Key Market Factors: Interest Rates, Gold, China and Japan

This is a shorter format for my weekly “Global Markets’ Key Factors” article, replacing details on 16 factors with commentary on the most important ones this week. Factor rating changes mainly reflect impact on the margin of news just this past week, previous week’s ratings are in ( ). Exhibits are grouped at the end of the article. As in all my articles, BTE is abbrev for better-than-expected, WTE worse, that’s just part of the game.

0 Interest rates and credit: With long-term interest rates remaining very low (U.S. 10-year 3.34%), U.S. Treasury mega-financings going off without difficulty, global monetary policy still unprecedented accommodative, and the major central banks continuing to assure markets they will remain that way, one might make the case this factor should be positive. But the next phase will be the tightening cycle, the issue is when, for it likely would trigger a major global equity markets correction, if something else doesn’t first.

I'm paying attention to emerging markets, which are leading the global rally, not just the Fed and ECB. China started tightening, guiding banks to much lower loan growth in July and Aug, resulting in a -20%-plus correction in the Shanghai composite in Aug. The Bank of Israel was the first central bank to raise rates, on Aug 24. After the Bank of Korea kept its rate unchanged at 2% on Sep 10, its governor surprised the market with more hawkish remarks about a property bubble, touching off concerns as to whether it might tighten sooner than expected.

- (0) Dollar/Gold: The dollar index dropped for six straight days, breaking below key support around 78, closing the week at 76.93, its lowest level in a year, while gold hit an 18-mth high. I’ve been repeatedly asking in these weekly reports, “would breaking key support around 78 be bullish sign of less risk aversion for safe haven trades, or put Fed in tighter spot on its easy money policy?” Markets are now closer to finding out, as the dollar is being used to fund risky investments in carry trades. Very few Wall Street strategists and economists seem to be very concerned about the recent dollar and gold action as of yet, no surprise there.

++ Leading indicators: This factor has consistently been the highest ranked. ECRI’s WLI had its largest 1-wk chg Sep 4 in the last 4 weeks (see first table below). This kept the 1-wk chg of its 4-wk ma, 0.3, just above the low of 0.2 that has been hit 3 times since Mar 20 (the last being July 17), shortly after both SPX and WLI bottomed Mar 6. WLI’s annualized growth rate (AGR, first derivative, see chart below) was a record high, AGR’s 4-wk chg (WLI’s second derivative) declined for the 2^nd week after peaking Aug 21 just below the maximum “acceleration” reached on June 19.

ECRI commented on Fri:

The rise in WLI growth to a record high reinforces our earlier forecast that at least the early stage of the current economic recovery will be more vigorous than the last two…We expect non-manufacturing employment -- which is where 91 percent of us work -- to be positive by year end.

In previous articles I have been trying to make the point that there is a big difference between the “early stage” of a recovery and a sustainable expansion, BTE data about the former has led the huge post Mar 6-9 equity rally, but the latter is still open to question, since my Sep 2 article I have felt that market risk is now shifting to bubblevision permabulls downplaying the risks of the latter, after internet permabears have been in denial for months about the former.

OECD reported its monthly Composite Leading Indicators (CLI) on Sept 11 (see table and chart below). The OECD area as a whole, the U.S., Euro area, China and Japan entered a recovery in July. The change from the previous month in the CLI for OECD area was both positive and increasing for the fifth consecutive month, since Mar, again corresponding to the low in most global equity markets (China bottomed 4 months earlier).

Btw, it might seem strange that OECD deems that both high-growth China and low-growth Japan (where last week domestic machinery orders were weak, and 2Q GDP was revised down to 2.3% WTE) entered recoveries the same month of July (and that Brazil still hasn’t), but this is relative to their trend growth, which is obviously much higher in China.

+ China: Data releases on Sep 10 showed strong retail, production (12.3%) and investment August data, a positive, and weak exports, a negative. Aug property sector data picked up and was strong. Aug bank loans at 410 b yuan were also much lower for the second month (356 b in July, 1.53 tr in June), though significantly higher than rumored a week earlier (below 300 bn). Wen reiterated yet once again that a “moderately loose” monetary policy and stimulative fiscal policy would be followed.

+ Tech sector: Positive comments on outlook from TXN, NSM, ASML, ALTR, MCHP, SKWS, others helped bolster positive sentiment. Clearly, as in 2Q, BTE top-line growth is leading to operating margin leverage in 3Q, not only in tech, but more generally, most especially in cyclical sectors.

0 Technical/Sentiment: This past week the prospect of increased M&A activity started to become more positive, but more secondaries a negative. The market remains overbought (see chart on % of stocks above 50- and 200 day ma’s), and insider selling remains very heavy, withTrimTabs reporting its insider buy/sell ratio hit a record in Aug.

I reported on my Instablog on Sept 9 that BAS-ML technical analyst had talked in a Bloomberg interview the day before about the increasing risk of a 15-20% equity market correction. Bartels' “Volume Intensity” indictor had just turned negative, making it the third of her five “trip wires” to do so, the first two being China’s correction and the low percentage of Investor Intelligence bears; market breath was still positive but showing a negative divergence, and the tech sector leading was the other positive. She also said the gold rally was real, and its price might reach $1300 in six months, should it break out.

