Feel Good About the Markets? Maybe You Shouldn’t Read This

By JAMES B. STEWART
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Traders outside the New York Stock Exchange. Investors have seemed oblivious to claims of Russian interference in the election, the firing of the F.B.I. director and other political turmoil. Credit Todd Heisler/The New York Times        


Throughout the turbulence of his first months in office, President Trump has been able to point to one bastion of support: the stock market. Earlier this month he tweeted the “great economic news” he thinks the mainstream media has been ignoring: The Dow Jones industrial average was up 16 percent and the Nasdaq up 19.5 percent since his election. Commerce Secretary Wilbur Ross maintained that the Trump administration had bestowed $4 trillion in gains on investors.
 
Investors have seemingly been oblivious to claims of Russian interference in the election, the firing of a director of the Federal Bureau of Investigation, and the appointment of a special prosecutor. As the second quarter ends this week, 2017 has so far been a banner year, with major indexes hitting records.
 
But as the bull market rolls on, some see storm clouds on the horizon. “Valuations are high and it’s one of the longest and largest bull markets in history,” said James Stack, president of InvesTech Research. “Bull markets don’t last forever. So the question is, when will the music stop?”
 
Investors “are on a knife’s edge,” said Michael J. Kelly, global head of asset allocation for PineBridge Investments. With many still scarred by the financial crisis, “they see a potential disaster around every corner.”

This month the so-called Faang stocks — Facebook, Amazon, Apple, Netflix and Google, which have led the market’s rally — faced a sudden downdraft, which many market watchers called a warning of turbulent times to come.
 
On June 14, the Federal Reserve raised short-term interest rates for the second time this year, a move that was widely expected and barely caused a market ripple. But more ominously for stock investors, the Fed also said it would reduce its $4.2 trillion balance sheet and taper its purchases of longer-term government bonds (though it didn’t say how fast), bringing to an end the quantitative easing it undertook after the financial crisis.
 
And then there’s Mr. Trump himself, whose unpredictability and erratic behavior still have the potential to rattle markets.
 
So I asked some prominent investors and market analysts whether they were pulling back from stocks, and how they viewed these latest developments.
 
A Crack in the Faang Stocks
 
After some of the Faang stocks plunged over 3 percent on June 9, Goldman Sachs compared them to the leading stocks of the tech bubble. But by the end of the month they’d recovered and were again approaching all-time highs.
 
There’s no question that these market darlings, which together have accounted for a disproportionate percentage of the market’s gains, are expensive, and getting more so. Price-to-earnings ratios range from 39 (Facebook) to 187 (Amazon). Their market caps are so huge they dominate the indexes.
 
They show up not only in so-called growth funds, but also in value and low-volatility funds. Should they embark on a sustained plunge, a bear market could quickly follow.
 
The tremor in June was “a warning shot across the bow,” said Bill Smead, the founder of Smead Capital Management in Seattle. The Faang stocks “are showing all the classic signs of being overcooked,” he added. “What magazine hasn’t had Jeff Bezos or Mark Zuckerberg on the cover?
 
There’s no question this can end very badly. But the market can stay irrational for a very long time.
 
My sense is that there’s one big blowout rally left in these stocks.”


Traders on the floor of the New York Stock Exchange this month as Janet Yellen announced the Fed’s decision to raise interest rates. Credit Drew Angerer/Getty Images       
 
 
Mr. Stack noted that the Faang stocks had brief sell-offs last June and October, only to rebound. Still, he said, “the Faang stocks will be among the hardest hit in the next bear market due to the amount of money that flowed into them and the high expectations that have driven them higher.”
 
But like Mr. Smead, he doesn’t expect that to be imminent. “We’re not buying them, but we’re not necessarily saying sell,” Mr. Stack said. He urged investors to rebalance portfolios that have become too heavily weighted in these stocks.
 
A Tightening Federal Reserve
 
Everyone I interviewed agreed that the Fed is the most likely catalyst for the next bear market, but that may still be years away.

“Historically it’s difficult to find a bear market that wasn’t triggered to some extent by the Fed,” Mr. Smead said. “But I don’t think unwinding the long bond position as gradually as they’re going to will have a significant impact. What would have an impact is if the Fed is forced to raise rates faster than everyone anticipates. The Fed has prepared investors for one more rate hike this year. That’s where the potential surprise could come. If we see two or three by year’s end, we’re going to see definite headwinds and maybe a market top of some significance.”
 
