Shanghai Meets The Bear.

After days of teetering on the edge, Chinese equities fell into a bear market on Tuesday amid the latest escalation in the burgeoning global trade conflict.

Reports that the U.S. is considering restrictions on Chinese investment in U.S. industries rocked global markets on Monday and attempts by Peter Navarro and Steve Mnuchin to walk back those reports offered little in the way of solace. Comments attributed to Xi Jinping by WSJ seem to tip Beijing’s readiness to see if Trump is more bark than bite.

All of that has weighed heavily on sentiment in China and the result is a 20% decline in five months for the SHCOMP, which seems to also be suffering from a perceived lack of “national team” (i.e., state) intervention to defend 3,000:

Sentiment in China is fragile amid the deleveraging push that many see as an effort that will drag on and affect liquidity and credit creation even as the PBoC steps in to manage the glide path with rate cuts and liquidity injections. Corporate defaults are a concern as is the yuan, which is sitting at its weakest against the dollar since December 20.

For their part, Goldman thinks an all-out credit crunch isn’t likely, but the following commentary from a note out Tuesday is worth a skim:

2018 has seen a meaningful increase in the volume of defaults in China’s domestic corporate bond market. We estimate that there have been 8 defaults so far this year, already exceeding the 7 defaults we saw for the whole of 2017. In terms of the notional amount of bonds outstanding, this has reached RMB42bn this year compared with RMB18bn last year (Exhibit 1). Not only have we seen bond market defaults, there have been a number of state-owned enterprises (SOE) and local government financing vehicles (LGFV) defaulting on their asset management plans. To a large extent, the increase in credit stresses is a reflection of the tighter financial sector regulations that have come into place which aim to curb shadow banking activities, which over the past several years have been one of the fastest growing sources of credit generation.

For the bargain hunters/falling-knife-catchers out there, the SHCOMP has been in oversold territory for what looks like at least five days now:

The index is also on pace for its worst monthly drop since January 2016, when deflation fears and the threat of more yuan depreciation had global markets reeling:

So go ahead and take a flyer on some A-shares if you like. Who knows, maybe Beijing will decide enough is enough and start intervening aggressively going forward. Or maybe they’ll just do what they did in 2015 after the margin-fueled equity bubble collapsed: arrest anyone who shorts stocks.

Whatever the case, it’s worth noting that this marks a stark contrast with the Russell 2000 and as SocGen’s Andrew Lapthorne wrote on Monday, “if Trump’s ‘Trade War’ is about rebalancing the prospects of US companies versus, say, China, then markets appear very much on message [as] the Russell has outperformed the CS300 by a remarkable 22% since the beginning of April”.