Global Markets in Review: Pros and Cons of a Pullback

A long-awaited reversal in the monumental global stock market rally since early March finally arrived last week. As the first-quarter earnings season started winding down and post stress-test capital-raising weighed on some banks, investors were faced with a slew of gloomy economic reports suggesting the recent optimism about a global recovery might have been premature.

“This week, the hard economic data remind us that the global recession is ongoing: exports remain deep in the red; retail sales disappoint; inflation still volatile on food and energy but down on year; and industrial production declines. However, the data are consistent with the story of a slowing economic decline, foretold by several ‘green shoot’ survey reports,” said Rebecca Wilder (News N Economics).

Source: Tom Toles, Washington Post.

“Less bad” economic reports provided investors with little comfort, sparking a reassessment of their risk appetite and leading to profit-taking on most bourses. Also, commodities retreated after recording four-month highs earlier in the week, and high-yield corporate bonds and emerging-market currencies came off the boil. On the other hand, safe-haven assets such as government bonds, gold bullion, the US dollar and the Japanese yen attracted buying. Investment-grade corporate bonds and Treasury inflation-protected securities also closed the week in positive territory.

The performance of the major asset classes is summarized by the chart below.

Source: StockCharts.com

After nine straight weeks of gains, global stock markets succumbed to profit-taking last week with the MSCI World Index falling by 3.4% (YTD +0.1%) and the MSCI Emerging Markets Index down by 2.4% (YTD +24.8%).

Similarly, the major US indices reversed course. The Nasdaq Composite Index (-3.4%, YTD +6.5%) and the Russell 2000 Index (-7.0%, YTD -4.7%) declined after rising for nine consecutive weeks and the Dow Jones Industrial Index (-3.6%, YTD -5.8%) and the S&P 500 Index (‑5.0%, YTD -2.3%) fell after being up eight out of nine weeks.

After last week’s sell-off the Nasdaq is the only major US index still in the black for the year to date, finding itself in the company of the majority of emerging and mature markets.

Click here or on the table below for a larger image.

Returns around the world ranged from top performers Serbia (+10.0%), Cyprus (+9.7%), Bermuda (+9.5%), Namibia (+8.5%) and Vietnam (+6.5%) to Romania (-12.2%), the Czech Republic (-8.3%), Finland (-6.9%), Luxembourg (-6.9%) and Indonesia (-6.0%) which experienced headwinds. (Click here to access a complete list of global stock market movements, as supplied by Emerginvest.)

China (+33.3%), one of the leading stock markets for the year to date together with Brazil (+46.7%) and Russia (+94.6%), notched up another gain (+0.5%) last week despite disappointing economic data. A revival in Chinese property transactions has been a major contributor to China’s recent recovery in industrial activity. Good news for Chinese equity bulls is the close historical relationship between property sales and the performance of Chinese stocks.

Source: US Global Funds - Weekly Investor Alert, May 15, 2009.

With nearly all the US companies having reported first-quarter earnings, the S&P 500 saw earnings decline by 34.6% compared to the same quarter in 2008, reported Bespoke. At the start of the earnings season, a decline of 38.2% was expected. The percentage of companies lowering guidance was cut by more than half, while the percentage of companies raising guidance increased by over 70%. A tough second quarter undoubtedly still lies ahead, especially as companies will not have the advantage of non-recurring cost cutting.

John Nyaradi (Wall Street Sector Selector) reports that the strongest exchange-traded funds (ETFs) on the week were SPDR Russell/Nomura Small Cap Japan (JSC) (+6.1%), Market Vectors Agribusiness (MOO) (+5.4%) and iShares MSCI Chile Index (ECH) (+4.4%). On the other end of the performance scale KBW Bank (KBE) (-15.4%), iShares Dow Jones US Regional Banks Index (IAT) (-14.5%) and KBW Regional Bank (KRE) (‑13.7%) were underwater as positive catalysts for the banking sector dried up.