Mr. Kelly said the Fed had plenty of room to maneuver before stocks start to be affected. “We just had a once-in-70-year crisis that left very long scars. Businesses basically didn’t invest for eight years. In tightening, the Fed is acknowledging that a monetary policy built on a very fragile economic backdrop is no longer appropriate. But we’re just getting to the point now where people are crawling out of their shells and we’re seeing more normal economic activity.”
 
Mr. Kelly said bull markets typically last another three to four years after such a point in the economic cycle, and can even go another eight or nine. “Bull markets die from excess, not old age,” he said.
 
Mr. Smead agreed. “There’s no question we’re getting closer to normal rates,” he said. “That will be difficult for the stock market when it happens. People will be less willing to be adventurous. But that’s still years away.”
 
Over at InvesTech Research, “we’re still quite bullish,” Mr. Stack said. “We’re not increasing cash reserves. We are rebalancing towards more defensive and out-of-favor sectors, like consumer staples and health care.”
 
‘I Wouldn’t Call It a Trump Rally’
 
“The risks don’t lie with potential charges of obstruction of justice or even impeachment,” Mr. Stack said. “For political mayhem to upset the economic apple cart, it has to irreparably damage confidence at the consumer and business level. So far we don’t see that happening. Consumer confidence and consumer sentiment measures are at 16-year highs, and C.E.O. confidence in April was the highest since 2004.”
 
Nor have investors given up hope that a Republican Congress will still deliver business-friendly corporate tax reform and a pro-growth overhaul of the tax code, despite the president’s troubles.
At the same time, “Trump shouldn’t be looking to the market for vindication,” Mr. Smead said. “I wouldn’t call it a Trump rally. He’s basically riding on the Obama years. “
 
His bottom line: “We don’t pay much attention to politics, and that’s been a good thing.”


All In Til It Drops, Forget All Warnings; The Ultimate High Risk Game

By: Doug Wakefield


I have not posted to the blog recently since week by week equity markets continue to reflect "perfect calm". Don't get me wrong, banana peels and trends are building that could shift the landscape quickly.

Yet today, what we are watching is not only "perfection" in the S&P 500 and Dow, but in South Korea's Kospi Index, India's Nifty 50, and in Argentina's MelVal Index.

Do global headlines support a time of world peace and booming economic prosperity worldwide? Do they support a "perfect calm" in global stocks?

Think with me. Don't fall asleep from the continued drone of algorithmic calm.

Look at these four charts, developed by UBS and Citigroup found in two recent articles on Zero Hedge.

The Global Credit Impulse


Credit growth has fallen off a cliff. The "perfect" stock market view is not supported by "perfect" credit growth.

Is the solution even MORE debt? The Keynesian central bankers seem determined to outrun the largest stock bubble on record by printing their way out of this conundrum.

Central Banks Buy 1.5 Trillion in Assets YTD, ValueWalk, June 10, 2017

After 8 years and over 12 trillion in asset purchases between 2009 and 2016, central banking actions continue telling the crowd, "we have your back". Yet the reality of 2000-2002 and 2007-2009 make it clear there is no such thing as a permanent bailout.

These charts by Citigroup make it clear that the era of the "assisted" stock investor is facing the reality of a severe credit contraction.

Central Banks' Response to Lack of Inflation
Credit Fuelled Asset Price Inflation
China House Prices and European Equities


There is no "the market feels"; only "the computers reacted". Without someone's computers preset to trade at specific technical lines over and over again, the "perfect calm" would not exist. A crowd of humans worldwide could never be this precise.

June 9th was a yet another major warning to global equity investors. Ignoring so many fundamental and technical warnings is only increasing more system-wide risk. When the patterns change due to extreme crowding, the big shift will not present investors with much time to mentally and financially adjust.


G3 Central Bank Balance Sheet

For 6 weeks I have been adding to my longest newsletter since starting The Investor's Mind in 2006.

It is called "Ten 'Little' Dominoes". We finished domino #8 last week, with #9 being released next week. Click here to join those reading The Investor's Mind as we monitor these world trends, and seek to prepare for what lies ahead, rather than hope in more "assistance",


Dow Weekly Chart


On Leadership, Virtue and Vice

By George Friedman

 

Last week there was a fire in a high-rise building in London that killed dozens. British Prime Minister Theresa May was slow to issue a statement, and it was another day before she visited the scene – and then only to meet with members of the emergency services. It was not until day three that she paid a visit to the survivors. Her explanation was that she was busy overseeing the management of the disaster and therefore couldn’t go sooner. She was met by a storm of criticism.

