China's economic struggles have led its stock markets to diverge from the seemingly ever-rising US markets. This could have major reverberations across industries and global asset prices if the divergence closes.
Faltering Growth
Once posting double-digit GDP growth, China's economy has slowed to just 3% annual expansion due to its zero-COVID policies, crackdowns on big tech companies, and trade tensions with the US leading companies to move operations from China to Vietnam. Property developers and local governments face stifling debts from the infrastructure boom. With the global economy teetering towards recession, demand for Chinese goods has fallen. Copper prices, highly sensitive to economic activity, highlight concerns as prices broke long-term trend support. Efforts to stimulate growth by reducing bank reserve requirements may stoke inflation globally if successful.
Tale of Two Markets
While the S&P 500 reaches new highs, the Hang Seng index trades at 13-year lows, comparable to the 2008-9 financial crisis. Historically, declines in Chinese stocks preceded sell-offs abroad as they did ahead of market tops in 2015 and 2018. If the divergence in stock market performance closes, it likely entails US stocks falling to meet distressed Chinese stocks rather than a booming Chinese market lifting American equities.
The psychology of seeing hitherto high-flying technology names like Microsoft, Google or Apple missing earnings could shock investors accustomed to stellar performance. Even after China's central bank eased policy, stocks fell further as restrictions limiting video game approvals were unveiled. Beijing may need to get more aggressive with stimulus and ease regulatory scrutiny of internet platforms if leadership wishes to reverse the dire investor sentiment.
Commodity Complex Symptoms
Industrial metals like copper have plunged as Chinese demand slowed and fears of global recession spread. Copper prices broke long-held trendline support and failed to recover it on the latest bounce, marking a technical sign of bearish sentiment rooting. Energy commodities face crosscurrents between supply and demand factors. US oil production rose to become the world's largest while forecasts suggest slowing demand into 2023 as China struggles and recession risks rise elsewhere. Natural gas may get a brief respite from lows not seen since 2020 but lacks additional upside absent more intense cold snaps. The commodities complex warns of slowing global growth as China falters under its real estate hangover.
Cracks in Tech Armor
While Silicon Valley has powered ever higher behind strong pandemic growth and favorable Fed policy, storm clouds appear on the horizon. Already, bellwethers like Microsoft and Google parent Alphabet trimmed headcounts and the carnage may have just begun. NVIDIA, star of AI and machine learning, sees 80% profit margins that history warns can collapse under competitive pressures as happened to electric vehicle pioneer Tesla once legacy automakers responded in kind. Meta and other tech high-flyers also face this threat to stretched valuations. Much as Netflix announced strong subscriber growth, analysts suspect password sharing crackdowns boosted these numbers. Continued strength is no guarantee.
Recession Risks Loom
With tech layoffs accumulating, a global recession over the next 12 months looks more likely, especially as central banks tighten financial conditions into slowing growth. US consumers still look healthy and higher wages may keep spending afloat longer. However, the Fed has never achieved a 'soft landing', making recession odds high.
Investment Implications
Investors should temper expectations after years of outsized returns, especially in speculative tech names. Don't let recency bias cloud your judgement — review present and future risks related to earnings misses or margin pressures. China may struggle to recover swiftly, weighing on multi-national companies exposed to its consumers. Commodities outside oil also look vulnerable to demand pullbacks as growth downshifts. Late cycle conditions call for caution as euphoria gives way to concern amid tightening monetary policy and unreliable Chinese stimulus hopes. With risks outweighing potential gains, investors should consider taking a defensive posture now rather than chasing further upside.