As far as the economic sector ETFs are concerned, defensive sectors outperformed during the week, with Health Care SPDR (XLV) and Consumer Staples SPDR (XLP) leading the way. Financial SPDR (XLF) and cyclicals such as Consumer Discretionary SPDR (XLY) and Industrial SPDR (XLI) were on the receiving end of the selling pressure.

Source: StockCharts.com

Lower interbank lending rates indicated reduced strains in the financial system, as seen from the three-month dollar, euro and sterling LIBOR rates declining to record lows. After having peaked at 4.82% on October 10, the three-month dollar LIBOR rate declined to 0.83% on Friday. LIBOR is therefore trading at 58 basis points above the upper band of the Fed’s target range - a great improvement, but still high compared to an average of 12 basis points in the year before the start of the credit crisis in August 2007.

Gold bullion seems to be regaining its luster and again edged higher last week.

As sure as night follows day, the Federal Reserve’s purchase of bonds and home mortgages and the resulting rapid increase in bank reserves (quantitative easing in Fed-speak) - unless soon reversed - are underwriting a coming acceleration of inflation,” said gold specialist Jeffrey Nichols. “… By the time the broad financial markets register a worsening of inflation expectations gold will already have made a major move to the upside. It provides an early warning or leading indicator of inflation, signaling the coming acceleration long before financial markets begin to quiver.

As to be expected, there is a strong relationship between the yellow metal (green line) and Treasury inflation-protected securities (red line).

Source: StockCharts.com

The quote du jour relates to whether the fact that bank stocks have rallied and in some instances been able to raise private capital, augurs an end to the financial crisis. Barry Ritholtz, editor of The Big Picture blog and author of Bailout Nation, a newly published and must-read book, succinctly remarked:

“You can’t drink yourself sober and you can’t leverage your way out of excess leverage.” Many big banks remain technically insolvent and “are only being held together by spit, bailing wire and tape,” said Ritholtz in an interview with Yahoo Finance, Tech Ticker.

The banking system needs more time, at least three to five years, to deleverage before it can be left to its own devices, Ritholtz remarked, suggesting only time can heal the sector’s wounds.

In other news, the US Treasury announced that it would make $22 billion available to insurers from the Troubled Asset Relief Program (TARP), and the Obama administration sought new authority to bring transparency to the credit derivatives markets and also to crack down on the credit card industry.

Next, a tag cloud of all the articles I read during the past week. This is a way of visualizing word frequencies at a glance. Key words such as “market”, “financial”, “prices”, “banks”, “government” and “economy” again featured prominently. For the rest, it is really a bit of everything.

Back to the stock market. An analysis of the moving averages of the major US indices shows the spring rally having encountered resistance at the important 200-day line and/or the early January highs. The highs of May 8 are the most immediate target to the upside, whereas the levels from where the rally commenced on March 9 should hold in order for base formations to remain in force.

Click here or on the table below for a larger image.

A useful indicator of market breadth is a chart showing the percentage of S&P 500 stocks trading above their 50-day moving averages. Although this measure has declined to 78% from 92% in early May, it is still at a level typically seen at prior peaks during the bear market. This still looks overdone in the short term, but for a primary uptrend to manifest itself, the bulk of the index constituents should remain above the 50-day line and also trade above their 200-day averages (31% at the moment).

Source: StockCharts.com

Interestingly, Bespoke highlights that on a sector basis the percentage of stocks trading above their 50-day moving lines has fallen the most in Technology, Consumer Discretionary, Utilities and Financials. However, Health Care has actually seen its reading increase over the last few days as investors rotate from cyclical to defensive stocks.

For more about key levels and the most likely short-term direction of the S&P 500, Adam Hewison of INO.com prepared another of his popular technical analyses. Click here to access the short presentation.

Marc Faber, the author of “The Gloom, Boom & Doom Report”, wrote in his latest research report (via CNBC):

I think that, at least in nominal terms (inflation-adjusted), the global printing presses being run by the world’s central banks and fiscal deficits have begun to impact asset prices positively. The lows reached by resource and mining stocks, as well as Asian equities and most emerging markets, are likely to hold for now.” But very high volatility and “price fluctuations that don’t appear to make any sense” will be the new dominant characteristic of the market, he warned.

