Shanghai Surprise

A trade war with no end in sight. A Fed sidelined by tariff inflation. An imploding U.S. dollar, further increasing inflation. Global markets that already crashed once in 2025. A mercurial president. Global policy uncertainty all time highs. At this permanent plateau of maximum risk and uncertainty, bulls see new highs.

Here we see hedge funds are playing catch-up with retail gamblers who have been buying all year long:

"Technology companies attracted the highest interest, with hedge funds accumulating the largest weekly number of net long positions in the sector in over five years"

Anyone who wants to view the manifestation of all of these risks need only shift their gaze away from the stock market to the Treasury bond market. Treasury bonds are manifesting all of the tariff inflation risk. And all of the dollar implosion risk. And all of the runaway deficit risk posed by Trump's "Big, beautiful" tax cut bill which is putting the U.S. at risk of default this summer if the bill doesn't get passed before Treasury runs out of money in a matter of weeks.

Today's stock bulls believe that bond yields can keep inexorably rising above 5% without impacting stocks. As we see below, Trump's first tax cut came in 2018 when inflation expectations were much lower and then it led to a spike in Treasury inflation expectations. Followed by a collapse in inflation expectations when stocks imploded -20% at the end of 2018. I expect the same thing to happen now. A spike in inflation expectations followed by a collapse in inflation expectations compliments of stock market collapse. In other words to reduce interest rates what the Fed needs is not lower egg prices, it needs lower asset prices.

I called this blog post "Shanghai Surprise" for a specific reason. Way back in 2015, hedge fund manager Hugh Hendry coined an interesting blog post to his shareholders called "Imagined Realities". In it he described a market environment dominated by global central banks which had incentivized undue risk seeking, wherein all investment was predicated upon false narratives. Hendry believed that a nimble trader could ride these false narratives to new highs and then exit cleanly ahead of the inevitable crash. When he penned that missive in early 2015 it directly preceded the vertical rally and collapse in Chinese stocks which Hendry said would be the focus of his investment that year. When Chinese stocks rolled over mid-year and exploded with extreme dislocation, I called it "Shanghai Surprise". Very few people got out ahead of time.

Now we see U.S. investors using the same inane logic of "Imagined realities" to justify buying into the riskiest markets of our lifetime. Only Trump could make an intractible trade war seem like a good buying opportunity.

What Trump doesn't know is that the Chinese are playing chess not checkers and they have no inention of capitulating so that Trump can take a victory lap ahead of the mid-term elections. The Chinese have been preparing for this moment since the last trade war in 2018:

"Strategically, Xi feels empowered to harden his position from Trump’s first term. The arsenal of trade tools China has built under He’s leadership, including export controls of critical materials used to make chips, cars and F-35 jets, gives it the ability to cause the U.S. real pain."

In other words, the U.S. is using import restrictions to cause China pain. Whereas China is using export restrictions to cause the U.S. pain. Both sides are feeling pain, but neither side is willing to capitulate.

China's housing market is already imploding, but now the U.S. housing market is starting to break.

"More than $330 billion worth of listings have been sitting on the market for 60 days or longer. Rising inventory and slow homebuying demand is pushing up the total dollar amount of home listings, and will push down home-sale prices by the end of the year."

In summary, the reason hedge funds are piling into Tech stocks at the fastest pace in five years, is because they have conflated a blow-off top for a new bull market. And that is what happens in a consensus of like-minded fools.