In recent issues we have taken pains to explain that a potential trend changing consolidation was under way. FTSE’s range since early May was very well defined between the levels of 4,300 and 4,500.
Time has now moved on, and on Wednesday 17th June, FTSE made the important break below 4,300. Such a move has two important investment consequences; those long of the market take fright that they might give back their gains from early March and sell; whilst speculators, who will have been monitoring the situation will look to take short positions.
We would expect, unless there is an almost immediate return to strength, for the decline to accelerate. The downside for FTSE could be very considerable.
According to Richard Russell, of Dow Theory newsletter fame, Lowry’s Buying Power Index has been steadily declining since the 8th May and is now only 24 points (about 2.5%) higher than it was on the 9th March, adding to the evidence that markets are excessively vulnerable to the downside.
In George Soros’ book “The Alchemy of Finance” published in 1987, he promoted his theory of reflexivity. A simple example would be that good sentiment is likely to generate positive stock market behaviour whilst bad stock market behaviour is likely to spoil sentiment.
The traffic goes in both directions, each situation is reflexively affecting the other. So don’t be surprised if, on the stock market falling further, all the recent “green shoots” rhetoric is binned and sentiment significantly sours.
Dow Theory works on the basis that the Industrials and the Transports should, if the economy is in good shape, be in sync to the upside. If they suffer from non-confirmation, one positive, the other weak, it’s a signal of trouble ahead. Jointly made new lows represent a loud and clear signal of deterioration. Conversely, on old highs being regained – positivity.
Below are the two charts. You can see the level that if exceeded to the upside on both would represent a very positive call for equities. If both arrowed lows are exceeded to the downside, that would be a very negative call.
During these recent few months there has been a series of data that seemed to give support to economic recovery and for stock market resurgence. For example, property markets in the US and the UK seem to have improved, although in the US that is against a background of a housing inventory that would take 10.1 months to sell, and continuing price erosion.
Most of the data that has been considered as better has not been better, just less bad; like last week’s better-thanexpected, but otherwise bad unemployment figures when US non-farm payrolls for May showed a loss of only 355,000 jobs against a consensus of over 500,000 job losses.
It’s probably worth puzzling out why that data might be misleading. We see it this way – an employer, nourished by the thoughts of the green shoots of recovery and a return to normality, might hang on to staff that he would otherwise let go. This is where reflexivity comes in. He hangs on to them causing the unemployment figures to be less bad and everybody then says the economy must be improving. In fact, all that has happened is a short term sentiment improvement.
Improved sentiment is essential for recovery but is meaningless unless backed up by genuine economic improvement that justifies the change in sentiment. Our financial system that, last year, had to be rescued, has not yet recovered to such an extent that normality has anywhere near returned.
Those economists who claim that there are genuine green shoots of recovery and are convinced that the economy is going to get lots better from here, are largely the same group who had no idea of the economic tsunami that was coming towards them at 100 mph in 2007.
Lex, in the FT on the 17th June, got it just right when saying “Economics involves supplying perfectly neat theories to a decisively imperfect world.” A bit like a snooker-mad skipper of a fishing trawler who, whilst his boat is in dry dock, buys from Rileys a snooker table. He has a specialist set it up on his boat exactly level as all snooker tables must be. He then sails out of dry dock to sea and expects to play snooker between bouts of fishing.
“Will emerging markets continue their new bull phase even if developed world markets collapse from here?”
Our answer is “We don’t know.” But there are certain elements that make us think it is possible. In 2007, the wellheld view was that they would decouple and emerging markets would sustain, even though developed world’s markets would weaken. Well, not only did they not decouple but, as most people know, emerging markets collapsed more; China’s stock market fell 75% whereas the S&P500, FTSE and others fell only 50% – so far.
However, they may have now decoupled. Emerging markets bottomed out in October last year whilst the developed world markets continued falling and didn’t bottom out until March of this year.
The big news is that “the game has changed”. In 2009, for the very first time, emerging economies will account for more than 50% of world GDP. The emerging economies, which are 75% of the world’s population, led by China, India, Russia and Brazil, will from here accelerate ahead of our world. Their standards of living will rise rapidly whilst ours will be curtailed. It is like moving a huge pile of bricks from one side of the garden to the other. To start with, each wheelbarrow load seems to make little or no impact, then the halfway point is reached; from then on the pile of bricks reduces very quickly – acceleration.
Looking forward, we see the best investment opportunities in emerging markets and those other nations nearby and closely associated with them, such as Japan and Australia.
• This article was written by
Full Circle Asset Management
, as published in the
threesixty Newsletter
on 19 June 2009