Viral Thinking

A new virus is attacking China - CPC over-reach. DiDi is doo-doo, Baba is bye-bye and Tencent is the new target price instead of the corporate name. Chinese equity prices are getting crushed. Could this virus, like Covid-19 before it, ultimately arrive on our shores?

The Chinese Communist Party is actively reversing years of laissez-faire governance over the most successful companies in its economy. They are moving to limit corporate power over data and financial intermediation in an effort to maintain control of the hearts and minds of their populous. This stunning reversal may have broader implications for the global economy down the road, but for now, the U.S.-centric narrative of ever-higher equities prices seems unaffected.

If data is the new currency of the political economy, the loss of control over that resource is threatening to governments around the world. When your cell phone provides more information about an individual's life than the sum of all the census and registration systems such as driver's license and social security files, you can see the problem. The lax rules around the use of un-permissioned data - mostly location and search-based - is a free pass to those seeking monetary and political gain at the expense of personal freedom.

In a closed political system, like China, that threat is existential. They cannot lose their grip on a wide swath of the economy in their rigid command and control economic model. In the more progressive OECD countries - what was once called the 'Free World' - there is a more nuanced effect. Depending on your political persuasion, the market power of the monopolistic mega-cap companies that control the vast torrents of data on individuals' behaviour is both a competitive advantage and a target for political interference.

Ultimately the effect of this on the economy is disinflationary, but risk assets initially benefit through the mechanism of lower discount rates. A slower growth rate that will result from this defacto deglobalization following China's shocking clamp-down, is reinforcing a downward adjustment in growth expectations that was already underway. Risks to those companies who are perceived, rightly, or wrongly, to exert their market dominance through the use of consumers' personal information are now growing.

Who among us hasn't experienced a 'creepy' feeling when seeing an advertisement for a product pop up on their screen that seems clairvoyantly prescient. If you 'google' an item, it triggers a series of events amongst companies in the data-verse that instantly attempts to monetize your query. How did the music site, Reverb, know I covet a 1961 Gibson ES-335 that I 'liked' on Twitter, and promptly offers me a chance to buy one for a measly $30k? I feel a bit violated by that level of targeted data mining, but you gotta admit it's a clever way to market your wares.

Gratuitous Photo of my Dream Guitar

How this plays out over the next few years is above the pay grades of most market forecasters, not just mine. Governments, both free and closed, are under threat from a new form of libertarianism that seeks to prevent their control over their constituents and the dynamic economies in which they participate. Bitcoin and the fintech disrupters have quickly generated a competitive response from governments in the form of CBDC (Central Bank Digital Currency). Other responses in the form of antitrust and regulatory oversight are likely to target many of the digital economy success stories. Predictably the new 'Robber Barons' like Jeff Bezos, Elon Musk and Tim Cook are easy targets. Bezos last week blurted out his 'inside thought' that his recent vanity trip to space was funded by his employees and customers - "You paid for it!" That type of cavalier attitude towards his less fortunate constituencies will come back to haunt him.

I'm not arguing for a market sell-off in response to these developments. The Fed is still fully in charge of the markets. They must be gleefully patting themselves on their backs after the recent bond market validation of their 'transitory inflation' call. And as I have argued recently, the mini-rotations between growth and value styles have successfully underpinned this modestly rising equity market. The recent slowing of expectations for economic growth rates is likely to, perversely, extend the bull market. The consequent pushing-out of the Fed's inevitable monetary tightening has effectively silenced the 'correction camp' for now.

The recent choppy market action is typical of a summertime environment. Upcoming earnings are likely to continue to help back-fill the valuation gap that was generated by the TINA-induced move in equities that began last November. Equity risk premiums are comfortably higher than just six weeks ago through a combination of lower bond yields and higher earnings expectations (chart below courtesy J Aitkens - TD Securities). Although the recent data show outflows equities have reduced risk asset exposure, they have been absorbed without any major market disturbance.

S&P500 Equity Risk Premium

So the 'governance virus' that is now raging in China is a potential threat to certain market-dominant companies and their control over their customer's data. I only point this out as an additional reason (on top of lofty valuations) to prefer value stocks for the next phase of the bull market. We just need to get a bit further into the global re-opening of the economy to see that leadership change reassert itself.

Risk Model: 3/5 - Risk On

The model is once again happy with only a pullback in AAII Sentiment and an overbought 200dma signal in negative positions. Although the recent 'drop and bounce' action in the averages has once again frustrated the market-timers like me, it is what it is. Earnings seem to be likely to support the market that is exhibiting an 'if it ain't broke ...' approach. That being said, the market - growth stocks in particular - has run up into these reports, increasing the chance of a small sell-on-news pullback.

The Copper/Gold ratio is exhibiting signs of a renewal in economic momentum that is hard to validate by any real-world data set. Is it simply a reflection of the failure of Gold to garner traction in the face of a risk-off bid to the U.S. dollar? Is Copper bouncing temporarily from short-term supply fears after the flood in Hunan Province? Is the good Doctor Copper seeing things that the bond market doesn't? We don't know but a timely repurchase of $FCX last week has me smiling now.

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