Global Markets: Pause or the Start of a Slide?

June 1 might have marked a turning point for international equities. Are they starting to slide back down or are they merely taking a rest and consolidating before they move further up? Either way, interesting times.

Many continue to see “green shoots” sprouting everywhere but the big difficulty is trying to distinguish what is driving them from underground – the massive liquidity being created, the perception (mistaken or not) that markets have overshot on the downside, or good economics. I rather suspect the first two.

This is the position in equities. I am plotting here three ETFs: SPY (for the US market in general, the S&P500), EEM (MSCI Emerging Markets), and EFA (Europe, Asia, Far East). This shows the big picture:

click to enlarge

So, we can see how SPY flattened and the other two, both better performers than SPY, have started trending down or, at least, failing to exceed their June 1st high.

Now, to focus on the main emerging markets. Is the situation similar in all the major emerging countries: The following graph shows FXI (China), INP (India), RSX (Russia), and EWZ (Brazil ), the recently materialized index BRIC:

The BRIC don’t seem to be all equal – Russia is in decline, India is quite okay, while China and Brazil are trying hard to keep on the incline.

A niche market, which so far has been behaving very nicely, is Chile (ECH), but it too seems to have suffered these last few days:

Note how the trend line has been broken. So, if this is happening to such a strong market, it may portent some unpleasantness.

Why are investors having second thoughts on equities? Maybe it is because they feel inflation is on the way. Empirically, equities suffer when there is inflation, especially if run-away or unanticipated.

So, how is the inflation picture?

Below we can see commodities (DBC), base metals (DBB), and precious metals (DBP):

An interesting picture emerges: Precious metals, gold and silver, represented by DBP, seem to be behaving much like equities. Commodities and base metals kept up except for the sharp fall starting Friday 12th.

It does not seem that equities are fearing inflation. Rather, with equities, commodities and precious metals falling, it seems that the market is growing more and more suspects of the fabled green shoots. It might have all been a false alarm, after all.

What about the US Dollar? The US Dollar index shows the value of the dollar against major currencies and is shown here:

This is nearly a mirror image of how equities and precious metals’ are behaving ! I have also superimposed the 20-year plus US government bonds ETF (TLT). It is too early to tell, but there is some indication that investors are once more seeking the security of the US dollar and government bonds (similar to what happened at the depth of the crisis).

Points to ponder:

• As far as the major developed markets are concerned, are investors expecting a second leg to the financial crisis and no longer putting faith in green shoots? Are they expecting the recession to worsen?
• As to the emerging markets, especially with BRIC’s recent efforts to distance themselves from the US dollar (while still paying lip service to it, so they can unload), are investors thinking that decoupling is taking place, thus the superior performance of India, China and Brazil?
• Is the threat of heavy regulation, heavy bailouts, and heavy social services chasing investors away from developed to the less regulated emerging markets?

DISCLOSURE: Long position in INP and ECH. No position in the other ETFs mentioned.

Comments

[cash:]

Good analysis & nice juxtaposition of plots, thank you

Jun 17 10:36 AM

[Larry House:]

Useful insights. You raise the 64 thousand dollar question. At the least the price action could be expected to flatten out for a while. No knows the answer right now, but it will become clearer over the next several weeks. We are all watching to see if the trend changes.

Jun 17 11:07 AM

[Dave Wrixon:]

The Dow is about to fall backwards off a cliff. The rest of the group have just paused to watch the spectacle and pay their respects.

Jun 17 02:40 PM

[jstratt:]

I very much appreciate the authors unique analysis. It sums up many factors in a useful approach.

Jun 17 03:47 PM

[Markmc:]

Very well done. Elegant in it's simplicity. Thanks.

Jun 17 05:19 PM

[Old Trader:]

I've heard faint rumblings that there may well be some problems coming for China, in that the stimulus plan there might not work as well as expected/hoped because it may be fueling a resurgence in property speculation. The recent elections in India seem to have been a real game-changer there. While it remains to be seen whether the new government there can get the country's economy back on a solid growth track, it seems the markets are willing to give the benefit of doubt, for now.

Jun 18 10:45 AM

[Uday Maitra:]

One of the interesting thing that your charts highlights is the increasing (although still weak) coupling of some or many of the commodities, particularly oil, with equities. Perhaps some spreads trades could be interesting.

Jun 18 11:30 AM