Deconstructing Evergrande’s effect on China

Elliot Clarke at Westpac says that China will be able to withstand the shock of Evergrande’s collapse and that power outages are a bigger threat.

We still think that the property sector contagion is part of a broader issue that China will struggle to overcome, as Michael Pettis succinctly explained:

China’s debt problem

Tweeted by Prof. Michael Pettis:

In the past — e.g. the SOE reforms of the 1990s, the banking crisis of the 2000s, SARS in 2003, the collapse of China’s trade surplus in 2009, COVID, etc. — whenever China faced a problem that threatened the pace of its economic growth, Beijing always responded by accelerating debt creation and pumping up property and infrastructure investment by enough to maintain targeted GDP growth rates. It didn’t adjust, in other words, but rather goosed growth by exacerbating the underlying imbalances.

That is why it had always been “successful” in seeing off a crisis. But when the main problem threatening further growth becomes soaring debt and the sheer amount of non-productive investment in property and infrastructure, it is obvious, or should be, that accelerating debt creation and pumping up property and infrastructure investment can no longer be a sustainable solution. All this can do is worsen the underlying imbalances and raise further the future cost of adjustment.

What would Putin do?

The Communist Party of China has an unwritten contract with the 1.4 billion people living under its rule: they will tolerate living under an autocratic regime provided that the CCP delivers economic prosperity. So far the CCP has delivered in spades. A never-ending economic boom, fueled by exponential debt growth as investment in productive infrastructure grows ever more challenging.

But they are now familiar with the law of diminishing marginal returns: governments can’t just keep spending on infrastructure without falling into a debt trap. All the low-hanging fruit have been picked and new infrastructure projects offer lower and lower returns as spending programs continue.

That was probably the primary motivation for the CCP’s Belt-and-Road Initiative (BRI): to source more productive infrastructure investments in international markets. But the COVID-19 pandemic brought the BRI to a shuddering halt and the CCP is unlikely to maintain its exemplary growth record — no matter how much they fudge the numbers.

Xi Jinping is faced with an impossible task: how to placate 1.4 billion people when inflation sends food prices soaring and ballooning debt precipitates a sharp rise in unemployment and falling wages. The CCP has been preparing for this very eventuality for some time. Investing billions in surveillance and social credit systems, brutal crackdowns on religious organizations and minorities, suppression of democratic forces in Hong Kong, the latest take-down of tech giants — Jack Ma’s Ant Group and Tencent Holdings — which could form a focal point for democratic opposition, and beefing up internal policing. These are not the whims of an autocratic regime but a desperate attempt at self-preservation. China’s internal security budget is even bigger than its military budget (WION).

Xi Jinping

Behind that inscrutable facade, Xi Jinping is a worried man. Even with all the technology and forces of suppression at his disposal, confronting an angry population of 1.4 billion people is a daunting task. In his darkest hours he must have asked himself the question: WHAT WOULD PUTIN DO?

Even if you don’t believe the RT hype of the bare-chested deer hunter, judo expert and chess grandmaster — a combination of Chuck Norris and Garry Kasparov — you have to give Vladimir Putin credit for surviving 20 years as the head of a murderous regime where only the strong and completely ruthless stay alive.

Vladimir Putin

What would Putin do? The answer must have hit Xi Jinping like a 500 watt light bulb: INVADE CRIMEA. Vladimir Putin enjoyed record popularity at home (if you can believe Russian opinion polls) after invading Crimea. Despite the economic hardships that the Russian people had to endure from Western sanctions. The only force more powerful than hunger is a wave of patriotic nationalism.

Now being the canny fellow that he is, Xi figured that Crimea was too far away to be much use. Luckily for him, there is a handy substitute. An island of 23.5 million inhabitants, living under a democratically-elected government, only 180 kilometers away, across the Taiwan Strait.

Conclusion

We expect the CCP to fuel a wave of nationalist fervor to distract the 1.4 billion people living under their harsh rule from the economic hardships they are about to endure. Conflict over Taiwan is an obvious choice.

At present the PLA is conducting daily incursions into Taiwanese airspace, to map ROC air defense systems and wear down defenders with “response fatigue”.

ROC Reports Incursion by 28 PLA Aircraft

The CCP would not want to interfere with the Beijing Winter Olympics but may use it as a distraction — straight out of Putin’s playbook.

