US equities finished little changed Thursday, the S&P500 down 0.2% after another late-afternoon sell-off prompted by President Trump announcing he would hold a press conference on Friday relating to the Hong Kong security legislation. That came after yesterday's vote by China's legislature to approve the new laws. There were better equity sessions through Europe and Asia. Oil recovered, up 2.7%.
All focus today will be on pre-positioning ahead of US President Trump's announcing new policies related to China in response to China's decision to move ahead with national security legislation for Hong Kong. With the US possibly preparing a new trade war salvo, short-sellers are mapping headline risk strategies to ~7% US markets drawdown that occurred on the previous major trade tiff in August 2019.
Traders also have vivid memories of Trade War days past when there was a cycle of stocks selling off on lousy trade news then regaining their footing and trend back to the all-time highs. Once stocks were looking good, President Trump would have the confidence to drop another headline bomb via new tariffs. Arguably with the S&P 500 above 3000 they might look good again in the President’s eye.
The Hong Kong factor
Most commentary has focused on the trade and financial implications, but that belies the fact that a US reprisal could be potentially far more reaching than that. Indeed, there’s a can of worms just waiting to be opened.
The big risk could be from the rating agencies. If the US is now going to treat Hong Kong like any other large city in China, why should rating agencies do differently? S&P has Hong Kong rated three notches above China; Moody's and Fitch put it one notch ahead. China is still comfortably investment grade at all three, so a downgrade for Hong Kong to the Chinese sovereign ceiling would not be an immediate threat, perhaps.
But a bigger risk could be the reclassification of HK as an emerging market. Hong Kong is in the MSCI World Index, for example, along with other developed markets. China is in the emerging markets index. If Hong Kong is to be reclassified as an emerging market, along with Shanghai and Shenzhen, a huge amount of capital invested in Hong Kong will have no choice but to leave.
US markets yo-yo overnight on trade war risk
An encouraging decline in continuing claims spurred the equity market in the US morning session. US initial jobless claims slowed to 2.1mn, as expected. Still, the real news was "continuing claims” which declined for the first time since the onset of the virus crisis. With an almost four million fall during May 16 week, there’s a suggestion the negative economic knock-on effects from the pandemic are not as severe as once feared and could hold May unemployment below 20%.
Still, the shift higher in the equity market over the last couple of sessions with the wrath of Trump looming has virtually caught everyone by surprise. But there’s been a remarkable switch in leadership. In the US, by far the worst-performing sectors in the previous period were real estate, industrials and financials. In the recent period they’ve pulled away by some margin. In Europe, the three best performing sectors were in the four worst previously. The critical question is whether some stocks are cheap for a reason.
European banks might be looked at in a new light with a strong balance sheet, but in a world of flat yield curves and negative rates it’s hard to see how much catch-up they can have. It’s not that long ago the press was talking about the death of the traditional auto sector long ago and now those stock are laying rubber and ripping higher.
The stimulus factor
But despite the omnipresent US-China trade war clouds putting the brake on improving risk sentiment overnight, the extraordinary global monetary and fiscal policy stimulus efforts could protect risk assets from a more profound trade war sell-off this time around.
With the impressive level of policy support, it gets more and more challenging to argue the relevance of bankruptcy and loan default risk, or Cold War 2 risk or HK going to one system risks, or fiscal risks or even deflation risks.
The Robin Hood factor
It's ironic that an app named Robin Hood, with armies of pajama traders using simplistic "hungry hungry hippo" strategies, has forced Wall Street's most cunning, ruthless and predatory short-selling bears to bend the knee amid one of the most enduring bear market capitulations I've ever seen.
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Sometimes you have to throw conventional wisdom out the door and just let the good times roll