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Moving past the edge of reason, China government sanctionned rally

The situation is excellent. The market is rallying led by a government sanctioned rally in China. Our constructive thesis is validated after a period of noise in the equity market led by a US spike in Covid-19 cases. This is excellent and precisely why we need to worry.

The last phase of a rally is one of euphoria with blinders on dismissing negative data such as Goldman Sachs’ downgrade of US growth expectations and high cross asset correlation either in clusters, pair trades or more broadly across asset classes. The underlying question is can the US stream of dividends, buybacks and price expectation match the potential in national profit (NIPA) projections. It is a bit like Purchasing Power Parity in currencies. It assumes a world without risk and without default where all maintain their profit shares - the growth style by definition contradicts it. I would venture that with lower structural growth, a higher debt burden leading to higher taxes, that this NIPA path grows at a slower rate which means lower “highs” in say the S&P500. NIPA profits have been stable for a few years before declining sharply recently which means that hope in the future has been the main guide for the S&P500. At one point, we should get a reckoning and that should be past the next 6 weeks or so ahead of the usual dread of September and October when markets become extremely jittery, would it only be because of history.


Slide we shall with risk, but the tide brings with it all boats and we continue to maintain that fundamental analysis of balance sheets and business models including onsite visits and engaging are now of paramount importance. One example of this is the sharp rise of Shopify which sounds like Spotify. There may be more than one Wirecard around and there may be a gradation of such business models. To prepare for the eventual shift in the market, we would favor covered bonds, very long duration US fixed income (it does exist), managed credit in the US and EU which might see some volatility but then revert, and flexible solutions either through automated re-allocation across asset classes or through portfolio managers. The art is to understand the regime in which you dance and the one you are set to slide into. Dance we shall, but without blinders as we approach slowly the edges of common sense. We maintain our four key themes: 1. ESG 2. Climate/Green 3. Rise of China 4. Opportunities in credit space.

China government sanctioned rally

Chinese commentators linked to the government have oft given key indications on the market that the market typically follows and hence equity markets have rallied around 5.7% following positive comments on such a “healthy” rally. This comes amid high turnover and a sharp increase in mentions of a “bull rally” online (Bloomberg News). Few expect a return of the debt fueled bubble and crash of 2015. Nonetheless, we maintain our view of a China led rebound and recent official economic data has been encouraging as has high frequency data. One important piece of data this week is inflation which has been declining for a few months after Covid-19 hit it. The CPI index is a reliable indicator and if inflation slows down more than expected, the PBoC is likely to ease again. The PBoC has preferred forced liquidity injections to changing interest rates worried likely of a bubble in equities or the real estate market. If it does ease, it should be a strong sign that they are more pessimistic on growth rather than some mild tweaking.


We maintain our case of a China led rebound propagating to the rest of Asia Pacific in the coming weeks and months.

Sébastien Galy , July 2020

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