0 Oil/Commodities: IEA said 2009 global oil demand will be nearly 500k barrels/day higher. OPEC held quotas steady. Despite a weakening dollar, major commodity indexes (CRB, LMEX) have flattened out the past month.

+ U.S. Economy: Consensus is that 4Q U.S. GDP growth will slow to 2.2% from 2.9% in 3Q, as the positive impact of a big inventory swing, “cash for clunkers” and home buyers’ tax credit starts to dissipate. The latest U of Mich consumer sentiment data was BTE, consumer credit much WTE. Retail sales on Tues will give the next read on the U.S. consumer..

WLI and AGR data from ECRI weekly releases (not final revisions). Key inflection points highlighted in bold ital.

Wk Ending	WLI	1-wk Chg	4-wk MA	1-wk Chg	4-wk Chg	AGR	1-wk Chg	4-wk Chg
4-Sep	125.4	0.8	124.8	0.3	3.8	21.3	0.5	7.0
28-Aug	124.6	0.3	124.6	0.7	5.1	20.8	1.2	10.4
21-Aug	124.3	(0.6)	123.8	1.2	5.1	19.6	2.2	10.8
14-Aug	124.9	0.5	122.6	1.6	4.4	17.4	3.1	9.7
7-Aug	124.4	2.7	121.0	1.6	3.0	14.3	3.9	7.3
31-Jul	121.7	2.2	119.4	0.7	1.7	10.4	1.6	4.2
24-Jul	119.5	1.2	118.7	0.5	1.7	8.8	1.1	4.9
17-Jul	118.3	0.2	118.2	0.2	2.1	7.7	0.7	5.6
10-Jul	118.1	(0.9)	118.0	0.3	3.4	7.0	0.8	7.6
3-Jul	119.0	1.6	117.8	0.7	4.6	6.2	2.3	9.7
26-Jun	117.4	(0.2)	117.1	1.0	5.2	3.9	1.8	11.0
19-Jun	117.6	0.6	116.1	1.4	5.2	2.1	2.7	11.4
12-Jun	117.0	0.8	114.7	1.5	4.8	(0.6)	2.9	10.9
5-Jun	116.2	2.7	113.2	1.3	4.3	(3.5)	3.6	10.1

Compiled from OECD CLI mthly releases, geographic order is same as charts in release. Change from prev month highlighted in bold ital. dt=downturn; pd=possible downturn; pe=possible expansion; pt=possible trough; re=recovery; sd=slowdown; se=signs of expansion; ss=strong slowdown; tr=trough.

9/11/2009	Jan	Feb	Mar	Apr	May	Jun	Jul
OECD area	ss	ss	ss	pt	pt	tr	re
China	ss	ss	pt	pt	pt	tr	re
U.S.	ss	ss	ss	sd	pt	tr	re
Euro area	ss	ss	ss	pt	pt	tr	re
Japan	ss	ss	ss	sd	sd	pt	re
France	ss	ss	pt	pt	tr	re	pe
Germany	ss	ss	ss	sd	pt	tr	re
Italy	ss	ss	pt	pt	tr	re	pe
U.K.	ss	ss	pt	pt	pt	tr	re
Brazil	ss	ss	ss	ss	ss	pt	pt
Canada	ss	ss	ss	pt	pt	tr	re
India	ss	ss	ss	sd	pt	tr	re
Russia	ss	ss	ss	ss	sd	pt	re

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Comments

[Mad Hedge F...:]

ssdm The dinosaurs of the market, like myself, are collectively being struck by the similarity of the current stock market and that of September 1987, just before the one day, 25% plunge in the Dow. That was when I tied to buy stock with the index down 300 from a payphone in Paris, only to have the trader at Morgan Stanley burst into tears and smash the phone down on the desk (remember that David G.?). My new guru is Gluskin Sheff’s strategist David Rosenberg, who says that stocks have already discounted two years of recovery and now carry a lot of risk. It is priced for 40% EPS growth and a “V” shaped recovery, which we have zero chance of getting. GDP this year will come in at negative 2.5%, and will claw back a listless 1-2% rate in 2010. Stocks are discounting a 4% GDP growth, compared to only 2% for bonds, so he’d much rather own those. With a deflation rate of minus 2% and high yield returns of 12%, junk now offers a 14% inflation adjusted yield, not bad. The secular 25 year bull market in credit expansion is over. Rent still accounts for a third of the CPI, and they are falling for the first time in 17 years. Sure, we’ll see ephemeral sugar highs like those for cash-for-clunkers and the tax credit for first time home buyers. But at best, it will only add up to a series of small “W”’s, or what I refer to the as the “square root” shaped recovery. With the price of everything stretched, you better start reeling in some of that risk.

Sep 14 02:38 PM

[Tony Petroski:]

I read the entire article and studied the charts. But I'm stumped. Do I buy, sell or hold?

Sep 14 02:59 PM