The chart below shows the 6-month performance of the SPY (State Street S&P 500 ETF) and MCHI (iShares ETF that tracks large- and mid-cap stocks in China).

Six-month performance, SPY (S&P 500 ETF) vs. MCHI (China large- and mid-cap ETF). Chart by Tradingview.com.

These indexes are comparable, representing mainly large and mid-cap stocks in the world’s two largest stock markets. Over the past 6 months Chinese stocks have underperformed the S&P 500 by 38%, which is a staggering divergence. I believe this is largely caused by China’s short-sighted political crackdowns on various entrepreneurial ventures (from fining Jack Ma $4 billion to, more recently, declaring various lines of business (such as “private education” tutoring companies) to be illegal, which instantly incinerated billions of dollars worth of stock).

President Xi’s hardline anti-capitalist stance is likely to soften at some point (more on this below). And, as we know, markets eventually rotate out of one theme and into another, and the best time to pounce on these rotations is when the market switches from bear to bull conditions — the best gains come at the beginning of a cycle. First prediction (made with high conviction): the S&P 500 will suffer a correction (probably not a bear), and recent market activity indicates this may have already begun. If not, it is close to inevitable that we’ll see a sharp correction no later than the semi-predictable Sept/Oct slump (those are the two worst months for stocks historically).

I am basing my market correction call on more than seasonality, however. Based on recent headlines, I am firmly convinced that the more-transmissible Delta variant strain of COVID is going to sweep through the US this fall and cause another economic disruption. It won’t be as bad as 2020, but it will definitely slow growth and raise unemployment. Moreover, the market will do its usual good job of looking forward and anticipating this. The real economic damage will be evident by December, but the market should “get the memo” by September/October, November at the latest. With half the country still unvaccinated, and the major unvaccinated states like Missouri and Florida already in mini-COVID crises, I believe this to be close to a foregone conclusion.

The most important question (as always) is, of course, why do we care? When the market correction begins in earnest global stocks are likely to tank across the board, led by the US (as we have had some of the best gains in 2021 and our stock market is profoundly overvalued). We care because of my second prediction (made with moderate conviction): if China’s stock market gets dragged down a little further by another COVID crunch and US market correction, I think the MCHI has the potential to be a good play when bull market conditions resume (which may take weeks or months, everyone will have to observe market conditions and act nimbly — corrections have been sharp and brief and have reversed promptly in recent years).  

SPY (S&P 500 ETF) vs. TLT (ETF that tracks the prices of Treasury bonds with approximately 20 years to maturity. Chart by Tradingview.com.

Finally, I present one additional indicator that supports the “overvaluation” hypothesis for US stocks: the above chart of the SPY vs. the TLT (index of the prices of 20 year treasuries) tells an interesting story. First note that 20-year Treasury prices have risen as much as the S&P 500 over the past 3 months (prices up means rates have been falling). Interest rate declines have predicted all the major corrections in this bull market. The bond market has seen through weak economic conditions before the stock market has gotten the memo quite consistently in recent years. As the chart makes clear, the indicator is flashing a warning signal again. If the economy, job market and inflation were as red hot as the Fed claims, rates should be RISING, not falling. As usual, the bureaucratic numbskulls at the Fed are completely wrong — there’s not going to be any tapering of QE. The Fed will be easing by late fall/early winter, and that’s going to send stocks soaring. We live in a QE-infinity world now. Fed stimulus will have to be supplied ad infinitum.

But first, it’s time to buckle up and get ready for a volatile summer/fall season. The correction is coming (and may already have started). I recommend watching the MCHI as a vehicle for diversifying a portfolio during the ensuing bull phase (yes, there will be another bull market!). China’s President Xi can only push his dictatorial impulses so far. If he destroys too much wealth China’s middle class will go berserk. China’s citizens have enjoyed incredible increases in wealth in recent decades and they are not going to go silently back into poverty. Even the usually compliant Chinese are capable of civil unrest at some point, and Xi will stay away from that brink. When we see headlines about Xi softening his anti-free market stance a bit, start watching for signs of a new uptrend in the MCHI. China’s economic miracle is not over, it’s just taking a break due to incredible political stupidity.