Hong Kong Is Now the Stock Market’s Biggest Source of Risk

President Donald Trump and General Secretary Xi Jinping pose for a bitter photo op.

Stocks are rising again today, prodded higher by new unemployment data that suggests the U.S. economy has finally “bottomed.”

2.1 million more unemployment claims were filed last week, boosting the total number to 40 million. The pace of the filings, however, has slowed considerably, dropping by almost 4 million from week-to-week.

The Dow (+0.4%), S&P (+0.4%), and Nasdaq Composite (+0.3%) are clinging to modest daily gains as a result.

To Bank of America CEO Brian Moynihan, that’s cause for celebration.

“You’re seeing us come out of the depths of where we were in April, and that’s good news.” Moynihan said this morning, adding that the U.S. economy is coming “out of the hole.”

The ongoing reopening efforts have galvanized many stocks over the last few sessions. Banks, in particular, did very well. The SPDRs Select Sector Financial ETF (NYSE: XLF), which tracks the top bank stocks, is up roughly 8.5% this week.

However, investors aren’t buying with nearly as much zeal as before, even after seeing improved unemployment statistics.

Are bulls simply running out of steam? Or, is it something else that’s keeping a lid on stocks?

The true cause of today’s muted gains is likely a mix of both.

The market appears overbought. Investors have already priced-in a rapid v-shaped recovery.

If one doesn’t materialize soon, stocks could easily give up their impressive May returns in a hurry.

But the other, non-coronavirus issue lurking under the surface could be even more devastating to the post-crash rally:

Hong Kong.

Yes, believe it or not, Hong Kong – the metropolitan area that boasts just 0.5% of China’s population but 2.7% of its GDP – is defying Beijing once again.

Last year, China attempted to pass an extradition bill that would slowly wrest control away from the special administrative region. “HKers” (people who reside in Hong Kong) took to the streets in protest. Both the Hong Kong police and Chinese enforcers were unable to control the local populace, and the bill was eventually withdrawn.

Today, the National People’s Congress (China’s parliament) approved a bill to impose a new national security law on Hong Kong. The NPC voted in favor of the bill 2,878 to 1. The 1, in this case, was likely told to vote “no” by Beijing to maintain some semblance of legitimacy.

Hong Kong has been ruled under a “one country, two systems” principle for years. It enjoys semi-independence from China, including election rights, self-governing powers, and separate legal and economic frameworks – all things the rest of mainland China doesn’t have.

The new bill seeks to “maintain national security” in Hong Kong. The details of the actual laws contained within remain unclear.

What is certain, however, is China’s expectation of Hong Kong’s government to enforce the new laws on its own. China wants to prevent protestors (whom the bill calls “terrorists”) from gathering and protesting.

Ironically, that’s exactly what’s happening in response to the security bill’s approval. Protestors are out en masse today, possibly in even larger numbers than last year.

And while that might seem like an obvious, if not counterproductive, misstep by Beijing, it’s also exactly what Xi Jinping & Co. intended.

China wants Hong Kong to fail. Beijing created this bill so that Hong Kong would be unable to enforce it. The Hong Kong police were completely overrun in the last round of demonstrations.

Just imagine how protestors will react now that they’ve been labeled as terrorists and are subject to new Chinese laws.

Once the protests get too out of control, and Hong Kong is forced to ask China for help, the Chinese government will swoop in to save the day. In this case, that would likely result in a further reduction of Hong Kong’s independence as China flexes its political muscle.

China has wanted more control over Hong Kong for decades, now. Mass protests (which, again, Beijing views as terrorism) could be China’s way of achieving that goal without angering the West.

There’s just one problem, however:

So long as Donald Trump is president, that won’t be allowed to happen.

And for investors expecting the COVID-19 rally to continue, that’s a potentially ruinous proposition. In the past, Trump has willingly sacrificed short-term stock market gains to wage (trade) war on China. Given Beijing’s past coronavirus coverup, plus Xi’s new gambit to absorb Hong Kong, Trump is almost certain to retaliate.

Even while America struggles to regain its economic balance.


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