China: It just got worse – more bad news and more policy mistakes: http://t.co/h6pwguOJl9 #China #PBoC #EndOfTheDollarBloc @bill_easterly
— Lars Christensen (@MaMoMVPY) September 1, 2015
S&P 500: Dead cat bounce?
After Friday’s narrow consolidation between 1970 and 1990, S&P 500 September 2015 E-mini futures broke support at 1970, indicating moderate selling pressure.
Sound domestic economic performance is likely to ensure that the S&P 500 returns to its primary up-trend in the medium- to long-term, but upheaval in international financial markets may have sapped investor confidence in the short- to medium-term. The doji star on the daily chart reflects indecision. A close below 1970 would suggest another test of support at 1870, with respect of resistance at 2000 a bearish sign. A 21-day Twiggs Money Flow peak below zero would also warn of selling pressure. Follow-through above 2000 is less likely, but would indicate light selling and a snappy recovery.
NYSE volumes reflect the increase in activity, starting Friday August 21st, with daily volumes over 2 billion and short sales jumping to 800 million. It will be worth keeping an eye on short sales this week. Recovery above 600 million would warn of rising selling pressure.
China’s conundrum: Capital flight or deflation
China's conundrum: Selling FX reserves to support the yuan threatens deflation. But falling yuan fuels capital flight http://t.co/XGz6S4HPz6
— Colin Twiggs (@Colin_Twiggs) August 29, 2015
AND capital flight causes collapsing stock and real estate prices, which could lead to…… deflation.
Greece and Its Misguided Champions
From Michael G. Jacobides in Harvard Business Review:
….while some EU policies are punitive or counter-productive, the strength of opinion of pundits long on conviction and short on detail seems to ignore the real root cause of the crisis. This is that the Greek economy has become inward-looking, unproductive, incumbent-favouring, and rife with rent-seeking. They may also underestimate how Grexit would exacerbate many of the Greek pathologies at the root of the crisis.
Greece’s main problem isn’t its currency. Rather, it is that its Byzantine regulations and institutional uncertainties discourage investments and reduce competitive pressures. Grexit would further restrict available capital, shatter the fragile banking sector, and increase the investment gap, which, as McKinsey’s recent study shows, is the key issue.
Read more at Greece and Its Misguided Champions.
ASX during the 1997 Asian financial crisis
Performance of the All Ordinaries during the 1997 Asian financial crisis and ensuing Russian financial crisis in 1998.
The index gained 7.9% in 1997 and 7.5% in 1998 despite the upheaval in Asian markets. Australia is now a lot more reliant on exports to Asia, however, than in 1997/98.
Reversal of 13-week Twiggs Money Flow below zero warns of long-term selling pressure. Follow-through of the All Ords below 5000 would confirm a primary down-trend.
S&P 500 during the 1997 Asian financial crisis
Here is the performance of the S&P 500 during the 1997 Asian financial crisis and the ensuing Russian financial crisis in 1998.
The index gained 31% in 1997, and 26.7% in 1998, despite the upheaval in Asian markets. Global markets are nowadays a lot more interconnected, however, than in 1997/98.
All the same, gradual decline on 13-week Twiggs Money Flow suggests medium-term selling pressure — a secondary rather than a primary movement.
Shanghai: Stocks in free-fall
Dow Jones Shanghai Index broke support at 440. Expect more government efforts, near the close, to shore up support. As futile as attempting to hold back the tide. Target for the breakout is 330*.
* Target calculation: 440 – ( 550 – 440 ) = 330
Australian Dollar during the 1997 Asian financial crisis
Performance of the Australian Dollar during the Asian financial crisis. The falling Dollar acted as a buffer, protecting the Australian economy from the Asian contagion.
A similar 25% fall from today’s 72 US cents would offer a target of 54 US cents. No science to this. Simply speculation.
A bad case of the ‘nineties
The 1990s featured two significant upheavals in global financial markets. First, 1990 saw the Nikkei collapse from its high of 39000, reaching an eventual low of 7000 in 2008.
The collapse followed strong appreciation of the Yen after the September 1985 Plaza Accord and the ensuing October 1987 global stock market crash. The Plaza Accord attempted to curtail long-term currency manipulation by Japan who had built up foreign reserves — mainly through purchases of US Treasuries — to suppress appreciation of the Yen against the Dollar and maintain a current account surplus.
