FYI | Feb 22 2010
(This story was initially published on Wednesday, February 17, 2010. It has now been republished to make it available to non-paying members at FNArena and readers elsewhere).
Today I received what I thought was an interesting question from Mark, who's a professional investor working for an asset manager with an international profile in Sydney. I thought I'd share my response with you all this week.
Mark asked me about my thoughts on when financial markets would be ready to leave Greece and sovereign default fears behind and start concentrating on strong company results, both here as in the US?
In line with what I wrote last week, I responded that I think too many people assume Greece is all that is keeping equity markets below the levels seen in early January. This may be true in the very short term, as in: we may see a rally for a day or two whenever there is a positive development in Europe, but is Greece really the only problem investors should be focusing on?
I think the problem in the background, the one that is hardly receiving any attention at the moment, is one of receding economic momentum. In Australia, for example, economists look at the very firm data that continue to come from the local labour market, data that are without any discussion impressive. And consumer spirits seem to remain upbeat, and so are business leaders.
But then again, National Australia Bank's January survey showed an unexpectedly large fall in business conditions. In fact, that fall was so large and out of synch with the overall trend throughout 2009 that some economists labelled it a probable statistical aberration. But as I pointed out last week, other data had been rather weak as well. And today's leading indicator release by Westpac -enormously strong- also suggests the availability for credit overall remains a problem.
Maybe, I suggested earlier today, maybe there is an underlying trend here: maybe indicators for January are somewhat less buoyant than those for December. This would not necessarily be a problem, as long as this doesn't become a new trend. Were the same to happen in economies such as the UK and most of Europe, investors might not be so kind to their equity exposures.
Taken from this perspective, some recent data releases from the UK and Europe have been absolutely dismal. Up to the point where I suspect that share markets haven't responded in a more negative manner because they already had been under the pump because of the Greece-factor. But consider, for instance, that the UK has only managed to put an end to negative GDP growth by the tiniest of all possible margins: 0.1%. One would hope the next revision doesn't slice anything off because that would automatically mean the UK still is in recession (or at zero growth).
And Europe's last GDP figure was effectively saved by France, with the eurozone's Q4 GDP also printing 0.1% growth. This was down from 0.3% in the previous quarter. The big question hanging over Europe now is: what if the next quarter is further down again? It would re-open the public debate about whether the economic recovery is a genuine one, at least in Europe.
Combined, Europe might represent the largest economic entity of our time, but there simply is no discussion: the most important economies remain those in the US and China. This is why the overall response from global financial markets to the problems in Greece and wider Europe has remained relatively muted. But China is tightening and regardless of whether investors like it or not, more tightening is around the corner. Economists at Standard Chartered suggested last week the central bank in China will continue raising the reserve requirements for banks every month this year.
The bulls in the market continue to tell us: it doesn't matter, it is a good thing for the longer term. That is more likely true than not, but the fact remains that for now Chinese authorities are focused on slowing down growth and asset prices, and they will achieve their goal. We have yet to find out how exactly this story will develop in the months ahead, but in its core the China story in 2010 can simply be summarised as: slowing down growth.
And the US? Well, it seems like growth in the US is about to hit some speed bumps too. Last week I reported proprietary leading indicators from IHS Global are indicating US GDP growth is likely to peak in the first months of 2010 and then gradually taper off by mid-year. Since then researchers at the Economic Cycle Research Institute, otherwise known as ECRI, have confirmed this is their view too.
Why do I mention ECRI? Because the Institute is making some big claims (see their website www.businesscycle.com) in that they correctly predicted the recession of 2000 and the subsequent recovery in 2002, as well as the next recession in March 2009 and the subsequent recovery in April last year. I have to also mention that various experts have publicly doubted these claims recently, but this has triggered responses from others, including economists and professional traders in the US, that they made correct decisions, and profits, on the basis of those ECRI predictions.
Now ECRI is forecasting that US growth will experience a pullback around mid-year. The so-called ECRI Weekly Leading Index has been on a gradual decline since late November and is now generating the lowest reading since a year and a half ago.
