The Thucydides cap on the China equity rebound trade
Eye On The Market
Deep Dive
Why is there a cap on potential returns for Chinese equities?
The cap on Chinese equities is due to a combination of geopolitical risks and economic issues. Geopolitical tensions, particularly between the US and China, have escalated since 2017, with China engaging in extensive corporate and military espionage. This has led to potential retaliations and sanctions, which limit the upside for Chinese equities. Additionally, China has the lowest pass-through from GDP growth to earnings and equity market returns, further capping potential gains.
What is the Thucydides Trap and how does it relate to US-China relations?
The Thucydides Trap, coined by Graham Allison in 2017, refers to the historical pattern where a rising power disrupts the dominant state, often leading to military conflict. Out of 16 cases over the last 500 years, 12 resulted in war. While the US-China relationship is unique due to deep economic linkages, the increasing geopolitical tensions, including espionage and cyberattacks, have heightened the risk of conflict, impacting investor confidence in Chinese equities.
What are the key variables that are most beneficial for investors to follow?
The most beneficial variables for investors include payroll growth, industrial production, leading indicators, financial conditions, and business confidence. These factors have shown the strongest investment signal benefits over time, unlike geopolitical risk indicators, which have a negative signal and are generally not helpful for predicting market returns.
How effective is the China stimulus package in boosting the economy?
The China stimulus package is a comprehensive effort to jolt the economy, combining monetary, fiscal, and macro components, along with market regulation measures. It aims to clear excess real estate inventory and incentivize stock buybacks and leveraged investments. While the package was implemented under economic duress, it has provided a decent boost to equity valuations, though they remain below median levels. However, geopolitical risks and economic inefficiencies limit its long-term effectiveness.
What is the impact of China's espionage activities on US-China relations?
China's espionage activities have significantly deteriorated US-China relations. Since 2017, China has hacked into over 200,000 devices in Western countries, embedded malware in critical US infrastructure, and stolen sensitive information from government and corporate systems. These actions have led to increased sanctions and retaliations, further straining the relationship and impacting investor confidence in Chinese equities.
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