Asking Richard Russell (Dow Theory Letters) what fundamentals he thought could cause the market to break the March lows, he replied:

You want guesses? Here are mine. (1) A collapse of the dollar along with a collapse in the bond market. (2) The US losing the reserve status of the dollar. (3) US consumers going on a long and unexpected buying strike plus a consumer saving campaign that shocks the economists and the Fed. (4) The Fed unable to halt asset deflation. (5) Federal budget deficits growing completely out of control, the compounding interest on the federal debt paralyzing the country with the catastrophic result that nobody will lend money to the US.

According to the Telegraph, James Montier of Société Générale said

Prolonged suckers’ rallies tend to be especially vicious as they force everyone back into the market before cruelly dashing them on the rocks of despair yet again. Genuine bottoms tend to be “quiet affairs.

“Teun Draaisma, Morgan Stanley’s stock guru, expects another shake-out, as reported by the Telegraph.

We think the bear market rally will end sooner rather than later. None of our signposts of the next bull market has flashed green yet. We’re not convinced the banking system has been fully fixed.

He anticipates the new bull market to kick off later this year - perhaps in October - anticipating real recovery in 2010.

I am of the opinion that the US and other mature stock markets are in the process of mapping out a base development formation, which probably means toing and froing between policy tailwinds and economic headwinds.

But the “too-much-too-fast” rally made it inevitable for markets to either consolidate or retrace some of the past nine weeks’ gains prior to moving higher. Such a pullback as is now taking place is natural and necessary and should not be too much cause for concern, provided the levels from where the rally commenced in March hold.

For more discussion about the direction of stock markets, also see my recent posts “Stock markets: Reversal time?“, “Technical talk: Nasdaq in correction mode” and “Video-o-rama: Gloomy economic reports rein in investors’ optimism“. (Also, Donald Coxe’s webcast has been updated for May 15 and makes for good listening material. This can be accessed from the sidebar of the Investment Postcards site.)

Economy

Global business sentiment has meaningfully improved since mid-March. The global confidence index remains consistent with ongoing recession, but the intensity of the downturn is abating. Most notable is a sharp gain in expectations regarding the outlook six months hence; it turned positive last week for the first time since the summer of 2007 just prior to the start of the current financial crisis.

- The latest Survey of Business Confidence of the World conducted by Moody’s Economy.com.

Jean-Claude Trichet, European Central Bank president, said on Monday the global downturn had bottomed out with some large economies already able to put the recession behind them and looking forward to renewed growth, according to the Financial Times. His remarks came as the Organization for Economic Co-operation and Development said there were signs of a “pause” in the economic slowdown in France, Italy, the UK and China.

Source: Financial Times, May 11, 2009.

The economic free fall has been stopped, the collapse of the financial system averted. National economic stimulus programs are starting to take effect. The downward dynamic is easing.

I expect the recovery to make up for around half of the downturn we have had and then to move into stagnation. Asia will be first out of the crisis, but America is also currently doing that.

- Billionaire investor George Soros was quoted as saying to a German newspaper (via Yahoo Finance).

The International Monetary Fund said the recovery would take longer than normal because the slump was precipitated by a worldwide financial crisis, expecting the global economy to contract by 1.3% this year.

Focusing specifically on China, the Financial Times reported

The total value of Chinese exports fell 22.6% to $91.9 billion last month compared with the same month a year earlier - a faster rate of decline than the 17.1% year-on-year drop in March.

However, Kevin (Sinolese.com) highlights that whereas total trade is down compared with March on an annual basis, this is because of a big increase from March 2008 to April 2008.

When compared with the March number of this year, the result is positive. Not only so, total trade has been up for two consecutive months, with imports increasing faster than exports.

Source: Kevin (Sinolese.com), May 15, 2009.

Turning to the US, a snapshot of the week’s economic data is provided below. (Click on the dates to see Northern Trust’s assessment of the various data releases.)

