A recent Societe Generale strategy note highlights the impact of the Eurozone crisis in China and draws out two potential scenarios – the hard landing and the soft landing.  The note strings together some potential asset class impacts in either case (via SocGen):

“The eurozone debt crisis is jeopardising China’s economic dynamism: China became the first contributor to
world GDP growth (31% on average for 2010-2013e: source IMF) in 2010. The recent cut to the country’s economic growth target to 7% by the Chinese Premier confirms that China’s economic expansion appears to be in jeopardy. Another sign came from the unexpectedly high trade deficit in February ($31.5bn far from the previous record at $7.9bn in a month). Furthermore, the political will to cool the overheated property sector is in question as home prices are now in free fall after the fifth consecutive monthly decline. Two scenarios: 1) a “hard landing” in China, with growth below 7% and dire consequence for commodities; 2) A soft
landing in China, with growth at 7.5% which would favour developed economy assets.

Scenario 1: China “hard landing” (growth below 7%): As Premier Wen Jiabao said last Tuesday, economic growth in China is still sensitive to the eurozone crisis. With fiscal tightening in Europe and structural reforms in China likely to take some time, there is indeed a risk that Chinese growth could slow. This would have negative impacts on: 1) emerging market equities, and 2) commodities. But, a fall in commodity prices, particularly oil, could support: 1) western economies, enhancing household purchasing power; 2) developed equity markets, mainly in Europe, particularly considering that only a small portion of
European revenues are generated from China, although there are exceptions (luxury goods).

Scenario 2: China soft landing (7.5% growth): This suggests, as presented in the “China 2030” World Bank report, that China succeeded in implementing structural reform with a better equilibrium between growth from exports and growth from internal demand. This could also push Chinese authorities to further revalue the yuan (already up 30% vs the USD since 2005). Under this scenario, it would be positive for risky assets. But, inflation would be a major issue for developed countries as: 1) commodity prices and particularly oil prices would remain at very high levels; 2) bond yields would go up sharply in developed countries; 3) emerging equity markets would remain bullish.”

Source: Societe Generale


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Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  • Larry

    Conversely, we will gain insight as to which of the two China scenarios is more likely by watching the performance of 1) emerging market equities, and 2) commodities. If those two markets weaken, then a China hard landing below 7% growth is more likely.

  • Octavio Richetta

    Heads you win, tails you win! Goldilocks at its best!

  • jt26

    Hard landing. Still needs that last tipping point … something to force a rebalancing in China – protectionism threat or a trade war. Will a re-elected Obama or activist Republican Congress agenda force China? Will an increasingly desperate PIIGS (they’ll have to give an ultimatum to Germany … if you want us to pay back then trade with us not China; Europe was very protectionist in the 80’s Japanese auto wars).

  • Conventional Wisdumb

    Funny although this has been in the public domain for a long time, I still think the idea of a “hard landing” is out of the realm of conventional thinking and into the contrarian idea and therefore would qualify as the proverbial shock to the markets.

    Still haven’t seen a convincing argument as to why China’s inverted yield curve isn’t sending an ominous signal.

  • Octavio Richetta

    Great point. A china hard landing is a good candidate for a smart contrarian positioning.

  • Andrew P

    Everyone assumes that since China runs on full blown MMT, with the Government controlling not just interest rates and money supplies, but bank lending as well, and an effective Job Guarantee to boot, that a hard landing in China is truly impossible.

    I think only a massive rise in the price of oil (as paid by China) has any chance of causing a real “hard landing” in China. Given that China buys most of its oil from Iran with RMB, this means a bet on a Chinese Hard Landing is a bet on a nuclear war between Israel and Iran.

  • Greater Fool

    I have never seen a soft landing in anything, unless it never really took off.

  • Larry

    Late 3/21/2012 ,10:59p, Hong Kong stocks, Aussie fall on weak China data

    10:55p HSBC flash China March PMI tumbles to 48.1
    Here it comes, the start of the China hard landing. The surprise that the bulls failed to position themselves for. A fall in growth from 10% down to below 7% qualifies as a hard landing. Not a good time to be long EEM or China stocks.

  • Octavio Richetta

    Larry, you bet me to it!

