Under Threat
Capital markets were on the receiving end of an abrupt reminder on Friday that the confrontation between the U.S. and China is ongoing when President Trump released the following X post regarding Chinese trade restrictions on critical minerals it controls:
Risk assets were rightfully rattled by the announcement to ramp up tariffs by another 100%, which in effect renders almost all imports from China for U.S. purposes as uncompetitive and ultimately acts as an embargo on future inbound shipments should this go into effect. The S&P 500 sold off by more than 220 points from its intraday high and ended up closing down -2.7% on Friday. The Nasdaq decline was even more aggressive at -3.5%, the small-cap Russell 2000 plunged 3.0%, and the Dow fared best with a drop of 1.9%. It’s no surprise that gold rallied more than 1% on Friday and Treasury yields fell (bonds rallied), given the potential negative impact this would have on economic growth, but I was surprised to see the U.S. dollar fall by 0.5%.
Look, I’m structurally negative on all fiat currencies relative to real assets, but seeing the U.S. dollar (which is still the world’s reserve currency, for now) trade down on a big risk-off day like Friday reinforces to me the degree to which the U.S. economy's fate is tied to the stock market. Bitcoin showed once again that it lacks the portfolio diversifying characteristics that gold provides, in that it got whacked -3.6%. I’m not implying that Bitcoin should not be a part of a diversified portfolio, but for now, its correlation is more tied to the Nasdaq than any other asset class and therefore should be evaluated with this relationship in mind when analyzing the risk/reward profile of an investment portfolio.
Jumping ahead to today for a moment, where capital markets are in recovery mode from Friday’s black eye following what I describe as an intentionally soothing X post by President Trump Sunday afternoon:
This administration knows all too well the importance of the equity market to businesses, households, and fiscal policy; therefore, it should come as no surprise that they know how, what, and when to make remarks to manipulate the trading algorithms. In my view, the path of reason remains the highest probability outcome, as neither the US nor China benefits from a sharp acceleration in their respective strategic decoupling processes. Recall that earlier this spring, the US and China escalated tariffs to at least 125% on both sides before reaching a deal to revert to current levels, which are 10% Chinese tariffs on US goods and combined 30% US tariffs on Chinese imports atop preexisting levies.
However, don’t mistake my optimism or even hope that this clash between the globe’s two strongest economies can be ironed out without some collateral damage. China has set its sights on catching up to and overtaking the U.S. in terms of economic significance and power for decades. Most recently, with its “Made in China 2025” (MIC2025) strategic plan launched back in 2015. I asked Google’s AI engine “Gemini” to summarize the MIC2025 initiative and this is what it came up with:
1.Core Goal: Transition from "World's Factory" to "High-Tech Powerhouse"
The central aim is to move China's economy away from being primarily a producer of cheap, low-tech goods (the "World's Factory") to becoming a global leader in high-end, innovative, and smart manufacturing.
Key Objectives:
Reduce Reliance on Foreign Technology: A major target is to increase the Chinese domestic content of core components and materials, with an explicit goal of reaching 70% by 2025.
Increase Innovation and Quality: Promote an innovation-driven approach, emphasizing product quality, efficiency, and integrating information technology into manufacturing (smart manufacturing).
Establish Global Competitiveness: Cultivate powerful Chinese multinational companies that can compete—and dominate—in global high-tech markets.
2. Focus Areas (10 Key Sectors)
The plan prioritizes significant state investment, support, and resources toward developing self-sufficiency and world-class capabilities in ten strategic sectors:
1. New Advanced Information Technology (e.g., AI, 5G, Big Data, semiconductors)
2. Automated Machine Tools and Robotics
3. Aerospace and Aeronautical Equipment
4. Maritime Equipment and High-Tech Shipping
5. Modern Rail Transport Equipment
6. New-Energy Vehicles (NEVs) (e.g., electric and hybrid cars)
7. Power Equipment
8. Agricultural Equipment
9. New Materials (e.g., advanced alloys, rare earth elements)
10. Biopharma and Advanced Medical Products
3. Strategy and Implementation
MIC2025 is a long-term plan that is the first phase of a three-step strategy aiming for China to be a world manufacturing and technological leader by 2049. Its implementation is heavily state-directed, leveraging:
Financial Support: Providing massive subsidies, low-interest loans, and state-backed funds (e.g., the National Integrated Circuit Industry Investment Fund) to key domestic companies.
Talent Cultivation: Investing heavily in education and training to create a skilled workforce.
Smart Manufacturing: Promoting the use of the Internet of Things, wireless sensors, and digitalization to improve manufacturing processes.
4. International Context and Impact
MIC2025 has been a source of significant global tension and scrutiny, particularly from the United States and the European Union:
Concerns: Foreign governments and industry groups have raised concerns that the initiative uses state subsidies and practices that distort global competition, encourage intellectual property theft, and force technology transfer from foreign companies to gain access to the Chinese market.
Trade Response: The strategy is a primary underlying factor in the escalating trade and technology disputes, including the imposition of tariffs and export controls by the U.S. and other nations to limit China's progress in specific high-tech areas like semiconductors.
