Its capital city, Beijing, China “officially” reported its first case on Saturday night.

It’s not an entirely surprising development given that the COVID-19 variant has been reported in other cities in China during the past week and that it seems to spread as easily as dust in the wind.

But things are about to get more complicated…

In just three weeks, this metropolis of 21 million people is scheduled to host the Winter Olympics and the entire country is going to celebrate Chinese New Year which means a lot of visitors, gatherings, and travel.

Olympic athletes have already started to arrive in China from around the world and the annual New Year’s celebration typically sees millions of its citizens travel to see family and friends, like the holiday season in the United States.

The Communist government wants to stomp out an Omicron spread ahead of these celebrations and is enforcing what it calls its “dynamic zero COVID” strategy, which includes constant testing, nationwide monitoring of people’s movements, and phone apps.

They’ve ramped up COVID-19 testing in Beijing and other Chinese cities, strengthened travel restrictions, isolated workplaces, and even seem to be starting a propaganda narrative about the virus’ spread, pointing the finger at Omicron arriving in the mail from North America.

According to the French international news service Agence France-Presse…

Health official Pang Xinghuo told reporters Monday the virus had been found on the surface of a letter the infected person had received from Canada, as well as inside the unopened letter.

Before going further, we’ll just say bluntly that we believe the likelihood of that single paper letter being the single source of Omicron’s spread to China’s capital city is unlikely.

Today, in the U.S., tens of thousands of workers are calling out sick, there are still backups at ports, and airlines have been canceling thousands of flights. We can only hope that Omicron peaks in the U.S. soon, but now things are ramping up in China.

This means supplies coming out of China (again, the world’s second-largest economy) – like electronics or everything you see that says “Made in China” – could slow down or be stuck longer on ships.

Already, there are reports out of Chinese port cities experiencing congestion and weeklong delays… In Tianjin, a city of 14 million, people, carmaker Toyota suspended operations at its plant.

This is all happening while, relatively quietly, China’s economic growth has slowed down, to the point that the Chinese central bank lowered a key lending rate recently just the opposite of what is happening here.

At the same time, demand for Chinese products in the U.S. and other nations will remain at least steady for the most part.

In short, this means you’re going to hear about more supply-chain problems and that means more fuel for the inflation we have seen, as demand continues to outstrip supply.

And it could also mean an economic slowdown at the same time if those supply problems last long enough.

Stagflation

That’s the phrase used to describe stagnant or slowing economic activity and accelerating inflation.

Last month, consumer prices rose 7% year-over-year the highest increase in 40 years.

When the term stagflation was coined in the 1970s on the floor of the British House of Commons, persistent, high unemployment was also part of the definition.

To that point, today the comparison is not necessarily identical ‒ the unemployment rate is historically low at the moment ‒ but has a similar result, with fewer people working.

You see, labor-market participation is also near multidecade lows, signaling people just don’t want to work.

Now, some argue stagflation is simply a byproduct of easy monetary policy, which makes sense. Don’t ignore central bank and fiscal policy’s role in higher inflation, not one bit.

Trillions of dollars created from thin air starting in March 2020 have made a lasting impact. And this is it…

When Federal Reserve policy gets tighter (higher interest rates, fewer asset purchases), it’s done to slow economic growth in the U.S., which may or may not have been artificially stimulated by the central bank in the first place..

China is doing the opposite.

 

Central Bank Digital Currency (CBDC)

 

As it looks to keep up with global financial innovation, and preserve dollar supremacy, the Federal Reserve has finally released a long-awaited paper discussing the pros and cons of a potential U.S. central bank digital currency (CBDC). While the 40-page document doesn’t take a stance on any specific policy, it will open the discussion between the central bank and stakeholders, as well as solicit public comment. Some upsides include faster and safer payment options, though risks like privacy protection and financial stability would have to be addressed.