Two questions arise from this affair. First, why would anyone think an empty gesture like visiting the site of a fire – no matter how many died – to be important? Perhaps the prime minister ought to be doing something productive? Second, why did May answer that she was busy overseeing the crisis? Exactly what was it about the disaster that she could oversee? She faced what seemed to be unreasonable condemnation and replied with a preposterous justification.

But it is the first question that I want to discuss because it raises another, more important question: that of leadership.
More Than Policy
The simple answer to the first question is that May ought to have visited the site of the fire because that’s what prime ministers do. They engage in gestures, and whatever they may privately feel or not feel, they show themselves to be grieving the dead. A prime minister, a president, a king or a queen represents the country at moments such as these, and their responsibility is to convey to the country the gravity of the event, the sorrow they feel, and that the state – personified by them – is not indifferent to the suffering of its citizens.
Members of the emergency services work inside the charred remains of the Grenfell Tower block in Kensington, west London, on June 17, 2017, follwing the June 14 fire at the residential building. TOLGA AKMEN/AFP/Getty Images
Even if the grief is posed, there is value in it. The philosopher La Rochefoucauld wrote that hypocrisy is the tribute that vice pays to virtue. Many of us are incapable of feeling the emotion we ought to feel. The reason is that, in some way, we are corrupt. But in pretending to feel it, we are validating virtue.

A leader must represent the best of us. May is not the head bureaucrat; she is a political leader, and the exercise of leadership is meant to display the virtues the nation ought to have. This is so important that the U.K. has two such leaders – the prime minister and the queen – both of whom are required to show what is appropriate and what the state feels, even if they don’t themselves feel it. A political leader must first lead, and in leading, gain the authority to make policy. A leader who wants to make policy and is indifferent to the task of leadership will fail. Policy is easy; leadership is hard.

The statue of Abraham Lincoln in Washington superbly grasps who we wanted Lincoln to be: a brooding, grieving figure who felt every death, on both sides, during the Civil War. Whether he actually felt that I don’t know. But he convinced the nation that he did. Otherwise, his statue would not have been built or honored. Lincoln understood that the country had to be healed, or the union, saved in battle, would be lost in peace. To heal it, he had to project to the country that the war was not only a tragedy but also a necessity. He also knew that there had to be a reconciliation. And for this reconciliation, the Confederacy could not be absolved, but those who fought for it had to be. Its soldiers had to be treated with honor – not for their beliefs, but because they believed deeply enough to die.

This is the purpose of leadership. A leader understands what is necessary. He also understands that governing, properly done, is a work of art. A leader paints a picture of who he is by what he says, by the gestures he makes and by framing an abiding concern for the nation. It is a concern that ought to be natural but in the greatest of politicians is crafted, sometimes in opposition to their nature. In our age, this would be the crime of inauthenticity. La Rochefoucauld would celebrate it since it is far harder to appear to be caring when you are not than it is to feel the things you ought to. But a leader who knows what is right and needed in spite of his nature does something much harder: He does what he should and not what he is inclined to do. And he does it in such a way that we can believe in his virtue, and through him, in our own.

A nation that does not feel itself as virtuous is wounded in its soul. When there is no leader who even goes to the trouble of appearing to understand what the virtue of a leader is, then the country itself loses its sense of virtue. When a leader cannot imagine leadership beyond expertise in policymaking, and sees the role of leadership as a trivial task, then we are in equal trouble.
The Art of Leadership
In focusing on the question of leadership, I am challenging one of the foundations of geopolitics. Geopolitics, as we interpret it, argues that nations are too vast to be ruled by any one person, particularly since no leader rules for very long compared to the life of a nation. For us, the course of nations can be best understood by ignoring presidents and prime ministers, and all the lesser figures, and focusing on the impersonal forces that shape millions of people and cause the nation to act in certain and predictable ways.

If this is true, then Lincoln’s leadership would be a matter of indifference. The North, having defeated the South, would inevitably have unified the nation. In fact, with Lincoln dead, the victors imposed Reconstruction, a relatively harsh regime that told the South that it had lost and would pay the price. Despite the absence of Lincoln’s sensibility after the war, the union survived. From this, it could be said that Lincoln was irrelevant.