Based on my research over the past decade in various regions of the world, U.S. economics, and various industries, I surmise that China has made tremendous progress in achieving many of its targeted initiatives. They are the only country that has a tech industry that can compete with U.S. tech monopolies. Every auto analyst I speak with about the automobile industry, in particular EVs and autonomous driving, is adamant that China is running circles around U.S. manufacturers. Ford CEO Jim Farley has proclaimed as much about the Chinese EV Industry, saying they are “far superior” to Western manufacturers in terms of ‘cost advantage’, ‘quality’, and ‘in-vehicle technology’.
“The Chinese EV sector is the 700-pound gorilla of the industry…”, noting that 70% of all EVs are made in China and are rapidly dominating the global EV landscape.
“We are in a global competition with China, and it’s not just EVs. And if we lose this, we do not have a future Ford…”, calling the progress of the Chinese industry “the most humbling thing I have ever seen.”
There are other industries I could highlight (Aerospace, shipbuilding, railways…), but I’m going to end with the dominance they command in the critical minerals (rare earth metals) space. The following tables speak for themselves in defining the leverage China has in this confrontation with the U.S.:
This isn’t to say the U.S. doesn’t have its own leverage points as well, but what I see playing out in real-time is a wake-up call to U.S. policymakers and business leaders, where action needs to be taken to remove how vulnerable and dependent various aspects of U.S. national security have become. We can’t continue to expect China to send us rare-earth magnets to fabricate high-end tech and defense weapons that we could use to fight a kinetic war against them. Not implying it will get to that point, but we can all be pretty confident that it would be a ‘hard no' from China on rare earth shipments well before we got there. I thought the following X post from Aaron Slodov was on point in summarizing the setup:
What is important to note is the timeline Aaron alluded to, a ‘5-10 years minimum’ to build out alternative supply chains in some of these industries. Take germanium and gallium, for example, which are two critical minerals key to the fabrication of infrared optics, thermal imaging, fiber optics, solar cells, electronics, and semiconductors. Many of these use cases are for military applications, yet China controls nearly 98% of the global supply. Now we’re starting to comprehend how nuanced our Western skewed view is that ‘global free trade’ prevails over ‘all’. Not necessarily, and such blind belief in efficiency and optimization over security and self-reliance has left U.S. industrial policy and national security in a very fragile position.
Look, it’s above my paygrade to provide a comprehensive analysis and conclusion on a command economy vs an economy governed by democracy, but make no mistake, this difference is at the core of this conflict. From all I read, I’d much rather live in a functioning democracy (some might dispute it is functioning at the moment), but I make such a claim out of ignorance, admittedly, having never lived in a Communist regime. This isn’t a statement to be cute, but rather showcase my ignorance in terms of rendering opinions as facts which we Westerner’s are great at doing given our lot in life. Given what I’ve observed and analyzed through empirical research it’s hard to ignore the effectiveness of China’s model at competing away America’s once great manufacturing prowess. I’m confident we can get it back, but it won’t be easy and will not happen overnight.
I think the challenges, vulnerabilities, and fragilities we’ve uncovered over the past two decades that are coming to a head today are solvable. But not without patience, courage, time, and the fortitude to endure some periods of discomfort. Over the past three administrations, policymakers have become more aware of these issues, each taking incremental steps to address these challenges. But I think we are nearing that point where what was playing out ‘slowly’ is morphing into ‘all-at-once’. Treasury Secretary Bessent reiterated this administration's strategy to address these challenges at a Community Banking conference held by the Federal Reserve last Thursday:
“When I went to see President Trump approximately two years ago to tell him that I'd like to come out from behind my desk and get involved with the campaign. Not going to repeat many private conversations, but this was particularly notable. He looked at me, first thing he said, Scott, how are we going to get the debt and deficits down and not cause a recession? And we're on our way.”
“[T]he President's economic policy, as many of you would have seen me say before, is a three-legged stool. Trade, tax, and deregulation. The tax bill, the one big beautiful bill, has incentives for both corporate America in terms of full expensing for plant property and equipment, and the plant part is new. In the Tax Cuts and Job Act 2017 there was full expensing for equipment but we have added structures for both industrial structures and, importantly, agricultural structures. Secondly, on the other side of the ledger, it also includes the President's tax policies or campaign promises for working Americans. No tax on tips, no tax on overtime, low tax on Social Security and interest deductibility if you buy an American car. I think one of the things that we are seeing now, most taxpayers have not changed their withholding stance to reflect this. So we expect to see substantial tax refunds beginning of next year which I think will be accrued to lower end consumers for the bottom 50% who need the relief and concurrently they will change their withholding schedule so their real take home pay will be higher next year.”
“And then finally on deregulation, we talked a lot about financial deregulation, but we're also talking about energy and industrial deregulation. We're trying to make it easy to build things here again in America, whether it's permitting for factories, for pipelines, for the electric grid. So I think I'm very optimistic that 2026 could be a very good year across the corporate and the consumer economy.”
