The bullish resolve of the world’s major stock markets, particularly in the US, seems to have weakened which is not surprising given what’s been going on with regard to short and long-term interest rates.
Many of the major markets, such as FTSE 100, S&P 500, French CAC 40, German DAX, etc., are all close to the highs set in 2000, technically a crucial level. We have devoted this issue’s Conclusion to our analysis of this.
Stock market volatility
Recent stock market volatility has been blamed on a sharp rise in bond yields and Central Bank tightening, which together has made borrowing more expensive. So far, however, except for sub-prime mortgage borrowers in America, it has not in any way impeded the mad global credit expansion.
As Albert Edwards, Global Equity Strategist at Dresdner Kleinwort said “This is the big one, if the bond markets have truly entered a new era of steadily rising long-term rates, all investment portfolios will be shredded to ribbons”.
Of the asset markets affected by higher interest rates, the most sensitive is property where the relationship between interest rates and rental yields is of critical importance. Both the American and UK stock market real estate sectors have topped out. The chart we are showing of the UK stock market real estate sector shows that quite clearly. Since the start of the year, in spite of overall stock market strength, this sector has fallen significantly.
Jim Pickard recently wrote in the Financial Times that cracks were showing in the secondary retail property market. He quoted a closely watched mid-summer retail report from agents, Colliers CRE, which said that transactional prices have fallen sharply from last summer by about 10%. Apparently, Colliers expect a further fall of the same magnitude by the end of the year.
The worries of only two or three weeks ago about the China stock market have been forgotten even though, as yet, the Shanghai A Index (stock that only Chinese nationals can buy) is still just below its recent high whilst the Shanghai B Index (stocks that foreigners can buy) is much lower and looks very vulnerable. Those Chinese investors gambling on this market might well consider the current level a good opportunity to get out. Further evidence that we are, right now, living through a decision making period.
What the stock market indicators are telling us
Our Four Horses of the Financial Apocalypse show some signs of unrest, led in particular by –
The white horse – false peace – The Volatility Index (VIX)
Since February an important change has taken place. The lows of the VIX price action have been around 12.5 compared to previously 10 or lower. The fact that this period of price action is also supported by the 30-week moving average whereas the prior period was subdued below the 30-week moving average, is also technically positive for the VIX. It’s as if our horse has moved from being utterly disinterested to being nervously alert. The technical read of this recent action leaves us with no other thought than to expect, and probably quite suddenly, a sharp move to the upside, this horse is smelling the air and not liking the scent but, as yet, not certain of the scale of danger approaching.
The other three horses will inevitably be affected by the eventual behaviour of the white horse.
The red horse – war and destruction – The Philadelphia House Market Index
It isn’t getting any better. The National Association of House Builders has said that the outlook for US home builders is the worst in sixteen years. Its Housing Market Index fell two points to 28 in June (any number below 50 is negative), the lowest it has been since February 1991. The percentage of US mortgages ending in foreclosure is the highest for more than fifty years. Richard Iley, Economist at BNP Paribas, expects the recent implosion in sub-prime indices to resurrect concern over housing and its impact upon the consumer.
At some time in the future, the true importance of the American mortgage market problems will be seen as the first signal of the inevitable global credit market contraction.
The black horse – famine and unfair trade – Dow Theory
Since February the Transports have been forming a top, its determining level is 5000, below that, should it happen, an important early negative signal will have been issued by the market which will carry even greater weight if, by then, the Industrials are below 13225.
The pale horse – sickness and death – The Inverted Yield Curve
UK base rates are now 5.5%, 3-month money is 5.79%, 10-year yields are 5.47% and 48-year yields are 4.55%. Although the conventional measure of yield inversion comparing 10-year yields to 3-month money is virtually flat, we still have very much lower yields at the very long end of the curve.
The US Fed fund’s rate is 5.25%, 3-month money is 5.25%, 10-year yields are 5.25% and 30-year yields are 5.24%. The market expects the yield curve to steepen so that eventually long-term interest rates will be higher than short-term interest rates.
This particular horse is nibbling in its own bit of the field, disturbed only by the rising danger of inflation. However, and this is important, if credit expansion morphs into credit contraction, the financial climate will become much less inflationary and much more deflationary.
By John Robson & Andrew Selsby at RH Asset Management Limited, as published in the Onassis Newsletter, a fortnightly newsletter that gives insight into the investment markets.
For more from RHAM, visit https://www.rhasset.co.uk/