But that assumes that geopolitics, as important as it is for my understanding of the world, would be all there is to public life; there is what will be and what can’t be, and that determines the rise and fall of nations. This is what geopolitics is about, and it matters. But nations also have an aesthetic sense of themselves. We live in a work of art crafted by the founders and leaders of the nation. It defines our sense of self, and without that sense, we rise and fall in a very squalid place. Lincoln crafted a picture of who Americans are, and it is not unfair to say it has been lost – by all factions of our polity. Nothing worth having has replaced it. America is a great power, but one with a troubled and hungry soul.

I began this with a trivial moment, in Britain, where a prime minister did not present herself at a fire and show the nation that it is proper to grieve. She answered that she had no time to go because she was busy managing things. She did not know that management is not the task of the prime minister – at least not until after she leads. And if she leads, management becomes easier. Her predecessor, Winston Churchill, knew this.

Churchills come rarely into the world, and truth be known, he was a fairly poor manager. But he gave Britain the sense that the world was filled with evil, and that that evil had to be destroyed. He also gave Britain the sense that it was not only worthy of the task, but that it should feel itself honored to be placed in the role. Britain might have been victorious without Churchill. But Churchill not only made it far easier to win, but he gave the victory a meaning of transcendent importance. He made Britain into a work of art and lifted it among the prosaic and squalid business of just surviving. He did not change history, but he imbued it with virtues that even the most wicked of people would have honored by their hypocrisy.


Global Blast-Off Trade Setup
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Global Blast-Off Trade Setup



Our analysis of the global markets and metals markets are prompting us to issue a warning that may not shock a number of our followers – but may surprise others.  We use a number of custom indicators, custom indexes and other specialized features to try to keep our valued members aware of moves before they happen at ActiveTradingPartners.com.  You may recall our recent article warning of a VIX spike between June 9th and June 13th in correlation with a US market correction (NASDAQ).  We nailed this and predicted another VIX spike on June 29th, 2017.

Are you ready for what might become the most opportunistic setup we’ve seen in over a decade?  Well, before we get to the guts of our incredible setup, let’s go over some other data to support our predictions – the global markets.

On May 3rd, 2017, we authored an article regarding Global Economic Shifts that were taking place as a result of Capital Migration and renewed risk factors throughout the global markets. 

Our hypothesis was that capital will always attempt to locate and migrate to financial environments where risk is mitigated and returns are sufficient.  We consider this an active and intrinsic role of global capital – the hunt for the ability to thrive and develop success/profits.

Since this research was completed, a number of new and interesting facets have evolved.  Two of the most interesting are the shifts within the Arabic nations with regards to Qatar and the almost total isolation recently enacted on this wealthy nation and the news from Europe that a number of smaller, regional banks are collapsing with broader, tangible relations to the EU banking system.  This type of disruption within a financial environment (think globally) causes capital to migrate rather quickly to more stable locations for self-preservation.

China/Asian markets appear to be developing a level of “moderately healthy financial environment” in terms of global market capital migration.  In the past, I would have warned that Asia/China could become a temporary safe-harbor for capital as it migrates out of riskier environments and I would still support that claim simple because China/Asia are less of a mature market compared to other.  Thus, the likelihood that China/Asia could see dramatic asset revaluation or some type of unexpected market function issues is still near the top of my list.  Yet, we can’t accurately predict when this will happen and until extended signs of weakness cause us to adopt a more concerned stance, we have to understand that capital will move to environments that seem suitable for success.  At this time, we believe China/Asia are viewed as just that – moderately suitable for capital deployment and investment (till things change).

Asia Chart

You will see from our chart that a defined support channel is in place and resistance bands appears to be setting up near the end of June and throughout September 2017.

Asia_Custom_Monthly_F


BRICs Chart

BRICS markets appear to have “rolled over”, as predicted, near resistance bands that indicate pricing levels may be setup for some level of correction.  It is our opinion that an 8~18% correction may be near as capital will likely migrate away from perceived increased risk and towards healthier environments.  This would put a downside target on this chart near $13k~$12.5k.

BRICS_Custom_Monthly_F

Europe Chart

The European markets appear to be at a critical juncture near a classic Fibonacci retracement pattern.  Many people do not understand one of the basic concepts of Fibonacci theory that is; price will always attempt to develop new higher highs or lower lows.  Keeping this in mind, any failure to develop higher highs in the European markets within the next 2~3 months will likely result in perceptions being that these markets are developing greater risk.  Thus, capital may migrate away from the uncertainty and risk towards healthier alternatives.
 
