We are in the midst of a moderate economic recovery being led by emerging economies such as China. We cannot possibly justify the asymptotic uptrends we have been seeing in various markets. If this recovery is being led by emerging markets, especially China, then how has the Chinese market been doing?
The SSE Composite Index had already peaked in August 2009 and has continued to underperform the US market since. In fact, if you look at the latest US market fall, the Chinese stock market had already given us a short signal since April 19th when the S&P500 was still rising.
Again, as I have been continuing to harp about for a while now, the dollar has a major impact on what happens to stock markets in the US, Europe and Asia because of the carry trade effect. When oil and equities are moving together, it is almost always the case that it is a currency issue. In recent days, we have seen the dollar appreciate and you know where global markets have gone.
There was a bit of a breakup in correlations in the US at least during the February- March timeframe, but if you were disappointed in the EUR/USD for market cues, then the Yen dollar relationship came back. It is also not always the direction of the currency but the velocity at which the dollar appreciates that can create market down moves and lately we have seen both direction and velocity on the dollar appreciation front.
Socialist policies of European governments
Now we all know what has happened to Greece and the anti austerity reform protests in Athens have not helped matters. The fact is that even if Greece implements those deep fiscal deficit cuts, growth will take such a hit and debt to GDP levels will still remain so high in years to come that default is still likely. We also need to be worried about Portugal which may be downgraded in the coming months, and Spain does not look that great either.
Two years ago we had blamed the banks in the US for lending to everyone, now we can safely blame the socialist policies of various European governments that have debt levels that are completely unsustainable. The spread between German bonds and those of troubled Greece, Spain and Portugal have widened dramatically, putting the future of the Euro and the European Union into question.
This conundrum is showcased in that the 10 year Treasury bonds of Greece are the highest, the profligate Portuguese come in second, the notorious Spaniards come in third and the responsible Germans still get their debt for cheap. Now remember, this is supposed to be a union and hence all ten year treasuries are supposed to trade at pretty much the same yield as you can see for most of the period.
The Greek contagion is for all to see but even Italy and France are not out of the loop unless the EU fixes its problems soon. I think that they will come up with something but bond vigilantes are perhaps right when they say that eventually those countries will probably choose the option of debt restructuring simply because deep fiscal deficit cuts will create much a protest and will impact growth in a continent where GDP forecasts are already quite tame. Bond holders do not like that prospect and the market is punishing them for it.
Now that we have got all the background information, we need to know what we will do as investors. In terms of technicals, the Relative Strength Index of the S&P500 confirmed divergence from price chart on the 23rd of April indicating a top in that bull phase. We then received a short signal coming from the MACD on the very next day and since then the S&P has broken the important 1168 support level taking it towards the testing support of 1140-1150 area as at the 6th of May.
While one should continue to avoid European markets, only institutional investors should remain long US stocks as long as those levels hold but need to exercise great caution. If we are unable to sustain those support levels, then a 10-15% correction is very likely and of course that is assuming Europe gets its act together, which it must.
Again I have always been advising to book profits along the way of any rally but right now you need to be very careful. Within the equity portfolio, investors need to rotate towards high dividend yield plays and towards the foods and the underperforming health care defensive plays (even utilities for a more medium term play) and of course you need to look at the dollar very closely.
Emerging markets are undergoing quite a rollercoaster but I still think that on any stabilization of the dollar, you can still find value out there in Asia but your timing will be key. Active management will be important, for you will need to seek value rather than follow the dying beta driven rally. With all this currency volatility, gold has again shown its true value as an insurance policy and holding around 8-10% gold in any diversified portfolio at this stage remains a good bet.
By Sameer Sharma,
A Canada-based Chartered Alternative Investment Analyst.
Culled from Throwing Caution to the Wind in Conjoncture, a publication of PluriConseil Ltd.