Back in March we layed out the bull and bear cases for Macau as it neared all time highs, and concluded the analysis saying that it looks unlikely that Macau stocks will go much higher until September at the earliest.
Now, as the Shanghai Composite Index is officially in a bear market, defined as 20% below its highs, Macau stocks are falling with the broader Chinese indexes. The VanEck Vectors Gaming ETF (BJK), mostly Macau stocks, is down over 4% year to date now, after being up about 8.6% as of May 2st. At best, I continue to believe that Macau will trade unpredictably up and down with no prevailing trend until this worsening trade war is worked out, and currency developments continue to unfold. More on that in a minute. The risks for a bearish downtrend are higher though than an uptrend from here as I see it.
Macau is basically following the Shanghai Composite Index more or less, though Macau has been a little bit stronger than the general Chinese stock market. This could be because there is still a lot of bearishness to work off after Macau stocks bottomed out along with oil. Which brings me to something of a strange correlation. Macau does seem to move in tandem, somewhat, with oil.
As you can see from the chart above comparing BJK with the US Oil ETF, Macau crashed from 2014 to 2016 almost in lockstep with the price of oil, bottomed along with oil, and then began climbing back up with oil. At first glance this seems strange, and maybe even counterintuitive. Usually, when commodities fall, stocks rise because the cost of doing business falls, beefing up profit margins and encouraging more consumption. So why would Macau have a correlation with oil?
While you could say it is entirely a coincidence, and I cannot deny that oil’s fall did happen to coincide with the money laundering crackdown by Beijing that took Macau to the woodshed, I believe there is more to it than just coincidental timing. Oil moves inversely to the dollar generally speaking, since anyone who wants to buy oil from OPEC must use dollars by treaty. It was a 1970’s deal in exchange for the US Armed Forces being the House of Saud’s bouncer, a situation that still prevails today. A higher dollar pressures the Chinese yuan lower, which hurts the purchasing power of many Chinese, by far the biggest clientele for Macau casinos. Perhaps the timing along with the money laundering crackdown exacerbated the situation, but I believe Macau would have fallen anyway even without the Chinese government’s help at the time. It just wouldn’t have been as spectacular of a collapse as it ended up being.
Right now the yuan is under heavy pressure, and it looks like the People’s Bank of China may be deliberately weakening it as a tactic in the ongoing trade war. Artificial moves like this don’t last though. Longer term, we’re nowhere near the lows and I doubt the yuan will continue down to break through the 2016 lows of about 7 yuan per dollar. In order for that to happen the dollar would have to keep rising, and the chances of that are slim for several reasons.
First, the tariffs the Trump Administration has set against China will soon be put in force. That will slow down exports from China, leaving more goods within the country than before. The supply of Chinese made stuff in China, therefore, rises, and consumer prices go down in yuan, strengthening it. On the reverse, less stuff is now available in the United States, which pushes prices higher in dollar terms, meaning the dollar weakens.
Second, and this is a bit obscure but important: The Federal Reserve doesn’t have a lot of room to keep shrinking its balance sheet, the shrinkage of which is the primary reason for positive dollar perception, collapsing emerging market currencies like the Turkish lira and Argentine peso and so forth. The Fed balance sheet has decreased from $4.42 trillion to $4.28 trillion year to date, a 3.2% reduction. During that time, the dollar index has jumped almost the exact same, 3.3%. The point is, if and when the Fed stops reducing its balance sheet, the dollar will plummet, because it will expose the lie that the Fed has control over the monetary system, which it does not. The yuan and other currencies will probably catapult back up and at that time Macau stocks will have a better chance of storming higher. This isn’t imminent but we’re approaching it, perhaps by the end of the year or beginning of next.
Why must the Fed stop shrinking its balance sheet soon? Because they are having a hard time keeping the overnight rate (follow it here) within target range. It’s pushing up against the top of its range, last week going within 8 basis points of the upper target of 2%. It’s never been that close to the upper bound before since interest rates bottomed out, and in order to lower the rate, the Fed has to go into the bond market and buy bonds and add them to its balance sheet, cancelling out much of the shrinkage on net. What’s pushing the overnight rate higher though is inflation in the US, which is now at 2.3% by the Fed’s preferred measure, up from 2% last month. If that keeps getting higher, short term rates will keep trending higher, forcing the Fed to buy even more bonds and to keep it low, eventually more bonds than it is currently selling in order to shrink its balance sheet. The effect is the stopping of the shrinkage of its balance sheet, and the dollar goes into a tailspin as the myth that the Fed is in control, is exposed.
At that point, and we are within months of this happening, probably a year at most, there will be earthquakes in markets across the world. As regards Macau, stocks could go either way initially, either higher in relief that the yuan has stopped falling, or lower in fear of the global economy. It’s very hard to tell what the initial reaction will be. Basically, now is not the time to take a gamble or try to pick the Macau bottom, not yet. In a month or two, a few more inflation reports out and with a more developed trade war and tariff net taking shape, we’ll have a much better idea of where the Chinese economy is headed and how it is weathering all this. For now, keep watching Macau and keep powder dry for the fall.