A Reversal in Global Financial Markets

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What’s going on in the financial markets today? You have Russia trying to stitch the old USSR back together and China in the very early stages of a burst credit bubble, and the US equity market carelessly surging to new all-time highs.

Check out the S&P500 below. On Friday it briefly traded at a new all-time high, before finishing lower on the day. The reason for the reversal was a US-style dividend cut. That is, no one from the Fed promised a continuation of QE or zero interest rates for longer than expected. And a few of them spoke at various times during the US trading session on Friday.

The recent action of the market – that is, ignore all risk and keep trading higher – reminds us of the situation in 2007. Back then, the US housing bubble had clearly burst. As you can see in the chart below, there were a few concerns in late February 2007 and again in July/August.

But the bulls weren’t ready to give in. The US Federal Reserve would ‘contain’ the sub-prime issues and lower interest rates would push the market higher. That theory worked for a little while. But back in 2007, the stock market peaked out in October. You can see the intra-day spike higher to the right of the chart below. From there, the S&P went down…and down…and down…

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The two charts are not all that dissimilar. Friday saw an intra-day spike higher that ran out of puff too. (The red lines in the chart reflect a ‘down day’.) Only time will tell whether the intra-day action on Friday turns out to be the high for this bull market, or whether capital will keep surging into the US escaping from just about everywhere else.

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Which is one of the intriguing things about the whole ‘Fed ending the QE gravy train’ episode. That is, the Fed is tightening, which encourages the reversal of many speculative trades. This reversal is a form of deleveraging, which sees money flow back to the source – the US financial system.

The reversal of these speculative trades weakens the countries on the periphery first. That’s why you’re seeing a lot of stress in the emerging markets. Capital is getting out of these formerly strong performing markets and sitting in US large cap stocks. It thinks it’s in a safe harbour.

More than likely, the storm is on its way to the US too. Whenever financial conditions tighten after a prolonged period of easy money, you get problems. The US Federal Reserve is now tightening into a fragile global economy.

At the same time, China is tentatively tightening up its horribly loose financial system, hoping to engineer a soft landing for its economy, which is suffering from major overinvestment. We reckon the communist central planners are over confident. Used to pulling the strings and getting the movements they wanted for decades, they are now about to see just how hard it is to tame a burst credit bubble.

Many people don’t agree with that scenario. Indeed, the market is treating it like it treated sub-prime in the early stages in 2007. In other words, it’s not too concerned. Phil Anderson sits in that camp. He’s been in the office recently recording a series of videos with Dan Denning on market and property cycles, and in a newly recorded interview he also had a few words to say about China.

You can sign up to get free access to Phil’s interview here. The China comments should be out later this week. Even though I hold different views to Phil, I still find his thoughts challenging and well worth listening too.

If you want to catch Phil in person, you won’t be able to unless you have a ticket to our World War D conference, which gets underway this time next week. If you haven’t got a ticket or can’t make it for some reason, you can pre-order a conference DVD and, this week only, we’ll give you a 40% discount. Not a bad deal at all…

We’ll leave you this week with a great research paper on the effect of commodity exporters from a potential hard landing in China. It comes from the Bank of France, of all places. Given Australia’s relationship with China, we wonder why our own central bank isn’t studying these potential risks.

Anyway, here’s a chart that should get the ‘China doesn’t have a property bubble’ crowd thinking. Cement, like steel, is a major input in housing construction…

The chart speaks for itself…

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Regards,

Greg Canavan+
for The Daily Reckoning Australia

Greg Canavan
Greg Canavan is the Managing Editor of The Daily Reckoning and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails. For more on Greg go here.
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Jason
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Either insider trading or being tipped off by a time traveller from the future.

Yet again, most Australians have no clue as to how economics works, even fewer could point to the Crimean Peninsula on a map.

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