    So who was saying I was exaggerating in December when talking about a china hardlanding?

    But don’t worry whatever happens in china is good. Soft landing, hard landing, takeoff. And of course the us is decoupled!

  • Octavio Richetta

    Of course, Japan still looks green as Tokio is close for the lunch hour. I will wait a bi before going to bed so that I can see the open.. One of the things I have in my to do list, if the yen ever gets weaker, is to go there on a gourmet visit.

  • Octavio Richetta

    Time to go to bed. Live quote: it reopened lower but still green.

  • VII

    I would advise waiting for china to be all clear, the middle east to calm down, the fed to get out of the way, Europe to crumble, the sovereign debt bubble to pop, the Nasdaq to retest 2400, apple to sell off, the gold bubble to pop, unemployment to come down, and Tebow to fail at football.

    We never forget 2008 because we assume its always right around the corne. It turns an economy growing at a 7.5% clip into a negative. Isn’t china Rebalancing the economy for a build it no matter what to something more practical. So yeah commodities will look horrible, real estate will look poor, australia should contract but watching those three and others from the past 20 years to ratify how chnas doing is like watching the sale of Christmas trees in Israel to predict how the holiday sales will look.
    NEWS FLASH the natural progression of EM at this stage is to now start consuming and to build less.

    When is it going to be the right time in a world digitally connected to clear all the troubles we can see to invest?

    Chinas the USA reverse engeneered in 2000. Your watching the NASDAQ in 2000 frozen when you should be buying real estate. Now your worried about China Real Estate build out while the Premier is encouraging a more balanced economy and you shoul look for companies not commodities that should benefit selling to Chinese consumers.

  • Octavio Richetta

    There is a point to what you are saying. For example, max drawdown in equity markets during the 2008 crisis was in the order of 60% so people plan for that and it may not happen again any time soon. I did quite well in the 80s 90s bull market and never followed the economy/read the news just bought and hold the way they taught me in B school.

    There is always negative stuff crossing the tape and if you get too serous about it you will never buy a stock.

    That being said, the foreign debt crisis, china bubble and housing bubbles is Australia and Canada very real. The first two I mention are enough to keep me back from hurrying into equities. Believe me, there will be better entry points.

    It is not just a single headline. Look at the trend. You have to put it together frame by frame to make a movie out of it.

  • Octavio Richetta

    I meant the European sovereign debt crisis, not the foreign crisis. Is getting late here and I am typing too fast!

  • VII

    @ Octavio

    80s – 90s. Imagine if the Internet was around with zero hedge to cover all the rumorss of the arms race with USSR. Satellite images of nukes being point at us. How about if we had ETFs momentum traders and HFT algos during Oct. 87. They would 0000 zeroed out the SPX. How about the internet during the peso crisis, Russian bread lines, LTCM etc.
    Is it different now…yes because we see everything. But after 2009 were numb to all the doom and gloom. 3 years of stories of Europe demise, of china hard landing, hyperinflation deficit gold hedging, now Canada and Australia housing collapse.
    Let me ask you this. If the U.S can survive the U.S housing crises than why are you worried about Australia?
    You know what I think…I think the SPX is The HONEY BADGER? It don’t give a shit. It doesn’t care about china, Australia, Iceland wanting to use Canadian dollars, Hussman 7 yr return estimates, CAPE PE ratios, Europe, gold bugs fear of hyperinflation. It’s a nasty f$$$. Look it eats bees…ew it’s getting stung like 100 don’t care about no’s the SPX. Uh oh it’s a cobra…look it got bit. But look there it goes… The SPX don’t care about no cobra bite…it’s a crazy shit. It keeps going.
    Why do we care about that which we can see. All the negative extraplations tell us why the SPX should go down..but it doesn’t. It doesn’t care. No matter how much everyone writes about China or Europe. Further let me offer some advice to Laksham from ECRI…….someone please put this on MSNBC for him to see. It may save his business.
    IF YOUR GOING TO BET YOUR REPUTATION ON A RECESSION CALL THEN DO YOURSELF A FAVOR….DON’T GIVE YOUR RESEARCH TO THE ONE GUY WHO CAN PREVENT YOUR CALL….don’t reaffirm the call if the guy with the levers to the printing press is being advised by you a recession is coming 100%. IT WILL NEVER HAPPEN SO LONG AS HE’s YOUR CLIENT. How can he not see this. If you want a recession….then send Bernake a fake piece that says everything looks great.
    The us so much worry and reasons why all the obvious villains will take down the SPX. But after 2009-2011 investors want the honey badger to keep going and are numb to one more story of another country they have to look out for.
    It can’t get bad until we stop giving reasons why it should. The honey badger doesn’t care what we think.
    Now is not different. There are always problems or reasons why to be safe. They never go away. Not with so many iPhones providing the bears with all salmon of bad news to eat.

