In the past few weeks, we likely saw a bear market rally. Most of the bears finally gave up when they heard QE3. Nevermind that the latest round of QE is underwhelming in size and scope. The bears just threw in the towel and asked questions later. Bears likely flocked to gold, ignoring the wider sell-off in commodities.
Yours truly is still bearish till year end. Might had been early to the call by a week or two. What is remarkable is that easing by G7 (Fed underwhelming QE3, BoJ buying bonds in desperation, ECB promise of unlimited bond buying to stem contagion) did not inspire large scale risk-on. Our favorite barometer, the Dow Jones Industrial, failed to make new highs after the impulsive short covering post QE3. The index even made a weekly loss the week following QE3, and looks likely to post another weekly loss tonight.
We said it will be Jackson Hole disappointment, followed by EUR euphoria and then Japanese jinx. Currently we are past the euphoria and waiting on a Japanese jinx. That would likely mean October will be a period of very high volatility. Those who are complacent about the China-Japan standoff should read the book written by Henry Kissinger entitled ‘On China’.
Being economically important to each other is irrelevant. Germany and Britain started World War 1 despite the then prevailing view that they are too important to each other economically. What matters is perceived ability to win, and a realization that we are dealing with the heirs of Mao (not Confucius):
“Traditional Chinese political [Confucian] theory held military force in relative disesteem and insisted that Chinese rulers achieved stability at home and influence abroad through their virtue and compassion. Mao, driven by his [Maoist] ideology and his anguish over China’s century of humiliation, produced an unprecedented militarization of Chinese life.” pg 94 Henry Kissinger On China
Of course we are unlikely to go into traditional warfare. A traditional war would be repeating the mistake of Europe in WW1 and WW2 to the benefit of American businesses. What is likely is an economic war. China likely knows that Japan is in a very precarious position. Once the European sovereign debt crisis is ‘solved’ by whipping Greece and huddling together with the rest, the bond vigilantes will go on a hunt. Perhaps in the Chinese calculations, economic warfare on Japan will open up the can of Japanese Government Bond worms.
Good luck in the markets.