China risks weigh on stocks, Fed meeting ahead

Morning Note

Rough day for equities: China risks to the fore at the start of the week as the fallout from the collapse of Evergrande weighed on the Hong Kong market. The Hang Seng fell 3.5%, with Evergrande down another 12%. Basic resources are feeling the heat as a slowdown in demand from Chinese property developers would be a negative. Luxury also hit – Chinese investors are seeing portfolios hammered, which means less for fur coats. Hong Kong’s weakness was all the more noticeable with Japan, China and South Korea on holiday. Spiking natural gas prices and a European energy crisis, talk of produce shortages and surging inflation don’t provide an encouraging backdrop. Meanwhile a Federal Reserve meeting this week and Sunday’s German election both offer macro uncertainty.

Contagion risks from the Evergrande meltdown are the prime cause of today’s sell-off. You’ve got all kinds of banks and insurers caught in the net but ultimately, I don’t see this as a Lehman’s moment right now. But combined with the tech crackdown it’s probably another reason why investors will be seeking to avoid China in the near term. What we are seeing today is how risks get priced gradually then suddenly. It is definitely though a major cause for investor concern right now and it is possible we see further losses before the dip finally gets bought. A market so well-conditioned to buying the dip will find it hard to resist. But the Fed meeting this week will be of particular importance – does a Chinese property collapse and energy crisis collide with expectations for a Fed rate hike next year and biting inflationary pressures? That would be a pretty nasty cocktail for risk appetite and I think these are the risks being priced into today’s (and possible further) selling.

European equities took the weak handover and limped to a decline of more than 1% in early trade. The blue-chip index is now testing its 200-day simple moving average at 6,880. Rolls-Royce and AstraZeneca gained 2% each but the rest of the board is nasty looking, led lower by basic resources and financials. Prudential fell 4% after placing 130m shares in Hong Kong following the demerger of its US business Jackson Financial. A very soft start for the DAX’s brave new world – 10 more companies added as of this morning but down more than 2% at the start of the session. Airline stocks are just about the only bright spot on the Stoxx 600 as investors bet that looser restrictions will drive up demand over the winter. Also, Lufthansa’s decision to launch a capital raise to pay back the €2.1bn state bailout it received during the pandemic is also being viewed as a positive – clearly, the company feels the medium-term prospects allow it to think about paying back the state. All sectors on the Stoxx 600 are lower.

Wall Street suffered a third straight down week, with the S&P 500 failing to hold its 50-day SMA support and declining 0.9% on Friday to 4,432.99. Futures indicate the market will open about 1% lower around 4,390. The Dow Jones industrial average was lower by 0.5% on a day of veay volume – the highest since July on quad witching day. Although the S&P 500 has traded through its 50-day SMA before and bounced in the last year, we’re dealing with a set of financial fears (China) rather than ‘concerns’ about a variant weighing on growth.

Conspiracy theory: Handy timing for Fed officials to be forced to sell their stocks a week or two ago because of ‘ethics’, not perhaps because they wanted out at the top? The Fed haters and many more think it’s more than a coincidence that their stock trading was revealed, leading to voluntary liquidation just in time to avoid a fallout. Better that than selling out at the top and people finding out later.

Metals weaker – copper down 2% and testing its 200-day SMA, gold treading water at $1,750 after last week’s steep losses, hitting its lowest since mid-August earlier this morning. Silver – once a darling of the Reddit crowd – dropped to its weakest since Nov 2020.

Natural gas prices in the US have come back after spiking last week above $5.60 – top called? Expected rise in demand going into the winter may be well priced. Remember what is happening in Europe with gas prices and the infrastructure problems are not directly correlated to the Henry Hub contract.

Natural Gas Chart 20.09.2021

The USD is finding all this risk-off sentiment a positive – fresh three-week highs for DXY. GBPUSD declined to a new three-week low at 1.36650, towards the bottom of the YTD range, whilst EURUSD is testing a 4-week low at 1.170.

GBP USD Chart 20.09.2021

Cryptocurrencies also markedly weaker on the general risk-off liquidation we are seeing across global markets. Bitcoin took a leg lower in early European trade and may want to test the Sep 13th lows around $44k.

Bitcoin Chart 20.09.2021

Little in the way of data today so all the China contagion/fallout stories will be the prime driver of sentiment. Looking ahead we have the Federal Reserve meeting on Wednesday – key question is whether it announces plan to taper QE or sits on its hands a little longer. But actually, the key risk lies in what the dots (if you still look at them) tell us about when Fed policymakers (increasingly hawkish?) think the lift-off date for rate hikes will be. Meanwhile, the Bank of England will need to respond to biggest jump in inflation on record when it convenes this week. Does is call time on QE now and prepare the market for a rate hike soon? Surging inflation is not going away and the MPC risks all kinds of trouble by not administering some medicine early.