Seven years later, collapsing currencies during the 1997 Asian financial crisis destroyed fast-growing economies — with Thailand, South Korea and Indonesia experiencing 40%, 34% and 83% falls in (1998) GNP respectively — and eventually led to the 1998 Russian default and break up of the Soviet Union. Earlier, rapidly growing exports with currencies pegged to the Dollar brought a flood of offshore investment and easy credit into the Asian tigers. Attempts by the IMF to impose discipline and a string of bankruptcies spooked investors into a stampede for the exits. Falling exchange rates caused by the stampede led to a further spate of bankruptcies as domestic values of dollar-denominated debt skyrocketed. Attempts by central banks to shore up their currencies through raising interest rates failed to stem the outflow and further exacerbated the disaster, causing even more bankruptcies, with borrowers unable to meet higher interest charges.
What we are witnessing is a repeat of the nineties. This time it was China that attempted to ride the dragon, pegging its currency against the Dollar and amassing vast foreign reserves in order to suppress appreciation of the Yuan and boost exports. The Chinese economy benefited enormously from the vast trade surplus with the US, but those who live by the dragon die by the dragon. Restrictions on capital inflows into China may dampen the reaction, compared to the 1997 crisis, but are unlikely to negate it. The market will have its way.
Financial markets in the West are cushioned by floating exchange rates which act as an important shock-absorber against fluctuations in financial markets. The S&P 500 fell 13.5% in 1990 but only 3.5% in October 1997. The ensuing collapse of the ruble and failure of LTCM, however, caused another fall of 9.0% a year later. Not exactly a crisis, but unpleasant all the same.
North America
The domestic US economy slowed in the past few months but increased spending on light motor vehicles and housing suggested that robust employment growth would continue. Upheaval in financial markets (and exports) now appears likely to negate this, leading to a global market down-turn.
The S&P 500 breached primary support at 1980, signaling a primary down-trend. The index has fallen 4.5% from its earlier high and presents a medium-term target of 1830*. Decline of 13-week Twiggs Money Flow below zero would confirm the signal but descent has been gradual, suggesting medium-rather than long-term selling pressure.
* Target calculation: 1980 + ( 2130 – 1980 ) = 1830
The CBOE Volatility Index (VIX) spiked upwards indicating rising market risk.
Bellwether transport stock Fedex broke primary support at $164, confirming the primary down-trend signaled by 13-week Twiggs Money Flow reversal below zero. The fall warns of declining economic activity.
Canada’s TSX 60 broke primary support at 800, confirming the earlier bear signal from 13-week Twiggs Momentum reversal below zero. Target for a decline is 700*.
* Target calculation: 800 – ( 900 – 800 ) = 700
Europe selling
Germany’s DAX broke medium-term support at 10700. Expect further medium-term support at 10000 but reversal of 13-week Twiggs Money Flow below zero warns of selling pressure. Breach of 10000 would indicate a test of primary support at 9000.
* Target calculation: 10700 – ( 11800 – 10700 ) = 9600
The Footsie broke 6450, signaling a test of primary support at 6100. Reversal of 13-week Twiggs Money Flow below zero warns of (long-term) selling pressure. Breach of 6100 would offer a target of 5000**.
* Target calculation: 6450 – ( 6800 – 6450 ) = 6100 **Long-term: 6000 – ( 7000 – 6000 ) = 5000
Asia
The Shanghai Composite reflects artificial, state-backed support at 3500. Declining 13-week Twiggs Money Flow warns of long-term selling pressure. Withdrawal of government support is unlikely, but breach of 3400/3500 would cause a nineties-style collapse in stock prices.
* Target calculation: 4000 – ( 5000 – 4000 ) = 3000
Japan’s Nikkei 225 appears headed for a test of 19000. Breach would test primary support at 17000 but, given the scale of BOJ easing, respect is as likely and would indicate further consolidation between 19000 and 21000. Gradual decline of 13-week Twiggs Money Flow suggests medium-term selling pressure.