  • Derfem

    Where do you see so many bears? Here? Yeah, TPC has a larger proportion of bears than in other places. But when I look mainstream media (Johnny come late’s media), I can only see euphoria: MarketWatch, Bloom, CNBC, and so on. Sentiment surveys are wildly bullish.

    So, in MY trading style (swings from several days to several weeks), I do not see any long risk-reward positions now:
    – sentiment is topping
    – oscillators are wildly overbought
    – broad market is not conforming (from sector rotation, emerging, commodities,…)
    – Surprise Index going down from very high levels.
    Translate: performance will be poor (flat) at best for the next 2-3 months.

  • VII

    @ derfem

    I don’t disagree with u. But everyone has built the same mouse trap u have. All the cautious intelligent investors are looking at the same thing and sharing this all over the Internet. But that mouse trap was built with the idea that, commodities matter anymore. With china purposefully changing gears and the. US as well other developed economies built out why would I not assume the next stage of growth will not come from CCI . Why would I not follow tech, or financials which have done nothing. We always read Cullen’s pieces on how so many underperform the market , under invested, why? Because we are looking backwards at correlations that son matter as much as they did during the real estate boom. And we get underinvested then get frustrated the SPX marches higher.
    Watch the price action of that which you own…SPX if that starts to not confirm then sell.

    BUT explain this too me.

    It’s like throwing a surprise birthday in well lit all glass see through building.
    Who the hell is surprised when everyone is tracking the surprise index.

    What if everyone ihas built the same vessel? Doesn’t the market evolve to make everyone who’s figured it out wrong.
    none of what u listed is unknown. Then why has the market chart looked like a honey badger? It doesn’t care.

  • B Ferro

    Come on Cullen…China hard landing?

    Why is it that people fail to grasp one of the simplest yet most universal maxims in economics / trading / investing…

    That which everybody can foresee rarely, if ever, happens.

    There is a reason the sub-prime and financial crisis of 07-09 came to fruition – excluding a tiny sub-set of now very rich hedge funders, nobody was smart enough to see it coming.

    Now, on the flip side, everybody is “smart” enough to foresee the inevitable of a Chinese hard landing and Europe blowing up.

    Reason and rationality tell me that the future likely holds in it something the majority are failing to see right now and that given posts like this, it isn’t a Chinese hard landing or a European blow up…

    What aren’t the majority seeing right now?? Probably includes the letters SPX, the number 1800 and the years 2012 and/or 2013…

    How bout them apples?

  • Derfem

    Because people swift from one bearish blog when the market is down to a bullish blog when the sucker is up. The reallity is neither bearish ou bullish but a bet (position) based on a scenario (market setup probabilities). That’s why most people fail. A bull will always find arguments to justify his view. A bear too. But they will never see the game changer.

  • Octavio Richetta

    I don’t think the crowd that was calling for the subprime debacle was any smaller than the people who are calling for a china hardlanding. I would actually venture to say the china hardlanding crowd may be smaller. Knowledge of the subprime mess was fairly well spread even though unknown to the masses and Benny.

  • Cullen Roche

    It’s awfully reckless to claim that there’s a “100% chance” the SP rallies to 1800 based on a historical precedent. You must know that’s a lot like saying “well, the last 3 times I rolled a 6 I then immediately rolled a 1 and that means that since I just rolled a 6 I will definitely roll a 1 this time”….Is there more to your thesis than “this has happened before therefore it will happen again”????? If so, I am all ears.