The European markets chart shows clear price channels that originated near July 2016 – the date Theresa May assumed the Prime Minister role.  It is interesting how the perception of an environment of strength, protection, leadership and opportunity can change the way capital migrates from different environments.  In this case, the disruption in Europe with May’s election victory changed the way people saw the future opportunities in Europe.
 
Now, with recent elections, banking issues, further debt issues and uncertainty with leadership, we can only assume that perception will change, again, towards an environment that is more risky and unstable – prompting capital migration away from these markets.

EU_Custom_Monthly_F


US charts

Meanwhile, on another continent…  The US markets appear to be the “Garden of Eden” in terms of capital migration.  It is true that the entire US/Canadian/Mexican conglomerate market is suitable and in perfect financial health, but it is also true that compared to many others, these market present the potential for the best and safest deployment of capital.  The charts show that capital appreciation has been tremendous since the US Presidential Elections and may launch much higher if extended risk exists in other global markets.
 
Again, capital is always searching for a safe and suitable environment for deployment.  Taken in global terms, there are really only two suitable locations for capital and the others are inherently more risky.  These conditions may change over the next few months, but our analysis points to one critical factor that could disrupt many aspects of this global capital environment.  One thing that could be related to a massively disruptive event.


US_Custom_Weekly_F

We are now at the point that you have been waiting for.  The incredibly disruptive and opportunistic setup that could change everything in the global markets (or so we hypothesize).  Before we get to the details, we want to make certain that you understand this type of research if far from 100% guaranteed or set in stone.  We develop our analysis based on a number of massively moving components within the global economy and are predicting price moves that may be weeks of month in advance.  We advise you to consider this a learning experiment in the sense that there is absolutely no way we can state with 100% certainty our research/analysis or conclusions will play out exactly as we suggest.  It is impossible for anyone to know what will or may happen, accurately, in the future.  That is what trading is all about – making an educated guess and protecting your trade.

Well, here it is, folks.  The setup/opportunity that may turn into the biggest move in the markets for the next century. 

METALS.

Think about this for just one minute. Given the knowledge that capital will migrate to sources of safety and investment return while avoiding environments that are risky.  And, given that we’ve made fairly clear points that much of the global is setting up for some levels of disruption, uncertainty and greater risk – leaving only China/Asia and the US as the safe-harbor capital environments.  We’ve also detailed how the China/Asia markets are setting up for disruption with technical resistance levels and exposure to other global environments. 

We’ve highlighted that Europe may enter a period of disruption and uncertainty with recent elections, debt, banking issues and more and illustrated that BRICs markets are rolling over as an early warning that emerging markets might contract as global capital migrates towards safer environments.  This is not doom and gloom stuff, this is just what happens when markets are disrupted.
 
Now, look at the setup in these custom metals index charts.  A clear Flag formation has setup near historical lows that is nearing the Pinnacle.  My analysis of this pattern shows that we are setup for one more lower price rotation before the rally begins.  One more attempt at buying near ultimate lows before we could see a massive, explosive rally capable of at least a 50%+ run.  Long term, this run could be much bigger..  much, much bigger.  Fibonacci theory shows the potential for 125% or 225% gains are easily posible.

Oddly enough, our research shows that this lower wave of metals prices should complete near or before June 29th.  Remember that date from the beginning of this article?  That’s right, this is the date that we predict would initiate a volatility spike (VIX Spike).  Just how big will this VIX spike be?  If our analysis is correct, the real VIX/volatility expansion won’t begin to happen till near the end of August or near the middle of September, 2017.
 
Our analysis shows that the Metals will begin to make a move near the end of June or early July 2017.  Our analysis also shows that the US and global markets will begin to see increased volatility near Aug/Sept 2017.  We also believe that any move in Metals will likely be the result of extended risk factors globally.

 


What Are the Odds of a U.S.-China War?

Handicapping whether the rise of one power inevitably leads to armed conflicto

By Andrew Browne

Is President Donald Trump’s vision for ‘America First’ on a collision course with Xi Jinping’s ‘China Dream’? Here, Mr. Trump welcomes the Chinese president at Mar-a-Lago in Palm Beach, Fla., on April 6. Photo: CARLOS BARRIA/REUTERS


SHANGHAI—Two fiery nationalists— Xi Jinping and Donald Trump —now occupy the seats of power in Beijing and Washington.

