of Asia and beyond. In a downside scenario where “de-risking” and “re-shoring” strategies take hold, output could decline by up to 10 percent over five years in the Asian economies most closely linked to China’s economy.

The latest data shows that property investment — the largest driver of China’s economic activity — continues to slump, with home prices and consumer sentiment falling. (Sound familiar, Canada?)

Notwithstanding intervention efforts from Chinese authorities, China’s primary CSI 300 Stock Index has erased all its gains during the so-called reopening rally in the final quarter of last year. See China’s Property Woes Pour Cold Water over Efforts to Boost Stocks. The Chinese stock market is today 40% below its manic cycle peak in October 2007, 16 years ago. When asset prices dramatically overshoot reasonable valuation metrics, it is typical for them to halve and not recover prior peaks for many years. Word to the wise.

The video report below offers a worthwhile overview and update.

China’s real estate industry is collapsing in slow motion. Major developers like Evergrande and Country Garden remain stuck in spiralling debt problems. So-called ‘ghost cities’ dot the Chinese countryside. And now the International Monetary Fund just cut its global growth forecasts for 2024 and called out China’s real estate crisis as a big reason why. Here is a direct video link.

The average time from a yield curve inversion (long-interest rates below short) to the onset of recession has been ten months historically, ranging from 11 to 22 months. October marks the eighteenth month of curve inversion this cycle. Moreover, since June, the yield spread has been flattening out. As we start this trading week, the US 10-year is just 59 basis points lower than the 3-month Treasury rate and 61 bps below the US Fed Funds rate.

Yield curve re-steepening has preceded the onset of past recessions with a lag of zero to nine months. As noted by Francois Trahan, re-steepening suggests the Fed has done more than enough, and a more extended period of inversion tends to correlate with a longer period of recession.

Economically sensitive small-cap companies are reflecting financial gravity. The Russell 2000 is now 33% below its November 2021 high and has gone nowhere for five years (below since 2000, courtesy of ISABELNET.com).

Other stock markets are at risk of following suit. Canada’s TSX is today just 5% above its pre-COVID February 2020 peak of 44 months ago. Financials have been leading down, and that’s never bullish.

The large-cap S&P 500 index has been buoyed by its whopping 25% weight in the seven most expensive tech stocks to date, but even so, the S&P is -12% since December 2021 and flat since May 2021–29 months and counting. The chart below from Bespoke shows the S&P drawdowns and rebounds within the 2-year bear market to date. After a ten percent drop, buy-the-dippers could drive another bounce. Anything is possible in the near term, but the longer bear markets grind on, the more financial and psychological harm they inflict as liquidity and patience run low. Remember, the Fed hasn’t even started to ease yet.

If the last Fed hike was in July, we are three months into the pause. Since 1969, the pause time between the last Fed hike and the first rate cut has been zero to 14 months. In each case, recessions began at or shortly after the first rate cut, with the stock market not bottoming until 13 to 33 months after the last Fed hike.

David Rosenberg, founder & president of Rosenberg Research and Ed Devlin, founder of Devlin Capital, senior fellow at C.D. Howe Institute and former head of Canadian portfolio management at PIMCO, join BNN Bloomberg to discuss their economic outlook. They say that even as many believe a soft landing is still accomplishable, there are some metrics suggesting the economy is already in a recession. Here is a direct video link.

Also, read this excellent overview: Canada is beating the US into recession.