Fortune Telling: Reading the Tea Leaves on China and Bolton

About 20 years ago, when I was a musician and teacher based out of the Morgantown, WV area, I had a little 1-bedroom apartment across the Monongahela River in the city of Westover.

It was one of a series of garage apartments situated way back from the main road, which all had a little deck overlooking the pool area – a secluded, nicely-decorated oasis fairly uncommon in that price range.

Because I lived a couple of miles from the downtown, most of my neighbors were younger laborers instead of college students… sort of like a redneck version of Melrose Place.

But when I gave directions to visitors, I always used the same landmark – “just take a left when you see the sign for Psychic Tina… you literally can’t miss it.”

Psychic Tina was, of course, a fortune teller – not exactly a common profession in my hometown – and although I never stopped in when I lived there, I did a few years later at a friend’s suggestion.

We chatted for a bit and introduced ourselves, and my reading was interesting in that Psychic Tina said I wouldn’t be a musician for long.

“No, I see you somewhere by the water… and you’re driving a nice car… a convertible.”

One day, maybe a decade or so later, after moving out here to Annapolis, MD, I picked up my new BMW 330 convertible and called that same friend from my car while I was driving out to the beach.

I’ll never forget what she said…” Oh my God – Psychic Tina is a prophet of TRUTH!”

And in true economist fashion I responded “meh… it’s a small dataset.”

The Inside Baseball of Making Predictions

In order to make that prediction, Tina just took what she knew about me from our introduction – that I was a confident, entrepreneurial, nerdy, thoughtful, ambitious kid who liked cars and lived in the nearby apartments with the pool – and extrapolated that I’d likely move closer to one of the coasts to find opportunity, and likely have some success along the way.

Not exactly a stretch.

And frankly, not entirely dissimilar to the kind of work and analysis I do now.

This morning, for instance, I logged into the Terminal to see what economic data points were being released and saw that all eyes would clearly be on jobless claims.

Source: Bloomberg

Then I tried to figure out how “the crowd” was likely arriving at their estimates, so I pulled down the data for both initial and continuing claims to look under the hood.

The data points are offset, with initial claims pulled from last week’s data, while continuing claims are issued on a 2-week lag. If we add those two most recent data points together, we arrive at a simple estimate of what the next continuing claims data point should be – 22,471.

I then looked at the difference between that simple estimate and actual numbers, and on average they came in about 12% lower – or 19,781 – which turned out to be pretty darn close to the average projection.

Source: Bloomberg, Seawolf Research

When the data actually came in a little worse than expected, it told me that “the crowd” is absolutely looking backward to past improvements instead of looking ahead to new COVID-19 outbreaks in Arizona and Texas, as well as the potential for Oklahoma to see  a spike following Saturday’s scheduled Trump rally.

And with that in mind, I turned my eyes to what I think is turning into the most important data in the world – the ongoing second wave of COVID-19 infections in Beijing.

Beijing, Bolton, and a Bunch of Baloney

After reporting zero new daily cases from mid-April through the beginning of the month, China has confirmed 158 new cases in Beijing just this past week.

Source: Bloomberg

Despite the total number here being relatively small, China has taken what seem to be extreme measures, closing schools, cancelling flights – and even shutting down some neighborhoods – in response.

According to Leland Miller – CEO of the China Beige Book – China is being overly cautious in its approach to this outbreak because “if the (Chinese Communist) Party loses control of Beijing, it sends a symbolic message that they have lost control of power.”

Indeed, the CCP has already trotted out the country’s chief epidemiologist, who said the outbreak has been contained.

And yet, at least some videos coming out of the area paint a more concerning picture.

As such, the data point to watch, Miller says, is the unemployment rate. He qualifies that by saying that we all know actual numbers are far worse, and it’s anyone’s guess exactly where they dial in. But if they do begin to move off their current downtrend, it’s a sign things are worsening.

Source: China National Bureau of Statistics, Bloomberg

Another concern, Miller says, is Central Bank liquidity. “We’re not seeing liquidity roll out in China like we’re seeing in the US, which is surprising. More surprising is the demand picture – companies aren’t asking for loans, and the reasoning behind it is unclear.”

  Source: People’s Bank of China, Bloomberg

Well, the reasoning may be unclear, but the overall importance is crystalline. Low demand for loans means that economic activity is worse than is being reported.

And with China now coming back into focus thanks to former National Security Advisor John Bolton’s new tell-all book outlining a possible quid-pro-quo between Trump and Chinese President Xi Jinping, the level of scrutiny on this data will be far greater.

So, while I don’t yet have enough information to say for certain that China’s economy is about to take a serious turn for the worse, I have every reason to believe it will turn on a dime if the cat ever gets let out of the proverbial bag.

Unfortunately, there isn’t much in the way of equities that short China. If you were to do a Google search, you’d likely find ProShares Short FTSE China 50 (NYSEArca: YXI), but its average daily volume (~13,000 shares) and market cap (just US$7 million) is so low, I wouldn’t even touch it.

Instead, the best option here is to play the long fund – iShares China Large-Cap ETF (NYSEArca: FXI) – to the downside, either through buying put options or shorting the equity outright.

Now’s not the time, though, as we just don’t know enough, and we have our own (far more predictable) outbreaks on which to focus.

And since foreign equity performance is always relative, it means there’s also a possibility we may want to be long FXI for a short period of time – even with China’s economic data being a bunch of baloney.

Because even the baloney market does pretty well from time to time…

All the best,

Matt Warder