Melik Kaylan at Forbes:

I can say one thing about Vladimir Putin without fear of contradiction: he cares about timing. When he’s up to no good, he loves a sleight-of-hand distraction in global headlines. In 2008 [invasion of Georgia], the Beijing summer Olympics served as cover. More recently, the Sochi Winter Olympics ended just three days before Russia marched into Crimea.

Notes

  1. The 2022 Winter Olympics — also known as Beijing 2022 — is scheduled to take place from 4 to 20 February 2022.

The Coronavirus Threat

Spread of the novel coronavirus (2019-nCoV) is a “global health emergency” according to the World Health Organization (WHO). Restricted travel is already having an impact on the global economy, with Goldman Sachs anticipating a 0.4% fall in U.S. annualized GDP growth in the first quarter.

Imperial College in London estimates a dangerously high transmission rate for the disease:

Self-sustaining human-to-human transmission of the novel coronavirus (2019-nCov) is the only plausible explanation of the scale of the outbreak in Wuhan. We estimate that, on average, each case infected 2.6 (uncertainty range: 1.5-3.5) other people up to 18th January 2020, based on an analysis combining our past estimates of the size of the outbreak in Wuhan with computational modelling of potential epidemic trajectories. This implies that control measures need to block well over 60% of transmission to be effective in controlling the outbreak….

Johns Hopkins University CSSE reports 11,374 confirmed cases with 259 deaths and 252 recoveries as of 7.00 p.m. on January 31, 2020. Growth of the  number of reported cases in Mainland China appears linear, with an increase of 1,700 per day.

JHU CSSE 2019-nCOV spread

That seems highly suspicious when one compares to mathematical modeling and to social media reports from medical staff on the ground. Contagion rates are likely to grow exponentially, rather than in a straight line, and will only peak when authorities are able to bring the transmission rate below 1.0 (compared to the 2.6 posited by Imperial College).

A report in the Epoch Times suggests that Chinese public health authorities have suppressed the reporting of confirmed cases:

“The outbreak of Wuhan coronavirus is far bigger than the official figures released by Chinese public health authorities who cover up the severity by limiting the number of diagnosis kits to Wuhan hospitals, according to an insider and an independent journalist.

The insider and the independent journalist both say that diagnosis kits are only provided to certain ‘qualifying hospitals’ and in very limited quantities. Medical personnel at these hospitals have said that the number of kits they are supplied is less than 10 percent of what they need to test patients.

Now these hospitals claim that their responsibility at present is to provide treatment only, and they will not perform any diagnoses.”

UK researcher Jonathan Read projects that the epidemic in Wuhan will reach 191,529 by February 4 (prediction interval 132,751-273,649). Chart A shows total number of infections in black and new infections per day in red.

2019-nCOV predicted infection rate - Wuhan

2019-nCOV predicted infection rate - Mainland China

Restriction of road, rail and air travel to/from Wuhan is expected to achieve between 12.5% and 25% reduction in cases in the above areas.

2019-nCOV predicted infection rate - World

Importations into other countries may also be slowed by travel restrictions.

Mortalities are not limited to young children and the elderly and infirm as with most influenza viruses. Healthy adults, including health care workers, are dying. Reported recoveries (252) are low and provide an indication as to the severity of the infection.

Modelling suggests that the number of cases will double every seven days until it peaks. The peak number of cases will depend on how long it takes to contain the outbreak. Another four weeks would pose a serious threat to the global economy.

Where Fortune is concerned: she shows her force where there is no organized strength to resist her; and she directs her impact there where she knows that no dikes and embankments are constructed to hold her. ~ Niccolo Machiavelli, The Prince (1532)

Cracks are showing in China’s Debt Markets

“You only learn who has been swimming naked when the tide goes out…” ~ Warren Buffett

Beijing’s de-leveraging campaign, to set the economy on a sustainable path, is starting to expose some of the excesses in financial markets.

Local Government

Local governments owe some 49 trillion yuan (about $7 trillion or 50% of China’s GDP) in off-balance-sheet debt through local government finance vehicles (LGFVs). LGFVs generate no income themselves and are reliant on revenue flows from the city government to service the debt. Local governments in the past generated substantial revenue through land sales but dwindling sales make debt servicing a challenge. Many LGFVs are experiencing cash flow problems and have resorted to borrowing in shadow finance markets to meet their commitments. Interest rates are close to 10% and will simply accelerate the inevitable implosion.

