Our baseline scenario at the start of the year was that 2014 would see significantly higher stock prices at some point in the year even though the year as a whole could be poor, a big correction was in the cards, the main question was when and how big. This assessment was in spite of our view that we are in the last phase of this humongous bullmarket engineered by the Federal Reserve. In other words we feel that we are in the climactic phase of the rise in stock (asset) prices. Trying to pick a top to either exit or worse make downside bets generally isn't a good idea when signs of strong momentum exist as was the case until recently. The recent emerging market panic and the selloff in equity markets worldwide have us examine what may prove that outlook wrong and we cut our exposure dramatically as last Thursday's rally failed. Could it be that we were too optimistic not unlike the majority of advisors and investors ? Could we be much closer to the top than we thought ? Are we in the process of topping out and could 2014 be the year of the crash ?
For a few years now we have been typical contrarians on emerging markets, we warned of bad times ahead - or at least disappointing performance for investors - in the main emerging economies such as Brazil and China. The majority of observers don't see the current EM woes as a repeat of the 1997 crisis, emerging economies are in a stronger position than they were back then; they have flexible exchange rates, their foreign currency reserves are higher, their current account deficits and their debt lower. It should also be noted that the current extreme volatility has been confined to the currency market, stockmarkets in those developing economies have not suffered dramatic declines since the start of the year but many have been in a downtrend for some time, Brazil and China for example have remained entrenched in a downtrend since 2010 and 2011 respectively, the Bovespa is down a little over 7% since the start of the year, Shanghai is down 4%. Turkey which made headlines with its collapsing lira is down 10% and in Argentina also at the center of the EM jitters, the Merval is actually up for the year. From a technical standpoint though, the declines in EM indexes do not tell a story of panic among equity investors, we would say there is nothing new there, the downtrend remains in place for many of them but there is no sign of panic and capitulation. From a fundamental point of view there are plenty of reasons to worry about emerging markets, mainly China which to many is a ticking timebomb and then the consequences of a return to normalcy with the Fed taper. With higher interest rates in the developed world, emerging markets always become less attractive. The Economist summarizes the concerns of the pessimists : ".After
years of chasing yield in risky places, many American investors are bringing
their money home.
And after years of booming credit growth, emerging economies have new
vulnerabilities: complacent politicians, high corporate-debt loads and banks
that are dodgier than they appear ".
The extraordinary EM boom which came with its share of undesirable effects, excesses and bubbles was a by-product of the easy money policies of the Federal Reserve
Our view for a long time has been that emerging
markets enjoyed a period of very fast growth fueled by a credit boom and
speculative investments as western investors chased yield in emerging
economies. The extraordinary EM boom which came with its share of undesirable effects (e.g. pollution and environmental destruction , in Brazil's Amazon and China whose smog even reaches the US West Coast) excesses
and bubbles was a by-product of the easy money policies of the Federal Reserve.
We thought that at some point, the day of reckoning would come, bringing
destruction to these nations and, in a globalized world, to the world economy. That hasn't happened yet but we haven't changed our
mind. We think however that the current selloff in equities is not just a panic
response to EM troubles but a wider change of heart of investors (if only temporary) faced
with the withdrawal of QE. China is still looming of course, a recent default
by a shadow banking institution raised the specter of big troubles for the
financial system with a run by investors on Wealth Management
Products,(high yield savings products widely used for financing) . Wealth
Management Products remain one of China's many skeletons in the closets but in
the end default was averted and some say it was a unique situation unlikely to
be seen with many other WMP's. Yet China is just another shoe that could
be about to drop for the world economy.
http://www.cnbc.com/id/101379823
More worrying though in the short term is the technical damage in key US indices such as
the S&P and the Dow. Also, a down January is bad omen for stocks,
athough the January indicator has a more spotty record in mid term years. It's Yale Hirsch, editor of the Stock Trader's Almanac, who pioneered the January indicator. Almanac's excerpt : "though some years ended higher, every down January since 1950 was followed by a new or continuing bear market, a 10% correction or a flat year, down Januarys were followed by substantial declines". Another thing to be aware of and about which we have alerted clients and readers of this blog is last December low on various US indices which is a key technical level but it turns out there is also a "December low indicator". It was first brought to attention by Lucien Hooper a Forbes columnist and it spells trouble for stocks if the Dow violates its December low during the first quarter; the average drop in the Dow following that breach was 10% . Note that the Dow has broken through its December low. It has lost an additional 2% since then, far from the 10% average correction.
netdania
We will keep an eye on the monthly close for February, for the time being the picture is very bearish
netdania
Japan's Nikkei 225 had a very nasty reversal since the start of the year, this is very bearish as well. Recall we were skeptical last year of the ability of the Nikkei to sustain a rise above 15942, as this was the site of a reversal followed by a 20% crash-like drop. Well the Nikkei confounded investors and technicians alike, the end-of-year rally in 2013 was a trap, we would need confirmation by a failed rebound and further selling but this can be called a "bull trap" and it can be a sign of a very significant top. Below, the chart of EUR/JPY which shows a reversal as well.
netdania
Now let's go through some charts of other EM indices, currencies and various indicators to see if trouble may be brewing for the world economy. It seems it could very well be the case .
China Has Many Skeletons in Its Closets
Chart by Worden Brothers
Possible travel paths for SSEC-X
This EEG shows the Chinese patient is very very sick . The Shanghai Composite Index has been in a downtrend since 2010. A chart similar to the Nikkei after the 1990 crash. Some observers have said the collapse of China will be worse than Japan's. The chart shows the collapse happened in the stockmarket in 2008 after we predicted it, we believe a credit binge and cooked government statistics put bandaids and hid much of the damage to the economy. The argument in favor of the doom and gloom scenario is bolstered in our opinion by 1) the fact that China's economy is overly dependent on manufacturing and construction without the innovation power of Japan, but its competitiveness as the cheap factory of the world has also eroded and will continue to do so, 2) the shift to a consumption-led economy isn't going to happen soon given slowing growth and the absence of a welfare state 3) it's governed with a mix of communist, central planning policies and unfettered capitalism with simmering social unrest and a lack of ethics (not to mention corruption ) as a consequence. Add an investors' love story with China, an epic credit bubble and oversupply and you have a recipe for a spectacular bust with far reaching implications. Possible travel paths for SSEC-X
http://www.cnbc.com/id/101379823
Down Januarys are almost always followed by substantial declines
We will keep an eye on the monthly close for February, for the time being the picture is very bearish
Japan's Nikkei 225 had a very nasty reversal since the start of the year, this is very bearish as well. Recall we were skeptical last year of the ability of the Nikkei to sustain a rise above 15942, as this was the site of a reversal followed by a 20% crash-like drop. Well the Nikkei confounded investors and technicians alike, the end-of-year rally in 2013 was a trap, we would need confirmation by a failed rebound and further selling but this can be called a "bull trap" and it can be a sign of a very significant top. Below, the chart of EUR/JPY which shows a reversal as well.
Now let's go through some charts of other EM indices, currencies and various indicators to see if trouble may be brewing for the world economy. It seems it could very well be the case .
netdania
Technicians will see something worrying in this chart of Brent crude
Chart by Worden Brothers
US 10-year yield reversed to the downside, this could be a significant reversal as key levels were first breached then T-notes rallied invalidating last year's breakout. A level to watch : 2013 Q4 low
netdania
The ruble seems to be announcing a crisis for Russia
Technicians will not like this chart of the Russian RTS either
netdania
The Ukrainian currency , another one about to collapse ?
.
