With COVID-19 and an openly steroid-driven (and temporary yellow-jersey) market peddling toward an ultimate Lance-like disgrace recently capturing all the headlines, it’s almost hard to remember the once omnipresent topic of the pre-pandemic trade war with China.

As of today, however, tensions with China are once again front page, and thus once again impacting headline-driven market reactions.

For veterans of the Signals Matter community, you’ve already seen our extensive reports on the tariff war here, here, here and here, so I won’t unpack every detail of our prior concerns in these paragraphs.

Lose-Lose Scenario

In summary, we’ve made a fact-based case that no one (for a host of reasons) historically wins a trade war.

This is true even if one legitimately feels such “financial combat” is otherwise merited by the undeniable and long-term bad faith (and condition) of China when it comes to IP-theft, trade imbalances and an obvious problem with market transparency.

Now, as China upsets the international order yet again by essentially robbing Hong Kong of its civil, financial, and political freedoms, the U.S. is openly threatening further measures against China and its now slave-state, Hong Kong.

Tempers Flare in DC

This week, the President’s top economic advisor, Larry Kudlow, promised that “China would be held accountable” for its freedom-killing policies in Hong Kong.

Secretary of State, Mike Pompeo, added fuel to such incendiary talk by treating Hong Kong as a vassal state no longer subject to international autonomy.

This opens the door for US sanctions aimed at Hong Kong in order to strike the financial heart of China by revoking Hong Kong’s special trading status, which once saw 45% of Chinese trade flows, and now only 12%.

This, of course, would dramatically re-orient the already fragile state of global trade and supply chains; and effectively end any hope whatsoever of a trade deal between the two largest economies in the world.

And herein lies the problem: When two economic gorillas fight, every one gets a bruise.

Mutually Assured Destruction?

Regardless of what one thinks of China or its statist nightmare of bi-polar capitalist policy run by a deranged mix of communism and fascism, trade with China, well… matters.

We need their markets, they need ours. Our companies enjoy their cheap labor (at the expense of US jobs), and their citizens enjoy and buy our widgets, which they then export back to us.

Along the way, everyone cheats, exploits and distrusts each other.

In many ways, the financial relations between China and the US are reminiscent of the political and military tensions between the Soviets and Americans during the cold war.

That is, there was an obvious recognition of mutually assured destruction (aka “MAD”) if either side pushed the proverbial “red button” when it came to nuclear war.

Ironically, when it comes to financial war, there are similar “red buttons” which both China and the US can play against each other. None of them end well.

The manners by which both nations can shoot themselves in the foot, by shooting trade bullets against each other, are myriad and obvious.

For example, if supply chains continue to erode, prices rise, which is never a good thing when global consumers (70% of global GDP) are already on their locked-down, economic knees.

And if China stops importing American agricultural commodities, this hurts Chinese bellies but also American farmers.

Similarly, given that China owns massive amounts of US Treasury debt, if Beijing decided to play hardball with DC by dumping those bonds into the open market, the impact on US Treasury yields, and hence US interest rates, would put our debt-soaked markets into a genuine hard place, prompting even more money printing to keep rates suppressed.

Such money printing, in turn, directly impacts currency markets, political stability and global trade—all badly.

As for US and global stock markets, they tend to fall when international tensions begin to rise, and already we saw a late, rally-killing sell-off on Thursday’s US exchanges as tensions with China made the latest news outlets.

Adding Insult to Injury

Such tensions, heaped upon increasing US jobless claims (2 million more were filed last week) just add more insult to the COVID injury already being played out in the US economy.

Add to that a Q1 GDP drop of 5% in the US (which marks recessionary levels) alongside escalating trade tension, the combo couldn’t come at a worse time, as companies like HP simply stop making financial projections for the year.

Meanwhile, China is no less immune from pain in this MAD setting.

Its offshore yuan just tested the weakest levels on record, an embarrassing milestone for its broken currency, although an obvious tailwind for its export advantages in the global market, assuming its economy doesn’t break down from within first.

 

Again, No Easy Answers, No Clear Winners

Stripping Hong Kong of its special status would imperil “all of the financial connectivity that China has to the free market,” said Robert Spalding, a senior fellow at the Hudson Institute in Washington. “Once that goes away, stocks, bonds, financial transactions, SWIFT…all of that is imperiled.”

Yep. No happy ending in sight for now.

The Crazy Gets Crazier and the Hope Harder to Sell

Still, uninformed investors chasing tops in that all-too-human “fear of missing out” continue to ignore such geopolitical signs in the same way they ignore economic signs, as if all the horrific data pre-COVID, mid-COVID and post-COVID weren’t horrific enough.

Despite such obvious signs of internal stress, now exacerbated by global trade tensions, the St. Louis Fed President, James Bullard, was (as usual) selling spin and hope yesterday that the COVID-beaten economy may have hit its bottom and it’s all up from here.

Such comments, much like the media hype that surrounds them, are openly shameful, for they suggest that getting back to “normal” is even “normal,” for well before the pandemic, the US was already in deep economic peril.

As always, however, the Fed and media will whistle past such inconvenient facts like US debt, the Fed’s desperate rate and printing policies or the uncertainty of further viral outbreaks.

Instead, and for the near-term, we can expect markets to continue to trade (and swing violently) upon orchestrated headlines rather than good old fashioned reality, the natural forces of supply and demand or anything close to resembling honest price discovery.

After all, most uninformed investors still believe there’s no problem a money printer can’t solve.

Europe: Picking Sides?

From my current desk in Europe, the ever-weakening body of 27 foreign ministers now finds itself caught between two angry superpowers, as well as its two largest trading partners.

Like the US, many in the EU see right through China’s espionage, political abuses, and deceptive trading practices.

At the same time, however, Europe is reticent to play hard-ball ala the US with China, as it simply can’t afford to impose anti-China sanctions which might endanger its own export deals with Beijing, all of which are critical to keeping an economically broken European Community from fully breaking apart.

In short, EU sanctions against China are unlikely given the financial Real Politik in which Europe now finds itself, especially after years of equally stupid central bank policies out of the ECB.

 

The last thing the EU needs is to be fighting a two-front diplomatic and trade war between China and the US.

What to Expect?

Increased trade tensions on top of a debt-savaged, GDP-tanking and an historically unemployed US economy is never a good thing, even as markets currently fight like mad to ignore the obvious on the backs a powerful Fed stimulus machine.

At Signals Matter, however, we don’t fight or ignore the obvious, we just follow the market signals, manage risk and beat the markets even when heavily hedged in cash. Nor will we fight the Fed, which makes shorting zombie stocks currently impossible—until signaled otherwise.

Our job is not to be bears or bulls, just blunt and rules-based.

As always, if this seems logical to you, simply join us HERE and get the portfolio you need to navigate the uncertainty and risk that just continues to grow with each passing day.

Your guides, Matt & Tom