This map from Rhodium highlights the most severely affected LGFVs, where debt in some cases exceeds 30 times local government revenues:

China: City Level Financial Stress

China’s Ministry of Finance (MOF) is attempting to keep a lid on the problem, offering long-term low interest loans from China Development Bank to repay shadow financing. Zhenjiang, an eastern city of Jiangsu province was one of the first beneficiaries, in March 2019. But debt substitution merely prolongs the crisis unless the city can sell off marketable assets to repay debt. Marketable assets which are, in many cases, proving hard to find.

This detailed report from Rhodium examines the problem.

State-owned Enterprises (SOEs)

We are also witnessing a $1.25 billion default by local government-owned Tewoo Group:

“China’s Tewoo Group has forced investors to take losses on a US dollar bond, marking the largest failure to repay dollar debt by a state-owned company in two decades….The commodities trader, which is wholly owned by the city government of Tianjin, completed an exchange offer this week that made investors take significant discounts on their holdings in the company’s debt.”
“The offer was ‘tantamount to a default’, S&P Global Ratings said on Thursday.” ~ FT.com

Based out of Tianjin, Tewoo is a bulk trader of commodities such as metals (ferrous & nonferrous), energy, minerals and chemicals….

In 2017, it had a turnover of $66.6 billion with profits of $122 million and was ranked 129th in the Fortune Global 500 list & 28th in the Chinese enterprises list. The company employs more than 19,000 professionals and has operations across the US, Germany, Japan and Singapore.

Tewoo’s financial challenges are closely linked to Bohai Steel Group, a business associate which has filed for liquidation due to high leverage. Bohai’s bankruptcy in 2018 triggered systemic risk in Tianjin’s financial market and Tewoo has been facing serious liquidity challenges in recent months. ~ MoneyControl

Bank Bailouts

Many small and medium-sized banks are overly reliant on wholesale markets for funding and tightening credit has left them high and dry.
Barclays Research highlighted a number of banks that had failed to submit their 2018 annual reports on time (source Zero Hedge/Macrobusiness):

China: Troubled Banks

  • Baoshang Bank underwent a state takeover in May.
  • Bank of Jinzhou was taken over by state-owned strategic investors in July.
  • Heng Feng Bank was taken over by China’s sovereign wealth fund in August.
  • Troubled Anbang Insurance Group is selling a 35% stake in Chengdu Rural Commercial Bank to “an investment firm owned by the southwestern city of Chengdu.” (Caixin)

While, according to Caixin:

“China’s Hengfeng Bank will raise 100 billion yuan ($14.21 billion) through a private placement to a group of state and foreign investors…..The troubled Shandong-based lender will issue 100 billion shares, Hengfeng said Wednesday in a statement.”

Foreign investment is simply window-dressing, with Singapore’s United Overseas Bank subscribing for 4% of the new issue. Probably with a “put” on the other state-owned purchasers.

“The bailouts for China’s troubled small banks roll on……China’s sneaky system-wide bank bailout is well underway.” ~ Trivium China

Efforts by Beijing to curb exponential debt growth are praiseworthy, but are likely to come at a substantial cost. Expect GDP growth to slow and gradual “Japanification” as the state attempts to avoid hard choices, supporting the continued existence of “zombie” companies ……and sclerosis of the Chinese economy.

China: Exports fall despite weaker Yuan

Reuters says that export orders are falling and the contraction is expected to worsen in coming months:

Beijing is widely expected to announce more support measures in coming weeks to avert the risk of a sharper economic slowdown as the United States ratchets up trade pressure……

On Friday, the central bank cut banks’ reserve requirements (RRR) for a seventh time since early 2018 to free up more funds for lending, days after a cabinet meeting signaled that more policy loosening may be imminent.

August exports fell 1% from a year earlier, the biggest fall since June, when it fell 1.3%, customs data showed on Sunday. Analysts had expected a 2.0% rise in a Reuters poll after July’s 3.3% gain.

That’s despite analyst expectations that a falling yuan would offset some cost pressure and looming tariffs may have prompted some Chinese exporters to bring forward or “front-load” U.S.-bound shipments into August, a trend seen earlier in the trade dispute…..

Among its major trade partners, China’s August exports to the United States fell 16% year-on-year, slowing sharply from a decline of 6.5% in July. Imports from America slumped 22.4%.

Many analysts expect export growth to slow further in coming months, as evidenced by worsening export orders in both official and private factory surveys. More U.S. tariff measures will take effect on Oct. 1 and Dec. 15.

Banks are suffering a liquidity squeeze:

The PBoC says the new cuts will release RMB 900 billion of liquidity. That’s more than the RMB 800 billion and RMB 280 billion released by the January and May cuts, respectively. (Trivium China)

Consumer confidence is ebbing.

