We bring up this lengthy intro because in his latest note, Nomura’s head of cross-asset strategy, Charlie McElligott, tackles the topic of the “global growth scare” which has gripped markets in recent weeks, and traces its origins not to the traditional market scapegoat, namely Trump’s trade rhetoric and actions, but a far more tangible concept: the collapse in China’s credit impulse.

Here is how McEliggott explains it in “Downshifting into a Growth Scare”

Tactical “risk (sentiment) downshift” message from last Monday’s note regarding the “market inflection” of the past month takes further hold, as the market trend deteriorates further and indicates a burgeoning “global growth scare”

• Clear signals of past month to “cut” directional “Cyclical Melt-Up” bets and get “tactical” / “market-neutral” grow even stronger last week / today, as we continue to transition into my expected “Financial Conditions Tightening” phase of 4Q18 / 1Q19—“risks” are accumulating and “red flags” are growing:
  • USTs / Rates rally further despite this month’s strong U.S. data and “hawkish hike” Fed, driving gradual covering in USTs from legacy CTA / trend ‘placeholder short’ positions
  • YTD Commodities rally (Classic late-cycle) now seeing “breakdown:” BCOM Total Return Index -5.1% over the past month / BCOM Industrial Metals TR Index -6.8% over the past month / BCOM Agricultural TR Index -10.5% over the past month
  • “Defensive” Equities now rallying powerfully over prior “Cyclical” leadership, while too we see MTD reversal in “Value” outperforming “Growth” as further signal of this very “late-cycle” market shift / rebalancing / rotation
  • QE-era “easy carry” plays such as Emerging Markets see further redemption unwind pressure, with largest EEM outflow ever last week (-$3.0B) and a -3SD sale of MSCI EM Equities futures by Asset Managers and Leveraged Funds (-$2.8B)
  • “Quant Insight” macro factor PCA model too picking-up on this “regime change,” with 9 of 18 “major markets” –tracked no longer “explained” by their prior macro price-drivers—previously a reliable signal of a potential “volatility event” over next 1-2m
  • Away from market-based indicators of said “risk (sentiment) downshift,” recent “dovish” policy pivots from the ECB and PBoC too signaling “growth downgrade”
• PBoC “easing” moves looking increasingly “frantic”: just this morning, they have 1) cut the SME loan relending rate, 2) made SME loans eligible as MLF collateral and 3) increased the SME loan relending quota to promote small businesses—all on top of 4) this weekend’s “as expected” RRR cut—and still we see Chinese (& Asian) equities sold overnight
• Chinese Equities looking increasingly as “patient zero,” with a double-whammy “growth scare” into the larger “QE to QT” regime shift: Shanghai Comp -9.8% QTD, Shenzhen Comp -14.4% QTD, Shanghai Property Index -8.1% QTD
• Chinese Yuan as another proxy for this “regime change”: the largest 8d weakening in offshore CNY vs USD (3.1 Standard Deviation move) since the “devaluation” shock of Aug ’15 ->PBoC is using the Yuan as their “weapon of choice” in the “tit-for-tat” of trade war rhetoric
• An escalation of / persistent weakening in the Chinese Yuan has potential to trigger a global “disinflationary impulse” via the supply-chain and contributing to further USD upside as a headwind to EM, Commodities and U.S. growth
• Asian EM “bleeding,” as “trade war” and overall “growth scare” impacts the psyche and drives “outflow” concerns: CNY, IDR, TWD, KRW and THB are the five worst-performing EMFX tracked by Bloomberg globally over the past week
• EM Equities underperformance analogs (especially vs Russell 2000) run by my colleague Anthony Antonucci speak VERY negatively over the next 6m period for both EM Equities and U.S. Small Caps, where using the current NDUEEGF underperf vs RTY (-18.2% over the past 3m) is a 1%ile return; prior -15.0% over 3m underperf analogs shows on average an EM Equities return of -7.3% / a RTY return of -5.2% over the following 6m period, respectively
• Market consensus now utterly focused on 2020 as U.S. “recession year,” with enormous interest from Cross-Asset / Macro funds in forward “Curve Cap” trades (reach out to set up a call on our favorite trade expressions)
• These curve options play for a “risk-off” UST curve STEEPENING due to inevitable U.S. economic deceleration (plus diminishing “half-life” of late-cycle U.S. fiscal stimulus) which would see FOMC normalization efforts pivot to “easing,” due to the impacts of recession and the much larger “secular stagnation” theme.

As noted in last Monday’s critical “phase shift” note, “signals” are accumulating which are indicative of the choppy transition in my “Two Speed Year” thesis: it seems that we are in the midst of the move from the “Cyclical Melt-Up” phase 1 to the “Financial Conditions Tightening” phase 2.

It is increasingly clear to me that China is the source of the this “new front” in the negative “QE -> QT” transition, as it seems we are in the midst of a good old-fashioned “growth scare” on top of the complications of tightening global financial conditions thanks to the Fed normalization efforts.The driver is likely the multi-year “deleveraging” efforts by the PBoC, which in turn is now bleeding into weaker domestic- and global- growth & inflation data.