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10/22/2010 - China/US in a pickle


  • The US markets are on shaky ground. $INDU is at the April10 highs, whereas $SPX and IWM are a little bit below them. The strongest foreign markets are China, Germany, and EEM, whereas the weakest is EWJ. USD is oversold and should stage some sort of rally from here, and if it does, I will look for a pullback in the market to at least the 50dEMA, but probably (hopefully) the 89dEMA. From this point I will watch to see what happens. The USD could also make a lower low below 76.12 and the market makes a new high, and then the USD could rise/markets fall. That will be the most likely scenario if markets are pushed higher due to “good” news, however it will be on low volume because nobody is going to get serious longs in at this extended price level now. 
  • So, some chance of marginal new highs, a larger chance of a ~38% retracement pullback of this last leg up. 


  • Bloomberg is reporting that the economists consensus is that GDP growth is improving @ 2% up from 1.7%, and consumer spending, which accounts for 70% of the economy, increased at an annual rate of 2.4% from July-September. The S&P500 is up 11% from Aug.27, almost completely because of QE2, which hasn’t even started yet. ~85% of S&P500 companies beat analysts estimates so far in Q3.
  • All of this would seem like good news, however housing has still not really picked up. The Case-Shiller Index is due on Oct26, and already published measures show new-home purchases increasing slightly off the May record-low. 
  • This all makes one think of the economy as starting to recover, but most of the companies with big profits are reporting that most of the growth and profits is coming from overseas, and the S&P rally is all due to people’s anticipation of QE2, which is already priced into the market now. However, only 25% of the s&p500 companies have reported yet. The good companies probably reported first, and from here earnings may start to fall. Consumer confidence is low and banks are still cautious about extending credit, especially with the foreclosure crisis still up in the air. Both of these factors combined dramatically slow the recovery of the economy. And regarding the Case-Shiller number, it will probably resume the downward trend, but the real drop will come next month when the last of the ‘homebuyer credit’ months gets dropped from the back of the data. 


  • Chinese CPI had the highest YoY growth rate in 23mnths, 3.6% vs 3.5%, with food inflation +50bps MoM @ 8% vs 7.5%. This inflation is starving the Chinese people, since ~36% of the population lives on < $2/day, with food being their largest expense. The interest rate hike is only the first of many in an attempt to stave off inflation. Chinese CPI is 110 bps higher than 1yr deposit rates (2.5%), so as long as the spread exists, it will encourage speculation in asset classes that will appreciate at the inflation rate. Industrial production growth was +13.3% YoY vs +13.9% YoY in August. 
  • The US is China’s largest customer (20%), so China needs QE2 to continue stimulating the demand for imports. But QE2 will drive DXY down even farther, which will increase commodity prices, which will hurt the Chinese businesses and people and adding to China’s inflation, leading to China tightening their monetary policy. 
  • So, in essence, if there is more QE, China will have to raise rates to fight inflation, and if there is less QE (than expected), the USD will rise again, leading to a decline in the US stock market, commodity markets, and global markets. 
  • Chinese interest rate hikes are a negative sign for Chinese growth, commodities, and by association, all emerging markets growth.


  • Short COF, XLY
  • want to initiate a short in SPX through one of its many proxies

Disclosure: Short COF, XLY