Juggling Dynamite

China’s economy is slowing. Amid weak borrowing, slack investment, deflationary pressures and uneven growth, the evidence points to China slipping into a “balance sheet recession”—a phenomenon our guest, Richard Koo, first diagnosed during Japan’s lost decades of the 90s, and then identified in the financial crises of both Europe and the U.S. The former New York Fed official, who has consulted governments and testified in the U.S. Congress, spent decades analyzing how economies recover—or fail to recover—from balance sheet recessions. Koo explores what China must do to avoid stagnation, and lay out the stakes for global markets, trade, and investment. Here is a direct video link.

As expected, the Bank of Canada (BoC) cut overnight interest rates by 25 basis points yesterday, lowering the banking system’s base rate to 2.75%, the lowest since September 2022.

In his prepared statement, BoC Governor Tiff Macklem struck a grave tone, saying, “We’re now facing a new crisis. Depending on the extent and duration of new US tariffs, the economic impact could be severe.”

Macklem said tariff uncertainty was “pervasive” and “already causing harm,” as “continuously changing” threats are hitting consumers’ spending intentions and limiting businesses’ plans to hire and invest. Canada’s unemployment rate was 6.6% in January, and job growth looks to have stalled out in February.

But, given rising costs, Macklem said central banks are limited in how much they can lower interest rates to offset economic weakness: “Monetary policy cannot offset the impacts of a trade war. What it can and must do is ensure that higher prices do not lead to ongoing inflation.” See Bank of Canada to be cautious about future rate moves: Full text.

Inflation is expected to increase to about 2.5% in March. The BoC’s preferred measures of core inflation remain above 2%, mainly because of the persistence of shelter price inflation (home prices and rents are still crazy high). Now, short-term inflation expectations are rising further due to fears about the impact of tariffs.  This is a stagflationary mix.

The BoC “will proceed carefully with any further changes” to borrowing costs, as officials would “need to assess both the upward pressures on inflation from higher costs and the downward pressures from weaker demand.”

The Canadian dollar strengthened on the prospect of slower rate cuts while treasury bonds sold off, pushing up yields and fixed-term loan rates—the opposite of what borrowers and exporters hoped for.

A wall of pandemic-era loans renewing at much higher interest rates in 2025-26 was daunting enough. Trade disruptions and stymied central banks magnify the challenges.

And, it’s gone…the widely owned Magnificient 7 stocks (Apple, Microsoft, Nvidia, Amazon, Meta, Alphabet A, and Alphabet C), down a collective 20% from recent highs, have given back their Trumphoria election gains (see pink bank below, courtesy of my partner Cory Venable).

The downdraft to date is Apple -15%, Microsoft -19%, Nvidia -27%, Amazon -20%, Meta -19.6%, and Alphabet -20%. Tesla, down 53% since December 18, has retreated to the 12th most expensive S&P 500 constituent.

So far, the group still accounts for an oversized 28.9% of the S&P 500’s market capitalization, and there’s a lot of downside room before prices retest the late 2022 cycle low (see red band below). This is especially true for A.I. mania leaders, Nvidia (in black) and Meta (in orange).

The U.S. dollar index has also round-tripped, with the DXY index returning to the same level as before Trump’s election.
The Euro has rebounded 5.5% against the greenback, while the commodity and recession-sensitive Canadian dollar has dropped 7.2% since last September.

Promising prosperity is easier than delivering it, and pain has not been restricted to tech shares alone. Most risk assets have slumped along with Trump’s approval rating.

The economically sensitive Russell 2000 index of small-cap companies -17% since November—is back to the same price level as December 2020, more than four years ago.

As usual, dividend-paying stocks and corporate debt are proving to be poor bear market shelters, with prices falling broadly. Cash and Treasuries have gained, while gold prices have flatlined so far.

This is not the change that bag-holders most would-be investors had in mind. The latest AAII sentiment survey found that 60% of respondents feel suddenly bearish. Small business sentiment soared into December but has been retreating since.

Extremes have a way of cutting both ways; it’s called mean reversion. Nothing moves in straight lines, but the spectacular speculative episode of the 2020-2024 period has a lot of giveback yet to go.