Dow 18,000: We May See a Correction in the Weeks Ahead

Hong Kong, China - July 2, 2011: iPhone running Bloomberg app, displaying Dow Jones Industrial Average data

US stock markets are only just hanging on right now. Overnight, markets reacted negatively to poor trade data out of China, only to bounce back later in the day.

China has been keeping its head down lately. The big stimulus effort earlier this year has kept things humming along nicely. There have been no worrying data releases, apart from the fact that the property market is showing signs of overheating once again.

But data showing weaker than expected Chinese exports and imports, released late yesterday, turned attention to the fact that China’s economy might not be as strong as many thought.

The Financial Times has the story:

A weaker renminbi failed to stop a sharp fall in China’s exports in September, damping economists’ hopes that demand would pick up in the fourth quarter and sending markets in the region lower.

In renminbi terms, exports fell an annualised 5.6 per cent, according to China’s General Administration of Customs, the first drop since February when outbound shipments contracted 20.6 per cent.

Imports grew only 2.2 per cent in local currency terms, down from 10.8 per cent growth in August.

The outlook was bleaker when valued in dollars, with outbound shipments falling 10 per cent year on year, sharpening from a rate of 2.8 per cent the month before and far worse than the 3.3 per cent shrinkage forecast by economists surveyed by Bloomberg. A drop of 1.9 per cent in imports also came in well below expectations of 0.6 per cent growth.

China’s been steadily weakening its currency, yet the trade data indicates these efforts are having little effect. That says two things: that global economic growth remains weak, and that yuan weakening will continue.

Neither of those factors is bullish for markets. When news of the Chinese trade data hit, US stocks fell sharply. The Dow initially fell below support at 18,000. This is a pretty important level. As you can see in the chart below, if it breaks, I think you’ll see pretty hefty falls.

Source: BigCharts
[Click to enlarge]

That level did break in early trading overnight, but a recovery in oil prices and energy stocks brought the Dow back above 18,000. It closed the session down 0.25%, at 18,098.

A close below 18,000 would be a concern. It will bring about a lot of ‘technical’ selling and, given there isn’t a great deal of valuation support for stocks at these levels, you could see the market fall hard and fast.

That would make things interesting for the Fed. Would a plunging Dow and S&P 500 give the Fed yet another excuse to sit on the fence?

That’s an interesting question. Yesterday saw the release of the September meeting minutes. These minutes indicated some members are increasingly concerned about the Fed’s credibility.

That being the case, will the Fed hold off on raising rates based on a stock market wobble? They have done so in the past, but it’s less likely they will do so in the future.

For one thing, the Fed doesn’t really understand how the market works. It’s full of academics, not hardened market traders. Markets price in the future ahead of the data. There are the occasional surprises, but, more often than not, when data is released it is already priced in.

If the market starts to break down because it sees a Fed rate hike leading to an economic slowdown, or possibly a recession, this won’t show up in the data that the Fed slavishly follows until early in 2017.

By that time, the rate hike will be over and done with, and the Fed will then be looking to reverse its decision.

That’s my guess, anyway. That is, the Fed will raise rates in December and then regret it in the new year.

The best market to follow for clues in this respect is the gold market. It’s already factored in a rate rise, having declined more than US$100 an ounce since peaking in July.

Gold now looks like it’s putting in a bottom at around US$1,250. If it holds this level, and starts to rise again, it will tell you that the Fed is about to blunder. That is, a December rate rise will hurt the US economy and, ultimately, lead to lower rates again in 2017.

We’ll get another read on what the Fed’s thinking today when Janet Yellen makes a keynote speech at the 60th annual economics conference hosted by the Boston Fed. It should hit the wires around 1.30pm eastern daylight time.

If she fuels the December rate hike speculation, there’s a good chance that US markets will finish the week by breaking down to new lows. That should keep a lid on our market today.

Futures prices suggest a positive day for Aussie stocks. But unless Yellen pulls out an ultra-dovish speech, my guess is that there won’t be a great deal of buying going into this weekend, and the market will be lucky to finish the day in positive territory.

I’m tipping we’ll see a decent correction over the next few weeks…just in time for the US election. But it will be a correction, not a credit crisis Mark II. Don’t get lured in by the bears telling you the world is about to end.


Greg Canavan,
For The Daily Reckoning

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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