The message from both IHS Global and ECRI is: expect robust growth in Q1, but beware for the weakness that follows next.
In terms of share market direction, this week may prove to be a very important one. Regardless of the low volumes in February, global equities and commodities have put in some big rallies recently (after seemingly staring into the abyss) and various chartists are turning more positive every day. A term that is commonly used these days is "bear trap" – was the correction between mid-January and mid-February nothing but a bear trap?
If this is the case equity markets and commodities should surge through key technical resistance levels between now and the end of the month. If they do, more and more money will flow into these markets and this in itself should ensure another extension to this week's advances.
The level that is currently on everyone's radar is 10,300 for the Dow Jones Industrial Average and 1100 for the S&P500. If these levels are broken, chartists predict both indices will go hunting for 10,750 and 1150 respectively.
In Australia, the ASX200 managed to surge through technical resistance at 4650 today, and close above it. The next target should be 5000 (again).
These levels have grown significantly in importance since equity indices tried to reach for them in January, and failed. Investors should watch two indicators that are often being watched closely by technical chartists:
1.) will equity indices manage to reach higher than last time? (If not, this should be regarded a bearish signal)
2.) will indices manage to break and close above these resistance levels? (If not, we are experiencing a so-called double top, which is bearish too)
3.) the most bearish scenario is one whereby the rally falls short in making a new high and subsequently retreats below the lows seen in the recent pullback
From a fundamental perspective I see clear support from bargain hunters at the low levels we saw over the past few weeks. But that, however, doesn't tell us anything about what will happen the next time we (might) fall back to these levels again. Were this to happen amidst an overall weakening economic environment, support may not be as ready and forthcoming as it was in this month.
One observation that deserves to be highlighted, in my view, is that currency movements have clearly led risk assets this year and it would appear that what was supporting the US dollar earlier (too many people positioned short) has now switched in favour of the euro (too many people went short from mid-January onwards). As such, the euro was always due for a bounce, which in return allowed equities and commodities to put in strong rallies.
It does, however, put a big question mark over what is really happening in today's markets, and about the sustainability of it all.
Only one way to find out.
I recommend subscribers also read this week's Weekly Insights "How Much Should Investors Pay? "
With these thoughts I leave you all,
Till next week!
Your editor,
Rudi Filapek-Vandyck
(as always firmly supported by the Ab Fab team at FNArena)
P.S. I – The chart below, courtesy of Glushkin Sheff's David Rosenberg, is quite disconcerting, no matter how hard market bulls try to look in another directions. American banks are not lending. Can the US economic recovery be sustained without banks lending?
P.S. II – Luke Slattery, Co-Founder of Movember (the reason why guys grow a moustache for charity in November each year) will be speaking at the inaugural Boardroom Radio Entrepreneur LIVE Series on Friday 26th February at the Commonwealth Bank auditorium in Sydney. This is a lunchtime presentation of 20 minutes followed by 20 minutes Q&A. Standard price to attend the event (incl. lunch) is $20.
However, if you are a subscriber to FNArena and you would like to attend, here's a special offer: two tickets for the price of one (you'll still pay $20 but you can bring someone with you).
To take up this offer, end us an email at info@fnarena.com
Some extra info:
Now in its 6th year, Movember has been embraced in New Zealand, USA, Canada, UK and Ireland, raising A$62m globally for the fight against prostate cancer and depression in men.
Luke will discuss how the idea came about back in 2003 after he & a few mates were sharing a beer at their local. Find out what inspired them to bring back the mo. Hear how the concept has grown from humble beginnings of 30 participants up to 125,000 participants last year. Learn how the national concept is now being taken to the world.
P.S. III – All paying members at FNArena are being reminded they can set an email alert for my editorials. Go to Portfolio and Alerts in the Cockpit and tick the box in front of Rudi On Thursday. You will receive an email alert every time a new editorial has been published on the website.
