A jolt of energy and nervousness from China
Friday’s selloff in S&P 500 futures was brutal taking the US equities down by 2.8% taking the US equity market back to levels not seen since 16 March. The selloff was unusually for the period led by commodities which were linked to increasing worries over demand from China as its zero-Covid policy is risking more lockdowns and negative impact on economic activity. These worries escalated in the Chinese session today sending the CSI 300 cash index down by 5% confirming our defensive stance we have had on Chinese equities since the Chinese technology breakdown started over a year ago. In a research note from late March we concluded that Chinese equities were not cheap despite the selloff and the lockdowns are a big tail-risk for foreign investors that are already contemplating how big the portfolio weight should be on Chinese equities going forward given the war in Ukraine. One thing is for sure, this month is becoming worse and worse for equities with only the defense theme basket being positive for the month.
China’s weakness is expressed in policy statements, but also policy actions with the latest being that Chinese banks are allowed to ease financing conditions for distressed real estate developers. In the currency market my colleagues Redmond Wong and John Hardy have recently expressed great points here and here of what is happening in China and how it relates to the currency and other markets. The market is currently saying that China’s issues is net negative for inflation in the short-term as it cools down demand for commodities, but the lockdowns also create bottlenecks and global supply constraints which are short-term inflationary, but of course not to the same degree as commodity prices themselves. However, the longer China waits in abolishing its zero-Covid policy the more the economy will need a big stimulus to recover. With the US and Europe slowing down and removing stimulus, China’s tailwind from exports will ease and a revival of the economy will have to come from domestic stimulus which could increase demand again.
With weak sentiment equities this week’s earnings releases are going to be critical for whether the market will test the March lows or it can muster a rebound. Around half of the S&P 500 market capitalization is reporting this week with US technology companies such as Alphabet, Microsoft, Meta, Apple, and Amazon dominating. As we wrote last Friday, profit margins among US large cap technology companies (Nasdaq 100) seem to be holding up despite inflation while the rest of the corporate sector is feeling the pain from rising input costs. If US technology companies as a whole this week can show that it is insulated from inflation then investors could suddenly begin treating large cap technology stocks as an inflation hedge and prop up the broader equity market while the long tail of non-technology companies will continue to suffer from inflation.
Today’s earnings from Coca-Cola and Activision Blizzard show that consumer companies such as P&G and Coca-Cola have for now the ability to pass on the rising costs. Netflix earnings showed that entertainment stocks that benefitted during the pandemic are paying back some of those gains as consumers are spending their time differently. Activision Blizzard has posted Q1 revenue of $1.48bn vs est. $1.81bn expected and adj. EPS is $0.38 vs est. $0.72 hinting potentially at more disappointments on technology earnings this week, but only time will tell.
We are also waiting for the latest update on Chicago Fed’s financial conditions index as a further push towards average financial conditions will weaken equities. The battle for Donbas in Ukraine has not yet been the source of risk investors feared but the pressure on the Russian military to deliver results by 9 May is increasing and the war in Ukraine is still a major latent tail-risk ready to show its ugly face at any time.