Google Searches for Recession

China’s response to tariffs has annoyed the Trump administration, making prospects of a trade deal even more remote.

China’s response to U.S. trade actions appears to reflect a cynicism about the efficacy of democracy. Beijing’s strategy appears calibrated to exploit the fact that the American people elect the head of their government, by attempting to influence how the American people will vote. In effect, it seems to be gambling on its ability to turn American democracy against itself.

At the center of China’s responses are the tit-for-tat tariffs intended to hurt American farmers, a constituency that tends to support President Donald Trump and to live in crucial swing states. These tariffs appear designed to deliver political pain in the U.S., not to produce any economic benefit for China. China’s other political meddling, as Vice President Mike Pence recently laid out, includes attempts at interference in the 2018 U.S. midterm elections. Recent targets of Chinese Communist Party influence campaigns also include state and local governments, Congress, academia, think tanks, and the business community. (The Atlantic)

A massive increase in stimulus is the likely eventual outcome, focused on housing and infrastructure. That would fuel demand for raw materials such as iron and steel.

If not, expect a sharp drop in imports to impact on China’s major trading partners.

Australia: The elephant in the room

June quarter real GDP growth slowed to an annual 1.4%, the lowest since the 2008 global financial crisis (GFC). Major contributors to growth are household consumption, public demand and exports; while the biggest handbrake is investment.

Australia: GDP

A quick look at the RBA chart shows that consumption is slowing but at a slower rate than disposable income. Households are dipping into savings to support consumption, with the savings ratio (savings/disposable income) declining to near GFC lows.

Australia: Disposable Income, Consumption and Savings

Gerard Minack warned of the danger that households will dramatically increase savings, and cut consumption, if employment prospects grow cloudy.

That brings us back to investment. Low investment is a drag on employment growth.

Australia: Job Ads

Low interest rates, on the other hand, are a tailwind at present. They seem to have shored up housing prices,

Australia: Housing

And states are taking advantage of ultra-low interest rates to boost infrastructure spending.

But low interest rates are a double-edged sword. Bank net interest margins are under pressure.

Australia: Bank Net Interest Margins

And credit growth is plunging.

Australia: Credit Growth

The housing recovery will be short-lived if there is not a dramatic increase in loan approvals.

Australia: Housing Loans

AMP chief economist Shane Oliver believes that:

“growth will remain soft and that the RBA will have to provide more stimulus – by taking the cash rate to around 0.5% and possibly consider unconventional monetary policy like quantitative easing. Ideally the latter should be combined with fiscal stimulus which would be fairer and more effective. While Australian growth is going through a rough patch with likely further to go, recession remains unlikely barring a significant global downturn.”

But that ignores two factors:

  1. increased pressure on bank net interest margins from lower interest rates; and
  2. the elephant in the room: China.

China: Activity Levels

China’s economic model is built on a shaky foundation and trade war with the US is likely to expose the flaws.

Chinese leaders are growing increasingly worried about the economy. Premier Li Keqiang said at this week’s State Council meeting:

“The current external environment is increasingly complex and grim.
….Downward pressure on the domestic economy has increased.”
(Trivium)

Twitter: Simon Ting

BEIJING, Sept. 5 (Xinhua) — Chinese and U.S. chief trade negotiators agreed on Thursday to jointly take concrete actions to create favorable conditions for further consultations in October.

The agreement was reached in a phone conversation Chinese Vice Premier Liu He, also a member of the Political Bureau of the Communist Party of China Central Committee and chief of the Chinese side of the China-U.S. comprehensive economic dialogue, held upon invitation with U.S. Trade Representative Robert Lighthizer and Treasury Secretary Steven Mnuchin. (Xinhua)

…Extend and pretend. Neither side wants a full-blown trade war. But they are miles away from an agreement.

Hope is not a strategy

Bob Doll’s outlook this week at Nuveen Investments is less bearish than my own:

Trade-related risks seem to be growing. President Trump looks to be holding out hope that the U.S. economy will stay resilient in the face of escalating tariffs and rising tensions. So far, the U.S. economy has not faltered, thanks largely to continued strength in the consumer sector and labor market. But if business confidence crumbles (as it has in parts of Europe), it could lead to serious economic damage…..