May 15, 2009
• The hike in core Consumer Price Index is temporary
• Factory production - moderation in pace of decline
• Consumer sentiment improves in May

May 14, 2009
• Auto industry shutdowns lead to jump in Initial Jobless Claims
• Food prices raise Wholesale Price Index

May 13, 2009
• Retail sales are stabilizing, but Q2 consumer spending should be weak
• Higher prices for petroleum imports lift overall import prices

May 12, 2009
• Small Business Optimism Index improves
• Trade balance widens slightly in March

May 11, 2009
• Fed’s program to purchase Treasuries, mortgage and agency securities - update

Also, RealtyTrac on Wednesday released its April 2009 US Foreclosure Market Report, which shows foreclosure filings - default notices, auction sale notices and bank repossessions - were reported on 342,038 US properties during the month, an increase of less than 1% from the previous month and an increase of 32% from April 2008.

Nobel Prize winning economist Paul Krugman argues that a rapid recovery is “extremely unlikely”. According to Bloomberg, he said:

Some of the measures that have been taken to deal with the crisis seem to be predicated on the belief that this is going to be a short, short recession. Everything says that’s wrong, that this is going to be a sustained period of weakness.

Week’s economic reports
Click here for the week’s economy in pictures, courtesy of Jake of EconomPic Data.

Date	Time (ET)	Statistic	For	Actual	Briefing Forecast	Market Expects	Prior
May 12	8:30 AM	Trade Balance	Mar	-$27.6B	-$29.5B	-$29.0B	-$26.1B
May 12	2:00 PM	Treasury Budget	Apr	-$20.9B	NA	-$20.0B	$159.3B
May 13	8:30 AM	Export Prices ex-agriculture	Apr	0.3%	NA	NA	-0.4%
May 13	8:30 AM	Import Prices ex-oil	Apr	-0.4%	NA	NA	-0.9%
May 13	8:30 AM	Retail Sales	Apr	-0.4%	-0.2%	0.0%	-1.3%
May 13	8:30 AM	Retail Sales ex-auto	Apr	-0.5%	0.0%	0.2%	-1.2%
May 13	10:00 AM	Business Inventories	Mar	-1.0%	-1.0%	-1.1%	-1.4%
May 13	10:30 AM	Crude Inventories	05/08	-4.63M	NA	NA	+605K
May 14	8:30 AM	Core PPI	Apr	0.1%	0.0%	0.1%	0.0%
May 14	8:30 AM	Initial Claims	05/09	637K	580k	610K	605K
May 14	8:30 AM	PPI	Apr	0.3%	0.2%	0.2%	-1.2%
May 15	8:30 AM	Core CPI	Apr	0.3%	0.1%	0.1%	0.2%
May 15	8:30 AM	CPI	Apr	0.0%	0.0%	0.0%	-0.1%
May 15	8:30 AM	Empire Manufacturing	May	-4.55	-14.0	-12.0	-14.65
May 15	9:00 AM	Net Long-Term TIC Flows	-	$55.8B	NA	$32.5B	$22.0B
May 15	9:15 AM	Capacity Utilization	Apr	69.1%	69.1%	68.8%	69.4%
May 15	9:15 AM	Industrial Production	Apr	-0.5%	-0.4%	-0.6%	-1.7%
May 15	9:55 AM	Michigan Sentiment – Preliminary	May	67.9	65.2	67.0	65.1

Source: Yahoo Finance, May 15, 2009.

In addition to the Federal Open Market Committee (FOMC) releasing minutes of its April 29 meeting (Wednesday, May 20) and the Bank of Japan announcing its interest rate decision (Friday, May 22), the US economic highlights for the week include the following:

Source: Northern Trust.

Click the links below for the following reports:

• Wachovia’s Weekly Economic and Financial Commentary (May 15, 2009)

• Wachovia’s Monthly Economic Outlook (May 2009)

• Wachovia’s Global Chartbook (May 2009)

Markets

The performance chart obtained from the Wall Street Journal Online shows how different global financial markets performed during the past week.

