Market Comment: September 24th

Free tickets on a Chinese roller coaster. Who's in?

We've often stated that markets can correct 10% at any time for any reason. Even during bull markets.

The ugly start to this week's stock market was largely attributed to continued bad news from one of China's largest private lenders, Evergrande Group, suggesting the indebted property buying frenzy hit unsustainable levels. The Chinese government's "Three Red Line" policy has encouraged deleveraging across the corporate sector; however, Evergrande's debt burden proved unsustainable, and there are indications the government is unlikely to bail out the real estate developer. To avoid moral hazard, Beijing may let Evergrande shareholders and bondholders absorb the losses, warning local officials across China to prepare for a 'possible storm'.

But markets found their footing mid-week as market participants gained a better understanding of the risks associated with Evergrande's potential failure. Foreign investors hold ~US$18 bln in offshore debt, the majority of which is held by well-capitalized banks. About 50% of Evergrande's commercial loans are backed by collateral, which will help Chinese banks recover losses. The government's priority has turned to ensure Evergrande day-to-day operations continue to limit the impact on the housing market and consumer confidence. While Evergrande will remain in the headlines, markets, for now, appear to have digested the potential adverse outcomes. Adding to the uncertainty has been the corollary prospect of the Chinese economy slowing, which suggests the Chinese central bank may begin easing monetary conditions.

Cryptocurrency landscape fell hard as well, with bitcoin itself down almost 9% on Monday and many mining stocks falling as much or more. Not helping the matter was China's central bank announcing that all transactions of crypto-currencies would be made illegal, effectively banning digital tokens. The joke crypto dogecoin crashed 12%. That's no joke. 

Nostalgia never remembers completely

It’s not fun watching markets correct but we take some solace knowing the worst factors that contributed to the downside turbulence of late were all based overseas. When the issues are homegrown, watch out. But China’s problems have little to do directly with North America investors. There is a major political shift whereby their current leader, XI Jinping (pronounced “she”), appears to be angling to break with over 40 years of tradition and precedent of no leader exceeding two terms. This practice started with Deng Xiaoping who came to power in 1978 after years of Chairman Mao’s rule. 

Mao, a man of little modesty, exhibited some of the worst central planning disasters in history. The “Great Leap Forward” was an attempt to move from an agrarian economy run by private ownership to one run by the collective and central planners. Instead of increasing food production, it caused tens of millions of deaths in the largest famine in human history.

A key to that disaster was the banning of private agriculture in favour of a communist-style industry. Seeing China’s leader today dress up in a Maoist suit, limiting and even punishing private sector activity, and quoting Mao’s theory that capitalism is a transitory phase on the road to socialism? They seem like steps backwards.

“China has entered a new stage of development, “ he declared earlier this year, citing his goal of building into a “modern socialist power.”  

It's all your (de)fault!

Prime Minster Trudeau managed to have prevailed a third election. The election, which few Canadians wanted, cost the nation close to $700 million. But that’s peanuts for the most spendy PM in Canadian history by a long shot.

Though he won the election, he failed to gain the majority he was after. Trudeau also lost four female cabinet ministers, all the more complicating his priority of appointing members on a 50/50 gender basis.

But government addiction to spending is hardly the domain of Canada. The White House told federal agencies to have preparations in place for a U.S. government shutdown. Both parties have agreed to fund government past the end-of-month deadline but time is running short. A House measure to fund government, suspect the debt ceiling (how convenient), and approve emergency aid is expected to not survive the GOP controlled Senate. 

In theory, Evergrande isn’t the only entity flirting with default. 

Musing Beyond the Markets

From “The Investivable: Understanding 12 Tech Forces That Will Shape Our Future” by Kevin Kelly:

A world without discomfort is utopia. But it is also stagnant. A world perfectly fair in some dimensions would be horribly unfair in others. A utopia has no problems to solve, not therefore no opportunities either.

None of us have to worry about these utopia paradoxes, because utopias never work. Every utopian scenario contains self-corrupting flaws. My aversion to utopias goes even deeper. I have not met a speculative utopia I would want to live in. I’d be bored in utopia. Dystopias, their dark opposites, are a lot more entertaining. They are also much easier to envision. Who can’t imagine an apocalyptic last-person-on-earth finale, or a world run by robot overlords, or a megacity planet slowly disintegrating into sums, or, easiest of all, a simple nuclear Armageddon? There are endless possibilities of how the modern civilization collapses. But just because dystopias are cinematic and dramatic, and much easier to imagine, that does not make them likely.

The flaw in most dystopian narratives is that they are not sustainable. Shutting down civilization is actually hard. The fiercer the disaster, the faster the chaos burns out. The outlaws and underworlds that seem to exciting at “first demise” are soon taken over by organized crime and militants, so that lawlessness quickly becomes racketeering and, even quicker, racketeering becomes a type of corrupted government – all to maximize the income of the bandits. In a sense, greed cures anarchy. Real dystopias are more like the old Soviet Union rather than Mad Max: They are stiflingly bureaucratic rather than lawless. Ruled by fear, their society is hobbled except for the benefit of a few, but, like the sea pirates two centuries ago, there is far more law and order than appears. In fact, in real broken societies, the outrageous outlawry we associate with dystopias is not permitted. The big bandits keep the small bandits and dystopian chaos to a minimum.

However, neither dystopia nor utopia is our destination. Rather, technology is taking us to protopia. Protopia is a state of becoming, rather than a destination. It is a process. In the protopian mode, things are better today than they were yesterday, although only a little better. It is incremental improvement or mild progress. The “pro” in protopian stems from the notions of process and progress. This subtle progress is not dramatic, not exciting.  It is easy to miss because a protopia generates almost as many new problems as new benefits. The problems of today were caused by yesterday’s technological successes, and the technological solutions to today’s problems will cause the problems of tomorrow. This circular expansion of both problems and solutions hides a steady accumulation of small net benefits over time. Ever since the enlightenment and the invention of science, we’ve managed to create a tiny bit more than we’ve destroyed each year. But that few percent positive difference is compounded over decades into what we might call civilization. Its benefits never star in movies.

Protopia is hard to see because it is a becoming. It is a process that is constantly changing how other things change, and, changing itself, is mutating and growing. It’s difficult to cheer for a soft process that is shape-shifting. But it is important to see it.