The president’s recent actions to delay the implementation of some new tariffs show that he is sensitive to the market impact of his trade policies. But the erratic nature of his on-again, off-again approach adds too policy uncertainty. At this point, we can’t predict the ultimate economic impact from these issues. Our best guess is that the U.S. remains more than a year away from the next recession, but risks are rising. In addition to the solid consumer sector, we don’t see financial stress in the system. Liquidity is still broadly available, and fixed income credit spreads are generally stable outside of the energy sector.

With additional Federal Reserve rate cuts already priced into the markets and bond yields falling sharply, the only catalyst for better equity market performance could be improving global economic data. We hold out hope that the global economy will improve, and still think there is a better-than-even chance of manufacturing activity and export levels to grow. But those improvements will take some time, suggesting equities will remain volatile and vulnerable for now.

Where we seem to differ is on the inevitability of the US-China trade war escalating into full-blown disengagement. This week’s events have not helped.

China’s national English language newspaper, Global Times, under the People’s Daily, announced new tariffs.

Global Times

Followed by an admission that the timing of the announcement was intended to cause maximum disruption to US stock markets.

Global Times

The inevitable Twitter tantrum ensued.

Donald Trump

The President also tweeted “Now the Fed can show their stuff!”

He is deluded if he thinks that the Fed can help him here. The best response would be announcement of a major infrastructure program (not a wall on the Mexican border). Otherwise business confidence will decline due to the increased uncertainty. Business investment will contract as a result and slow employment growth.

Retail sales have shown signs of recovery in recent months but will decline if consumer confidence erodes.

Retail Sales

Especially consumer durables such as light motor vehicles and housing.

Consumer Durables Production

The global economy is already contracting, as indicated by falling crude oil

Nymex Light Crude

…and commodity prices.

DJ-UBS Commodity Index

Volatility (21-Day) is rising as the S&P 500 tests support at 2840. Breach is likely and would test primary support at 2750.

S&P 500 Volatility

Bearish divergence (13-Week Money Flow) on both the S&P 500 and Nasdaq 100 (below) warn of selling pressure. The Nasdaq 100 is likely to test primary support at 7000.

Nasdaq 100

The Russell 2000 Small Caps ETF (IWM) is testing primary support at 146. Follow through below 145 is likely and would signal a primary down-trend.

Russell 2000 Small Caps ETF

Fedex breach of support at 150 would also warn of a primary down-trend and slowing activity in the US economy.

Fedex (FDX)

We maintain our bearish outlook and have reduced equity exposure for international stocks to 40% of portfolio value because of elevated risk in the global economy.

Gold spikes as Yuan falls

China has broken its unwritten guarantee that the PBOC will maintain the Yuan below 7 to the US Dollar. Official fixings for USDCNY crept above 7.0 this week, indicating the PBOC is no longer prepared to support its currency.

USDCNY

This is a two-edged sword. While it makes exports cheaper, counteracting the effect of US tariffs, it makes imports more expensive, spiking inflation. It is also likely to spark capital flight, as evidenced by the sharp spike in Gold.

Spot Gold broke resistance at $1450, surging to $1500/ounce. A narrow consolidation at $1500 is likely, signaling further gains. The Trend Index trough above zero indicates strong buying pressure.

Spot Gold in USD

The next major resistance level is the 2012 high of $1800/ounce.

ASX 200: Don’t ignore the headwinds

The ASX 200 is advancing to test its all-time (2007) high at 6830, having respected its new support level at 6350.

ASX 200

Shane Oliver, AMP economist, argues that an Australian recession is unlikely as the economy has tailwinds as well as headwinds:

  • mining exports have surged on the back of strong iron ore prices, narrowing the current account deficit;
  • a falling Aussie Dollar will act as a shock absorber to stabilize the economy;
  • the Australian government has strong capacity to stimulate the economy, through tax cuts and infrastructure spending;
  • house prices may be falling but there is no panic selling; and
  • the RBA has further capacity to cut rates if necessary.

The tailwinds can be summed up in two words: iron ore. Without high ore prices, our current account deficit and fiscal deficit would be much larger, limiting the ability of government to stimulate the economy.

Australian headwinds, on the other hand, can be summed up by one words: jobs. High ore prices do not create many jobs.

Job growth is falling and unemployment is expected to rise.

Low jobs growth is eroding consumer confidence, flagged by falling spending on durables such as motor vehicles.

ASX 300 Autos & Components

And housing.

House Prices

The critical question is: will the iron ore tailwind last long enough to save the Australian economy from recession?

High iron ore prices are unlikely to last long. From Reuters on Thursday:

Mining giant Rio Tinto on Thursday lowered its guidance on volumes of iron ore it expects to ship from the key Pilbara producing region in Australia for the third time since April, citing operational problems.

