NYSE short sales and daily volume are trending lower, suggesting that selling pressure is fading.
S&P 500: Market risk remains elevated
NYSE daily volume and short sales declined Thursday & Friday, indicating selling pressure is easing.
There is no sign yet on the daily chart, however, with 21-day Twiggs Money Flow respecting the zero line from below. Breach of support at 1900 would warn of another decline. Follow-through below 1870 would confirm. Recovery above 2000 is unlikely at present, but would suggest that the correction is over.
Daily VIX indicates market risk remains elevated.
The market is closed Monday 7th for Labor Day.
NYSE short selling rises
NYSE short sales and daily volume dipped slightly on Wednesday but remain elevated, warning of selling pressure.
NYSE Short Sales
NYSE short sales and daily volume are only published 24 hours after the close of trade, but are still a useful indication of where the market is headed. Short sales over 500 million on Monday, remain elevated. Keep an eye out for any increase above 600 million this week — which would warn of rising selling pressure and a likely breach of support.
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.
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.
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.
Public Debt and the Long-Run Neutral Real Interest Rate | Narayana Kocherlakota
Extract from a speech by Narayana Kocherlakota, President of the Federal Reserve Bank of Minneapolis, in Seoul, South Korea on August 19, 2015:
There has been a significant decline in the long-run neutral real interest rate in the United States over the past few years.
This decline in the long-run neutral real interest rate increases the future likelihood that the FOMC will be unable to achieve its objectives because of financial instability or because of a binding lower bound on the nominal interest rate. Plausible economic models imply that the fiscal authority can mitigate this problem by issuing more public debt, although such issuance is not without cost. It is, of course, the province of the fiscal authority to determine whether those costs are worth the benefits that I’ve emphasized…
How we got in this mess
There are two critically important price signals in the economy — the interest rate and the exchange rate. Tampering with them encourages distortions, leading to instability.
- The Austrians were right: allow market forces of supply and demand to set a neutral interest rate.
- The main function of regulators should be to ensure that debt growth is consistent with economic (GDP) growth else the banks can distort the supply of money by excessive debt creation.
- The Austrians are also right about not running consistent fiscal deficits.
- The other important element is to avoid consistent current account deficits to achieve a fair exchange rate.
None of these (in my view) sensible guidelines have been adhered to for the last half-century. Financial markets are in a real mess and Austrian “hands-off” policies are now insufficient to get us out of it. The only real alternative is to employ “hair of the dog” remedies advocated by Keynes: run fiscal deficits, increase public debt and distort real interest rates. Remember that Keynes published his General Theory in 1936 when financial markets were in an even bigger mess. Even a broken clock is right twice a day (or twice a century in Keynes case).
As for the Monetarists, Market Monetarists present the best opportunity to get us out of this “Keynesian hell” and set us on the path to Austrian (and Monetarist) utopia.
Read more of Narayana Kocherlakota’s speech at Public Debt and the Long-Run Neutral Real Interest Rate | Federal Reserve Bank of Minneapolis.
Currency Manipulation and its Distortion of Free Trade | A B Laffer
Extract from Arthur B. Laffer’s paper on currency manipulation:
….Successful currency manipulation inhibits the exchange rate from acting as an automatic stabilizer to macroeconomic events, and thereby leads to growth and trade imbalances. Currency manipulation has therefore, in part, inhibited the world from fully recovering from the financial crisis. For instance, real growth has been tepid at best for developed countries that do not intervene in the foreign exchange market, while countries that have been identified as currency interventionists have experienced a much steadier pace of recovery from the financial crisis—this has been dubbed as the two-speed global recovery.
The two-speed recovery has shown, in part, that persistent currency undervaluation has benefited the currency manipulators at the expense of countries allowing the flexible adjustment of exchange rates, since the latters’ export-related activities must quickly respond to the external balances caused by trading partners’ currency devaluations. As of 2012, the scope of currency manipulation is estimated to be approximately $1.5 trillion per year, with about 60 percent of these flows channeling into dollar assets. Moreover, the impact of currency manipulation has potentially dampened the U.S. current account by about 4 percent of GDP in 2012, which was approximately the size of the U.S. output gap in the corresponding year. While providing an exact number of U.S. jobs lost due directly to currency manipulation is tricky, it is likely that millions of jobs in the U.S. were lost as a result of current account imbalances that were generated, in part, by currency manipulation.
These spillover effects would likely disappear if exchange rates were liberalized to better exhibit market fundamentals, which would also potentially improve welfare in undervalued currencies’ economies by improving domestic demand. In fact, further movement toward freely floating exchange rates and the removal of capital account restrictions will help rebalance global growth, which in turn will reduce financial and economic risk. Moreover, research has found that future financial crises can be, in part, predicted by large current account imbalances as such distortions suggest the misallocation of capital. In fact, earlier studies from Laffer Associates confirm this link between current account imbalances and financial crises helped explain the Asian currency crisis in the late 1990’s.
Considering the employment and economic impact of currency manipulation on the United States and given that the United States is negotiating a free trade agreement, the Trans-Pacific Partnership (TPP), to avoid further harm and ensure the agreement’s benefits aren’t undermined by countries that have a history of manipulating their currencies, it is vital that the TPP include defined monetary policy standards and a means to identify currency manipulators and enforce violations…..
Read more at Currency Manipulation and its Distortion of Free Trade | A B Laffer