* Target calculation: 21000 + ( 21000 – 19000 ) = 23000
India’s Sensex is holding up well, with rising 13-week Twiggs Money Flow signaling medium-term buying pressure. Breakout above 28500 is unlikely but would indicate another test of 30000. Decline below 27000 would warn of a primary down-trend; confirmed if there is follow-through below 26500.
Australia
Commodity-rich Australian stocks are exposed to China and emerging markets. The only protection is the floating exchange rate which is likely to adjust downward to absorb the shock — as it did during the 1997 Asian crisis. 13-Week Twiggs Money Flow below zero warns of (long-term) selling pressure on the ASX 200. Breach of support at 5150 is likely and would confirm a primary down-trend. Long-term target for the decline is 4400*. Respect of primary support is unlikely, but would indicate consolidation above the support level rather than a rally.
China’s dangerous currency manipulation
I am surprised at John Mauldin’s view in his latest newsletter Playing the Chinese Trump Card:
….This whole myth that China has purposely kept their currency undervalued needs to be completely excised from the economic discussion. First off, the two largest currency-manipulating central banks currently at work in the world are (in order) the Bank of Japan and the European Central Bank. And two to four years ago the hands-down leading manipulator would have been the Federal Reserve of the United States.
John is correct that China has in recent years engaged in less quantitative easing than Japan, Europe and the US. And these activities are likely to weaken the respective currencies. But what he ignores is that these actions are puny compared to the $4.5 Trillion in foreign reserves that China has accumulated over the last decade. That is almost 2 years of goods and services imports — far in excess of the 3 months of imports considered prudent to guard against trade shocks. Arthur Laffer highlights this in his recent paper Currency Manipulation and its Distortion of Free Trade:
Accumulation of excessive foreign reserves is the favored technique employed by China, and Japan before that, to suppress currency appreciation over the last three decades. Dollar outflows through capital account, used to purchase US Treasuries and other quality government and quasi-government debt, are used to offset dollar inflows from exports. This allows the exporting state to maintain a prolonged trade imbalance without substantial appreciation of their currency. And forces the target (US) to sustain a prolonged trade deficit to offset the capital inflows. Laffer sums up currency manipulation as:
….. when a country either purchases or sells foreign currency with the intent to move the domestic currency away from equilibrium or to prevent it from moving towards equilibrium.
Even Paul Krugman (whose views I seldom agree with) has been wise to the problem for at least 5 years:
…..economist Paul Krugman and a group of senators led by New York Democrat Chuck Schumer wanted to impose a 25% tariff on Chinese imports.
Prolonged current account imbalances cause instability in global financial markets. A sustained US current account deficit was one of the primary weaknesses cited by Nouriel Roubini in his forecasts of the 2008 financial crisis (the other side of the equation was a sustained Chinese surplus). But currency manipulation is not only dangerous, it is also short-sighted. International trade is a zero-sum game. For every dollar of goods, services, capital or interest that goes out, a dollar of goods, services, capital or interest must come in. For every country that runs a current account surplus, another must run a deficit. Without international regulation, each country will try to engineer a trade surplus in order to boost their domestic economy at the expense of their trade partners. An endless game of beggar-thy-neighbor.
Participants will suffer long-term consequences. The power of financial markets is unstoppable. Central banks attempt to hold back the tide, distorting price signals and shoring up surpluses (or deficits), at their peril. The market will have its way and restore equilibrium in the long term. As Japan in the 1990s and Switzerland recently experienced, the further you move markets away from equilibrium the more powerful the opposing backlash will be. The scale of China’s market manipulation is unprecedented, and caused large-scale distortions in the US. The end result forced the Fed to embark on unprecedented quantitative easing which, in turn, is now impacting back on China.
The impact will not only be felt by China, as John points out:
The low rates and massive amounts of money created by quantitative easing in the US showed up in emerging markets, pushing down their rates and driving up their currencies and markets. Just as [governor of the Central Bank of India, Raghuram Rajan] (and I) predicted, once the quantitative easing was taken away, the tremors in the emerging markets began, and those waves are now breaking on our own shores. The putative culprit is China, but at the root of the problem are serious liquidity problems in emerging markets. China’s actions just heighten those concerns.
Chinese hopes for a soft landing are futile.