The guidance cut came just hours after Brazilian miner Vale, the world’s No. 1 iron ore producer, said late on Wednesday that it will fully resume Brucutu operations within 72 hours, after a favourable ruling from an appeals court…..Brucutu, which has been operating at only a third of its capacity, was shuttered in February as Vale’s mine operations came under close scrutiny after a tailings dam collapsed in Brazilian town of Brumadinho, killing more than 240 people…..The full operation of Brucutu “should help alleviate concerns about tightness in the market,” said ANZ Research analysts in a note. “However, issues at Rio Tinto’s operations suggest the market still has some challenges ahead.”

Rio Tinto said it now expects shipments from Pilbara at between 320 million tonnes and 330 million tonnes, mostly lower-grade and lower-margin product. Its previous target was between 333 million tonnes and 343 million tonnes.

Vale at the same time reaffirmed its 2019 iron ore and pellets sales guidance of 307 million to 332 million tonnes, saying sales should be around the midpoint of that range, instead of the low end of the range as previously expected.

Chinese steel production is strong.

China Output

Housing construction is rising.

China Housing

But rising housing inventories warn that construction is running ahead of demand, which is likely to exert downward pressure on prices.

While Chinese automobile production is faltering. From WSJ:

Auto sales in China declined for an 11th straight month in May, with the slump in demand showing no sign of easing and the country’s automotive industry bracing for losses tied to new emissions standards.

Sales for the latest month fell 16% from a year earlier, to 1.91 million vehicles….

I am not sure how long the iron ore shortfall will last but I wouldn’t bet on high prices by the end of the year. Nor would I bet on the G20 meeting between Donald Trump and Xi Jinping resolving US-China trade differences.

That leaves uncertain tailwinds and far more certain headwinds.

If earnings undershoot, stocks will fall

Annual employment growth is falling while average hourly earnings growth remains high. This is typical. Ahead of the last two recessions (gray bars below), average hourly earnings growth (green) held steady while employment growth (blue) declined.

Employment Growth & Average Hourly Wage Rate

If annual employment growth (blue line on the above chart) falls below 1.0% then a Fed rate cut is almost guaranteed. Not something to celebrate though, as the gray bars and further job losses illustrate.

Declining growth in hours worked points to lower GDP growth in the second quarter.

Real GDP & Hours Worked

From Bob Doll at Nuveen:

“China is taking a tough stance toward the U.S. on trade. Chinese officials appear open to ongoing negotiations, but a recently released statement denies the country’s role in intellectual property theft, blames the U.S. for negotiation breakdowns and calls out the damage done to the American economy as a result of the dispute. All of this suggests that trade issues will persist for some time.”

The CCP is upset that they are now being called out for bad behavior when this should have been addressed years ago. Conflict can no longer be avoided and is likely to last for a generation or more.

“On Monday, US President Trump told reporters that he would impose tariffs on an additional USD 300 billion of Chinese goods if Xi Jinping doesn’t meet with him in Japan.” ~ Trivium China, June 12, 2019

Trump is doing his best to kill any chance of a trade deal. He is making it impossible for Xi to turn up for a G20 meeting. Kow-towing to Trump would totally undermine Xi’s standing in China.

Xi wants a trade deal that is a handful of empty promises, so the CCP can continue on their present course. The US wants an enforceable undertaking, so that the CPP is forced to change course. Chances of both achieving what they want are negligible.

Both sides need to guard against economic war (time to call it what it is) slipping into a full-scale conflict. All it takes is a spark that sets off tit-for-tat escalation where neither side will back down.

Proxies such as North Korea, Syria and Pakistan are especially dangerous as they are capable of dragging great powers into direct confrontation (think Serbia before WWI, Korea after WWII).

Wannabe great powers like Russia will also do their best to foment conflict between their larger rivals. Stalin achieved this with the Korean War in the 1950s and Vladimir Putin is more than capable of attempting the same. The world is a dangerous place.

Upside potential for stocks is declining while downside risks are growing. Investors are flowing out of equities and into Treasuries despite minimal yield (10-year yield is negative after inflation and tax).

Stocks are being supported by buybacks but that can only continue for as long as cash flows (from earnings) hold up. Buybacks plus dividends for the S&P 500 exceeded reported earnings by more than $100 billion in Q4 2018.

S&P 500 Buybacks, Dividends & Reported Earnings

That is unsustainable. If earnings undershoot, stocks will fall.