“Now allow me to close with a call for action. Before President Trump took office, community banks spent days, decades on the defense. But under President Trump's leadership, the game has changed. The playing field will be even more even. The ball is in your hands again. What happens next is up to you. So my advice, go on the offense, retake market share, chase after customers, champion technology, leverage the new regulatory landscape to your advantage, and expand your role in the American economy. The community bank comeback will help pave the way for America's golden age. Recognize the outsized role you play in this effort and embrace it. Because if you lead the way, Main Street will follow. Thank you.”
Okay, Corey, let’s get down to brass tacks. What are the implications for markets? I’ll start my answer with the notion that the setup is fluid and requires mental flexibility to be adaptable to a heavy degree of nuance along the way. Policy will play an important role, which includes the transition we’ve seen from ‘monetary policy’ dominating market and economic outcomes to ‘fiscal dominance’, where the Fed now plays a supporting role to the Treasury Department. This is one of the major drivers behind the move we are seeing in gold over the past two years. Gold first broke above $1,000 per ounce over fifteen years ago on the back of the Bernanke QE program. It then broke above $2,000 per ounce during COVID-19 when the Fed cut rates back to zero, reinstated QE, and the U.S. government implemented a massive fiscal bailout. Then gold broke the $3,000 level in April in response to the Trump tariff war, and just recently surpassed $4,000 as the tailwinds of policy uncertainty, fiscal excess, and currency debasement gain momentum. All the while, global central banks have embarked on what can only be described as the “Great Reallocation” as it pertains to the ongoing shift in FX reserves towards bullion, and this is a critical driving force. You never want to bet against price-insensitive entities with extremely deep pockets.
But it’s not just gold enjoying the party, as silver, platinum, palladium, copper, and rare earth metals have skyrocketed. Additionally, we’ve seen companies geared toward mining and processing these resources handily outperform the S&P 500 in 2025. The chart below is one I pull up on a daily basis and speaks for itself in terms of where the real money has been made this year. I would not at all be surprised to see a correction because the charts of gold, gold miners, uranium miners, and copper miners look parabolic, but I remain of the view that the secular bull market is intact.
According to our work, the investment themes of AI, U.S. industrial renaissance, power generation, grid electrification, and currency debasement overlap significantly. You do not need to just own the Mag7 names to participate, but keep in mind this street runs both ways. If they are rallying together then it’s reasonable to expect that they will fall together when/if the market experiences some downside volatility. However, I will admit that the AI trade and concentration within the S&P 500 has me a bit nervous. Not that these aren’t some of the strongest and most fundamentally sound businesses the world has to offer, nor that they don’t continue to put up strong numbers. Furthermore, the scale of the data-center expansion is so large that it is stretching the ability of the U.S. to provide enough electricity, backup generators, and other equipment, which is carrying over to the utilities and natural resource markets. But you can’t ignore the fact that the top eight stocks in the S&P 500 and Nasdaq 100 have become identical – one is just more concentrated than the other (table compliments of Jim Bianco).
Bottom line, I think it’s as important as ever for investors to maintain discipline and use diversification to their benefit. Back in the decade following the GFC, when central banks had interest rates nailed to the floor, diversification was a drag on portfolio returns, but not anymore. Today, investors can benefit from the shift from a unipolar to a multipolar world by having some exposure to foreign equities. Commodities and energy provide a hedge to inflation, along with exposure to the resource demands from AI, nationalism, and a shift in globalization from efficiency to redundancy. Even though it will continue to be debased at a rate of about 6% per annum, bonds and some cash provide stability, decent income at current interest rate levels, and optionality to take advantage of opportunities when they present themselves. Most importantly, have a process and a strategy that removes the emotional impulse to make rash decisions on days like last Friday.
Now, more than ever, we must always question the headline:
Have we been overly exposed to the U.S.’s perspective of China?
Looking ahead, Q3 earnings season kicks off this week with the big banks JP Morgan, Goldman Sachs, Wells Fargo, and Citigroup releasing results on Tuesday. Bank of America and Morgan Stanley report on Wednesday, with the world’s largest contract chipmaker (Taiwan Semiconductor) reporting results on Thursday, and finally American Express on Friday which will give us an update on those consumers on the upper end of the K-shaped income strata. With the dearth of economic data as a result of the government shutdown running into its second week, earnings will be of particular importance. Consensus estimates from the analyst community are looking for EPS growth to slow to +8% from Q2’s +11% pace. However, it is expected that Tech will once again being contributing the bulk of the YoY gains (+20% vs. +3% for the rest of the index). While analysts have been reluctant to cut estimates going into Q3 results, I don’t think the bar is too high, and think the risk of disappointment is fairly low.
The articles and opinions in "Capital Market Musings and Commentary" are for general information only, and not intended to provide specific investment advice. Performance, dividends and other figures have been obtained from sources believed reliable but have not been audited and cannot be guaranteed. Past performance does not ensure future results. Investing inherently contains risk including loss of principle. Advisory services offered through Casilio Leitch Investments, an SEC registered investment advisor.
Copyright © 2023 Casilio Leitch Investments. All Rights Reserved.