The ‘Pain Trade’: A Simple Way To Determine Who’s Holding The Stronger Hand

In light of recent events, economists, analysts and a parade of pundits have bent over backwards to try and determine who has the better bargaining position in the increasingly tense standoff between the U.S. and China on trade.

To be sure, there are any number of ways to go about deciding who’s holding the stronger hand and if you ask Wilbur Ross, Peter Navarro and of course Donald Trump, the answer is the same: America, of course.

“If it really does get to be a big war, we have many more bullets than any of these other countries,” Ross told Bloomberg last week.

But China begs to differ.

In a characteristically amusing piece out Monday from Xinhua, state media in China alluded to Xi’s “powerful weapons” when it comes to fighting a trade war of attrition with the U.S.

According to Xinhua, those weapons include a giant market, a resilient economy and, amusingly, “strong leadership”, which Xinhua seems to be suggesting the U.S. might lack.

The state-run outlet also flagged Fed tightening as a risk to America’s position to the extent Jerome Powell’s efforts to stay ahead of the (Phillips) curve end up tightening financial conditions and thereby exacerbating any hit to growth from trade tensions.

Those of you who find elegance in simplicity might be inclined to take a more straightforward approach to things by noting that while the S&P continues to hang in there, the Shanghai Composite has plunged into a bear market. If Monday’s action was any indication, the pain isn’t likely to subside soon for mainland equities.

Well, speaking of “pain” and the SHCOMP, Deutsche Bank’s Alan Ruskin wrote the following on Monday in a short note:

[The] US/China equity ratio ‘pain trade’ – the Shanghai comp/SPX has broken the 2014 low. As long as this ratio is heading down, it will encourage views that China is under more duress than the US to compromise on trade issues.

Here’s the chart on that:

It’s a simplistic view, to be sure, and Wilbur Ross was out on Monday downplaying the importance of the stock market when it comes to crafting trade policy.

But make no mistake, the administration’s decision to back down last week on the methods for restricting Chinese in investment in U.S. industries pretty clearly suggested that no one at 1600 Penn. is in the mood to see the trend in that ratio reverse.

At least not to the extent that reversal comes courtesy of a declining S&P.