Source: Wall Street Journal Online, May 15, 2009.

Elroy Dimson, professor at the London Business School, said: “Risk means more things can happen than will happen.” Hopefully the “Words from the Wise” reviews will assist Investment Postcards readers in taking informed decisions to make sure “fewer things” happen to their investment portfolios.

That’s the way it looks from Cape Town (where the days are getting shorter and colder as winter approaches).

Comments

[Market Sniper:]

Still have a very large problem with the argument that the market somehow manages to just move sideways in a prolonged trading range. The fundamentals argue against it. We have, according to the latest BIS report a global bank CREDIT deflation rolling at an annual contraction rate of 22%. The economic effect of such a contraction is that is that prices flex downward in response. That is the CREDIT side of the equation. Now look at the monetary side. With central banks worldwide holding official interest rates at or below 1%, what incentive is there to SAVE? Add to that, these central banks are engaged in direct "money" infusions into their financial and banking systems. This results in monetary INFLATION, currency devaluation, if you will. It is a futile attempt to replace the saver with more credit "money." This is an attempt at alchemy by the central banks. It is the EXISTENCE of a factory or an avocado orchard that gives value to the money that they represent. NOT THE OTHER WAY AROUND! Remove the factory or the avocado orchard from the reality and there is NOTHING there for "money" to buy! This is the simple logic that escapes modern economists and politicians and it shall be our downfall.

May 17 04:09 PM

[Gold Barron:]

It is becoming more and more apparent to me that gold is the best investment in this economic environment. There is virtually little to no downside risk. My portfolio is currently 17% gold and silver. I am going to up that percentage to 30%.

The USA is in deep deep trouble and sadly most Americans are completely clueless. That sad reality should start setting in in about 6-9 months.

May 17 06:34 PM

[Jasper M:]

Gold Barron,
As long as the IMF is one of the largest holders of gold in the world, I would argue that there remains significant downside risk.
A similar argument might also apply to the Russians, who (while slightly smarter) are dependent on oil prices.

May 17 09:42 PM

[Gold Barron:]

Jasper, I agree with you to a degree about the IMF and their 3500 tons of gold. They apparently plant to sell about 400 tons I guess. I guess some people look at the IMF selling their gold as bearish, I however see that as very bullish.

Why you may ask? Well, in order to sell their gold they need a buyer. And I am sure some Asian or Middle Eatern country that has cash will snatch that gold right up in a heartbeat. The IMF is basically just a financial arm of the US government. Now, if the IMF tries to sell their 400 tons and can't find any buyers, well then I might consider gold to be a risky investment....but we all know China is probably just chomping at the bit for opportunities to purchase gold without driving the prices of gold higher and more importantly weaking the dollar further. The IMF gold sell would mask their intentions somewhat.

And I hope when and if they do sell, the price of gold falls to $300 an ounce. Then, I will trade every dollar I have for gold if and when the price falls.

May 17 11:51 PM

[Vuke:]

Gold Barron, I wouldn't sweat the piddly amount of IMF gold. They're all fighting over who gets to "buy" it. They're talking about a sale of 400 tons, which is peanuts compared to the paper being floated lately. They allegedly own a total of 3217 tons, worth less than $100B today.

In fact, it appears it may be the US has already bought it all!!!
www.numismaster.com/ta...

From the article: " On April 16, U.S. President Obama wrote a letter to congressional leadership seeking support for the U.S. government to loan the International Monetary Fund $100 billion. This is part of a plan for the IMF to expand its New Arrangements to Borrow (NAB) program from $50 billion to $500 billion.

President Obama is portraying this loan as an investment rather than an expenditure when he stated in the letter, "Such participation effectively represents an exchange of assets rather than a budgetary expenditure, and it will not result in budgetary outlays or any increase in the deficit. That is because when the United States transfers dollars to the IMF under the NAB, the United States receives in exchange another monetary asset in the form of a liquid, interest-bearing claim on the IMF, which is backed by the IMF's strong financial position, including its significant holdings of gold." .........................

