China might just get Donald Trump re-elected in 2020, despite the US president’s best efforts to prevent it. In the topsy-turvy world of post-global politics, Trump hailed last year’s plunge in China’s stock market as proof that his policies were working – except that the US stock market crashed during the fourth quarter.
The US president blamed the Federal Reserve, claiming that the Fed’s excess stringency had cost the Dow Jones Industrial Average 5,000 to 10,000 points. That’s not quite true: the fear of a deflationary contraction of the world economy in conjunction with tighter Fed policy was at fault.
Now China’s CSI 300 Index is up 39% year-to-date (36% in US dollar terms), triple the Dow Jones’ 13% gain. We haven’t heard any presidential tweets about that. The US market is starting to take cues from the Chinese market, and that’s good for political fortunes of the US president.
The most important development in world markets during the past 24 hours was a jump in Chinese bank H-shares. Almost all the top performers in the Hang Seng China Enterprises Index were banks and insurers, led by China Construction Bank with a one-day gain of nearly 4%.
Bank investors took heart from another month increase in the 70-cities index for new home prices, up 0.61% in March, another indicator that China’s stimulus strategy is working.
In the New York session, major indices closed virtually unchanged after a higher start, but the performance of individual sectors is nonetheless of great interest. Banks started the day lower after Bank of America warned that its net interest margin would continue to shrink. But by the end of the day, the whole bank universe had moved up in lockstep, while the most defensive sector, real estate investment trusts, fell by 2.5%.
It’s risky to make too much out of one day’s rotation, but the turnaround in the banks and the plunge in REITs both suggest that investors are repositioning for a less lugubrious market environment.
Deflation risk has dominated investor concerns since last fall. I have pointed to the relationship between commodity prices and so-called breakeven inflation (the inflation rate at which an investor would get the same return on an ordinary Treasury note and an inflation-indexed Treasury note). Late in 2018 and early 2019, 10-year breakeven inflation failed to rise with commodity prices, a divergence that bothered the Federal Reserve. It indicated that the specter of disinflation continued to haunt the market. During the past two weeks, though, breakeven inflation has converged on its long-term relationship to commodity prices.
These are green shoots, to be sure, rather than a proper spring, but they nonetheless suggest that China’s unexpected quick recovery from the slower growth regime caused by the Trump tariffs seems to have changed market expectations for the better.
As I noted yesterday, China surprised the world by managing domestic demand adroitly enough to insulate its economy against the effects of the Trump tariffs. That, in turn, is good news for the rest of the world. China accounts for more than a third of world economic growth, and a significant slowdown in the Chinese economy would send a chill wind whipping through the whole world economy. The risk of a China slowdown raised fears of deflation; now that China has proven its ability to manage through the trade war, deflation fears seem to be subsiding.
Of course, the US economy is still slowing. The latest data point came from the Federal Reserve’s industrial production index, which showed year-on-year growth of just 1% (and slightly negative 3-month growth).
The problem in the US and world economy remains lower-than-expected capital investment, despite the largest corporate tax cut in US history. That is in large part the fault of the trade war, which created uncertainty about the location of global supply chains and put CapEx on hold. The best thing Trump could do for his own re-election campaign would be to put the trade war behind him.