How do CBDCs differ from electronic cash? When you deposit money into a bank account, the commercial entity takes responsibility for the sum. The cash is then held in electronic form and can be used across a variety of platforms, but it’s limited to the bank’s ledger. Companies like Venmo can even track electronic transactions on their own internal ledger system, but the money is still being held and tracked by a commercial bank provider. In the case of CBDCs, the government is the counterparty and takes liability for the money, while the ledger that’s being used (known as the rails) can be a very different structure than a commercial institution.

Definitions first… While there are many descriptions of “digital currencies,” they are broadly broken down into three categories: CBDCs, cryptocurrency and stablecoins. Check out the other two types below:

Decentralized crypto: These are unregulated offerings like Bitcoin (BTC-USD), Ethereum (ETH-USD) and Dogecoin (DOGE-USD). Since they are issued by a network, and not any central authority or government, they are often volatile, but can also be exchanged for goods or services like traditional currencies. Cryptos often use distributed ledger technology (like blockchain) that can confirm valid tokens and log transactions.

Stablecoins: These also use distributed ledger technology, but they attach the value of tokens to something that already exists. By pegging the asset to the dollar, a basket of currencies, or commodities like gold, these currencies are more grounded and reduce volatility. The most famous example of this is Meta Platforms’ (FB) Diem project, formerly known as Libra, which has had a tough time getting off the ground due to regulatory and technological hurdles.

 

US Economy

 

  • The U. Michigan current financial situation index dropped to the lowest point since 2014 due to inflation concerns.

 

 

  • The West Coast ports remained clogged up.

 

 

  • When will supply chain issues ease?

 

 

  • The first regional Fed manufacturing report (from the NY Fed) was a shocker as new orders weakened.

 

 

  • This report does not bode well for January factory activity at the national level (ISM).

 

 

  • CapEx expectations have been surging, which is great news.
  • The Evercore ISI company survey showed deterioration in business conditions/sentiment.

 

 

  • Retailers, in particular, were more gloomy.

 

Market Data

 

  • Market sentiment has been shifting toward more neutral levels as Fed rate hikes loom. The equity market froth we saw last year has come off.
  • Bond yields tend to matter more for equities if earnings are being downgraded.
  • Clean energy stocks’ underperformance relative to traditional energy companies has blown out.

 

 

  • The 2-year Treasury yield broke above 1% as the market prices in faster rate hikes ahead.
  • And the market is starting to price in the possibility of more than four rate increases (or one 50 bps and three 25 bps hikes).

 

 

  • During the past 6 months, there have been numerous days when 52-week lows outnumbered 52-week highs, only days following new highs in indexes like the S&P 500. These kinds of cluster of technical warning signs were seen near some important market peaks.
  • Rising real yields continue to pressure stocks
  • With both stocks and bonds selling off, the 50/50 portfolio had the worst day since May.
  • Rotation out of growth shares to Value continues
  • Funds’ tech allocations hit the lowest level since 2008, according to a survey from BofA.
  • The Nasdaq Composite dipped below the 200-day moving average.

 

 

  • Breadth continues to deteriorate. The percentage of Nasdaq 100 members trading above their 200-day moving average dipped below 50% for the first time since early 2020.
  • High dividend stocks are outperformaning as investors seek defensive sectors.
  • Analysts expect a slowdown in Q4 earnings driven by a decline in sales and margin growth.
  • Since the Treasury yield curve has already flattened a lot, the Fed may not be able to raise rates aggressively without inverting the curve, which typically preceded a recession, according to Alpine Macro.
  • Goldman sees the 10yr Treasury yield climbing toward 2.5% by the end of 2024.
  • Nasdaq entered correction territory on Wednesday, down over 10% from it’s peak.
  • The Small Cap Russell 2000 index is down over 15% as of last Wenesday’s close.
  • With the Russell 2000 entering a death cross.

 

 

  • Small caps are trading at the largest discount to large caps in two decades.
  • The S&P 500 dipped below its uptrend support.

 

 

Thought of the week

 

“Be wise.  Don’t be a fool”

 

Pictures of the Week

 

 

 

 

 

 

All content is the opinion of Brian J. Decker