  • VII

    @ Derfem-

    I said the same thing you said. I’ve got the best mouse trap of anyone on the internet. And well it was wrong. I agree with you on the game changer. 100%
    The game changer was in October of 2011. If your selling now or were out your not honoring the price. Thus it tells me your bearish and think you’ve sniffed out the bear trap everyone else can smell.

    I don’t care about any of this. I dont’ care if the SPX breaks down. If it does then I’ll take my losses as I exit. But until it does…and it hasn’t. SHIT…look at today…China posted 48 and the thing is struggling to get to triple digits. If China contracting for 5 months can’t do it, Greece defaulting and Germany slowing then WHAT?
    More- I get what your saying. And I agree. But this isn’t an investing book with little maxims… Your telling me it’s going down…but the SPX has not confirmed this yet. So that tells me your watching the wrong things. And that will cost you. Until The SPX trend changes this honey badger aint’ going down. No matter what China does. The louder Zero Hedge gets the better I feel about my position.

  • Alberto

    I have different opinions but I’m respecting your arguments… but not this time. Are you really believing we’re living in a world populated by hungry bears ? It seems the contrary. This is from a recent post:

    “…Bullish sentiment declined, while bearish sentiment rose slightly in the latest AAII Sentiment Survey. The spread between bullish and bearish sentiment stayed in positive double digits for the 12th consecutive week, the longest such streak since 2005…”

  • B Ferro

    I do have a second data point that also suggests there is a 100% chance the market is higher in Oct of this year vs Oct-11 and that on average, you should expect the SPX at ~1550. That said, this analysis only takes me out to Oct-12 and SPX 1800 is likely to take a bit longer. That said, it is still a separate data point that suggests the damage done last fall has historically, with to-date 100% accuracy, had you up on a one year forward basis on the SPX from the time the signal is generated. Believe the data set has ~12 samples. Funny enough, the data is publicly available.

    But – statistically, what i have referred to in the past on this site as having happened to market internals last fall has only occurred at the lows of the 62, 74, 87 crash, summer 98, 02 and 09 bottoms.

    The smalllest rally off any of these lows was 60% before any top to speak of was in place. Using 1123 as the weekly closing low last fall *1.6 = ~1800.

    Given the rarity of the latter two statistical market anomalies, the uniformity of the price action which has followed, the reliability of the data and the proce action to-date off the Oct-11 lows, which is tracking perfectly the moves off the other aformentiomed historical lows, I’m going to place my bet on history, yet again, repeating.

    So yea…there is always a chance something fails and doesn’t repeat and I totally believe no tool is infallible. That said, we are in the business of probabilities. If I cam find 2 that tell me my chance of success is 100%, the degree of that success could be huge and the markets price action is whispering in my air the same thing is happening again, I’d be a fool not to listen…

  • B Ferro

    Alberto – what happened after 2005? The SPX ripped in 2006 and 2007 and the favored sectors, such as industrials and basics, went up multiples of the SPX return.

    Sentiment is very valuable when timing bottoms. Though not worthless in timing tops, incredibly unreliable at best and always way too early.

  • Cullen Roche

    A data set of 6 is not playing probabilities…. Now, if you had 100 or 1,000 instances of this event with 60% likelihood then that would be a different story….I’m not saying you’ll be wrong, but I don’t think you’ll be right because of 6 past events….

  • B Ferro

    I hear you on the small data set from the various 6 major market bottoms.

    However, like I said, there is another data set from a different analysis with 2x the sample size, the same probabilities of a positive outcome and with the degree of positive outcomes being roughly the same on order of magnitude.

    The combination of all of this is confidence inspiring, despite the small sample size in the one analysis.

    Also, the major market sell-offs with the concurrent market internal damage I’m calling out as having a 100% likelihood of producing a ~60% rally off a low are in and of themselves hugely rare. Saying you need a bigger sample set for something like this to believe we hit 1800 with 100% likelihood is like saying just because there have been 10 major tsunamis on the planet over the past five decades and they produced deaths in the X thousands and financial damages reaching $X billion doesn’t mean the same or similar results are likely to happen when the next one strikes…

    To me, the rarity of the damage done to the market last fall is like one of these tsunamis…