In their mission to make their countries great again, one pursues the “China Dream,” one “America First.” Both see the other as the chief obstacle to their ambition; they’re locked into a zero-sum competition.

Halting efforts to cooperate on North Korea have papered over deep tensions on a range of issues including the South China Sea.

Are the U.S. and China headed for war? That has been the recent hot question in China circles, spurred by a deluge of books that handicap the chances.

Graham Allison, the Harvard professor who popularized the term “Thucydides Trap” to describe the risk of conflict when a rising power challenges the incumbent, isn’t optimistic.

Thucydides, the Athenian historian and general, summarized the causes of the Peloponnesian War (431-404 B.C.) in a single line of a monumental history: It was the rise of Athens and the fear that this inspired in Sparta, he wrote, that made conflict inevitable.

War has resulted in 12 out of 16 similar setups over the past 500 years, Mr. Allison asserts, including Germany’s challenge to Britain that led to World War I.

In a new book that bears the ominous title “Destined for War: Can America and China Escape Thucydides’s Trap?” he lays out how conflicts over trade, the South China Sea or cyberspace could all spin out of control.

It is “frighteningly easy to develop scenarios in which American and Chinese soldiers are killing each other,” he writes

Nonsense, responds the noted Sinologist Arthur Waldron, a history professor at the University of Pennsylvania. War is by no means ordained.

In a caustic review of Mr. Allison’s book, he declares that the Thucydides Trap is a fallacy. Dig deeper into Thucydides’s text, he argues, and it becomes clear that Sparta, though warlike, tried to head off confrontation with Athens, at one point suggesting a simple compromise.

There’s much more here than an academic dispute over classical history.

Fundamentally, the two professors disagree in their estimates of China’s rise, and thus the severity of the challenge it represents to the U.S.-led order that has kept the peace since World War II.

Mr. Allison focuses on data showing China’s wealth and power soaring ever up.

Mr. Waldron dwells on figures that indicate China’s crippling vulnerabilities. He mentions chronic water shortages and energy wastage. Others point to an alarming surge in corporate debt and an aging population that could stall, or even reverse, growth.

Those who live in China, rather than observe it from afar, juggle both perspectives daily.

Inhale the toxic air in almost any city and it’s clear why wealthy Chinese are fleeing.

Yet, testifying to China’s creative energy are the fleets of emerald, blue and fluorescent orange bicycles that have overrun the same cities in a matter of months as multiple startups have jumped into a bike-sharing business powered by smartphone apps.

China is choking to death; China is vibrant. Both are true. Washington’s challenge is to make sense of these contradictions, and steer a policy course that avoids the extremes of capitulation and reckless belligerence.

The Obama administration was timid; Beijing seized the opportunity to start turning the South China Sea into a Chinese lake.

To the extent that the Trump administration has a China policy, it’s on hold due to North Korea.

Mr. Trump has suspended the verbal hostilities he unleashed on the campaign trail in hopes that his Chinese counterpart will use his influence to halt Pyongyang’s nuclear program. If, as seems likely, Mr. Xi can’t, or won’t, deliver a solution this truce could quickly crumble.

Influential voices are urging a hard line. Ely Ratner, a senior fellow at the U.S. Council on Foreign Relations, recommended last week the U.S. should consider basing troops on disputed South China Sea islands. Whether the White House takes that inflammatory suggestion, once its disillusion with Beijing’s North Korea efforts sets in, expect renewed bellicosity on issues from trade to Taiwan.

There’s little doubt about Chinese intentions. As the journalist Howard French points out in his erudite book “Everything Under the Heavens: How the Past Helps Shape China’s Push for Global Power,” China aspires to restore its position at the pinnacle of East Asia.

The coming decades, he writes, will involve “a certain amount of yielding to China.”

How much will depend on a fine understanding of Chinese capabilities. While China has made giant leaps in military technology—enough to strike U.S. aircraft carriers—it will become progressively harder and more expensive to advance further.

In a speech two years ago, Mr. Xi insisted that “there is no such thing as the so-called Thucydides trap.” But he went on to warn against strategic miscalculations by unnamed “major countries” that “might create such traps.”

The next few years will be perilous: The risks of conflict can’t simply be dismissed. Mr. Waldron, though, is confident that Chinese leaders would quickly smother any unintended conflict rather than escalate and risk their country’s ruin.

“They are, after all, not idiots,” he writes.