It is really amazing how the small amount of gold ever mined in the whole of history has been stretched to the point governments claim huge amounts, the IMF has it, India, China and the middle-east have been buying it, ETF's own huge amounts of it and so on.

Maybe that's why it's so hard for the ordinary Joe to find the odd coin or bar to buy. It's just stretched too thin.

May 18 12:22 AM

[Hask:]

Money quote from this article:

Asking Richard Russell (Dow Theory Letters) what fundamentals he thought could cause the market to break the March lows, he replied:

"You want guesses? Here are mine. (1) A collapse of the dollar along with a collapse in the bond market. (2) The US losing the reserve status of the dollar. (3) US consumers going on a long and unexpected buying strike plus a consumer saving campaign that shocks the economists and the Fed. (4) The Fed unable to halt asset deflation. (5) Federal budget deficits growing completely out of control, the compounding interest on the federal debt paralyzing the country with the catastrophic result that nobody will lend money to the US."

May 18 10:13 AM

[The Aft Deck:]

While many have pointed at green shoots, there is still a continuing stream of very concerning facts, US banks big and small need more money to survive, The second wave of unemployment is starting to show, and the Auto collapse is echoing through the economy.The recession is certainly ongoing.

May 18 10:23 AM

[aarc:]

More likely the next run down will be initiated by profit taking among traders and investors and by those investors who had bought high and trying to sell closer to buy price as this relief rally continues to it's conclusion.

More sell-off will prevent an attempted rally if the unemployment goes higher and the next earnings report proved more negative than expected.

Then finally, the what they call the capitulation sell-off can be triggered by the end of the year by many factors such as deteriorating government financial balance sheet; consumers going into a severe crunchdown as unemployment remained un-addressed by the government; SnP earnings; news companies both financials and non-financials going bankcrupt on day to day basis as they burn-out their reserve capital with the banks still in credit crisis mode; or even man-made catastrope similar to 9/11 or those that can be caused by nature such as Katrina, the Tsunami of Thailand, the earthquakes of China, or the SARS of Hongkong.

None of the original causes of this downturn has been solved. While new problems had been created.

The panic sell-offs of Aug 2008 to Mar 2009 may have been over-done as compared to the original problems of housing bubble meltdown and the ensuing banking crisis.

However, the cumulated sell-offs may not have priced-in yet the current domino-effect problems such as surging unemployment rate, prolonged consumer crunchdown, earnings deterioration due to consumer boycotts; local governments going bankcrupt; and perhaps next shoe to drop = waves after waves of small to medium size companies going bankcrupt as they run out of cash. A couple or two giant companies going bankcrupt can only add to the potential next wave of stock market panic selling.

May 18 01:08 PM

[Living4Divi...:]

Nice article ! Thanks for posting that Financial Times Chart (Financial Times, May 11, 2009.chart of downturns comparing China France US UK )

It really puts things into perspective. Wow !

May 18 01:29 PM

[Peter Cooper:]

Or to sum it up differently, can China really fill the boots of the US consumer? There is a contrary force to the economic downturn but is it really big enough to do the job? See:
arabianmoney.net/2009/.../

May 19 01:13 AM

[Fighting Yoda:]

We know stock markets react to the stimulus and financial liquidity more quickly than the real economy. The real economy may not react at all, if that happens the stock market will have to fall back. This is what is likely to happen. With mounting job losses - GM and Chrysler mega bankruptcies - will ensure 500K+ job losses for several months. The worst case stress test scenario of 10.3% unemployment by end of next year will likely be realized end of this year itself. California already has 11.2% unemployment, budget deficits, and the tax hike measures on poll tomorrow are all destined to fail.

Unless job losses abate and housing stabilizes economy will not stabilize. Recent 'better than expected' corporate profits have been conjured by accounting forbearance (FASB 57), onetime gains (bail outs, asset sales etc) and most importantly cost cutting. Cost cutting simply is- fire employees. How is that good for the economy? Fewer consumers, fewer tax payers.

US consumer will retrench big time, it has no choice. This will take the world economy down with it.

May 19 03:45 AM