The Worrying Signs Coming from the Dow Jones Index

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BORING!

The most anticipated interest rate non-decision came and went overnight. It was a fizzer. The market already knew the outcome yesterday.

Although gold clearly liked it, rallying US$10 an ounce right on 2pm Eastern Standard Time, which was the time of the Fed’s statement.

Speaking of gold, I’m presenting at this year’s Gold Symposium in Sydney. Held over two days, I’ll be winding things up at the Four Seasons Hotel on 27 October. This is one of the best gold focussed gatherings in Australia, if not the world. I encourage you to check out the line-up and come along if you get the chance. You can find all the details here.

Gold’s positive reaction to the Fed statement was due to the focus on inflation. Over the past few months, the Fed has clearly shifted the goalposts. After talking about the need to see a lower unemployment rate, they now see low inflation as the biggest hurdle to a rate rise — a measly 25 basis point rate rise.

I wonder how the narrative will change now. For months, the market has slowly come to terms with the fact that US rates will rise. The narrative behind this prospect is that the US economy is strong enough to handle it.

But now, that assumption may come under question. The Fed is also worried about China and financial market volatility spilling over into a weaker economic performance. And so it should be. Financial markets usually lead the economy by six to 12 months.

If we look at the Dow Jones as a proxy for global growth, there are worrying signs. Check out the chart below. It’s the one year performance of the Dow…


Source: BigCharts

The Index reached a top in early March. It made a marginal new high in May, but quickly sold off. There was no conviction about the market reaching new highs.

Then in June and July, the Dow made lower highs, before plummeting in August. This was on the back of panic over China devaluing the yuan, and general concern about an emerging markets crisis.

After such a steep sell-off, there’s always a reaction. Prices go the other way. We’re in that period now. But after such a steep sell-off, which follows on from a lengthy topping out process, it would be very unusual to see a quick bounce back to new highs.

And as I’ve pointed out before, the trend of the market is now bearish. The trend turned in late July. I warned you about it at the time in The Daily Reckoning. This tells you that the market sees weaker growth ahead for the global economy.

Just how weak is the question. But it’s this concern, along with the convenient excuse of low inflation, that has the Fed sitting on its hands – again – for the time being.

Note also in the chart above the big spike in volume during the sell-off. That tells you the break in the market flushed out a lot of weak hands. They dumped shares quickly — and weren’t too concerned about the price received.

But for every seller there is a buyer. It’s important to take note of where the price stabilised. It tells you where the buying power is strong enough to offset panic selling.

As you can see from the volume spike, buying support clearly came in as the Dow dipped briefly down to 15,400. It then dropped away quickly as the rally continued higher.

That tells you there’s not much follow-through buying power. My guess is that we’ll head back down into the area of previous buying support soon to see whether the buyers show up again.

Whether that happens or not depends on a whole multitude of factors. But China will likely be the focal point. The fact that the Fed’s non-decision today didn’t do anything for stocks (the Dow finished down 0.4%) means that the market is on its own for a while.

And the Fed-based news cycle is pretty much dead for now too.

Maybe Greece will come back onto the financial pages? The country goes to the polls this weekend.

And apparently it’s neck and neck between the ruling Syriza party and the challengers, the New Democrats. Syriza’s decision to accept the harsh terms of the Eurozone bailout and return to the austerity measures that it initially campaigned against has damaged its cause.

Britain’s Independent quoted former Syriza MP Maria Bolari as saying:

“There will be instability after the election…because there is a great polarisation in the country. As in the years from 2010 to 2013 there will be more big strikes and chaos will return to the streets. When people voted for Syriza last time, it was able to implement its own policies. But if it wins again, it will merely impose the Memorandum’s terms – and the people won’t take it.”

And the Financial Review reports that

The man who negotiated the bailout of Greece in 2012 says that whatever the outcome of this Sunday’s election in Greece, it is “highly likely” global financial markets will yet again be thrown into turmoil over the beleaguered country’s debt burden and the long-term sustainability of the euro.

Greece may be out of the headlines at the moment, but it’s not out of trouble. Its economic problems are as intractable as ever. Soon enough it will come to a head once again.

What many people don’t know is the very long history between the Greeks and the West. In short: for centuries they hated and mistrusted each other. Modern day Greece only became important to the West because of its proximity to and antagonism towards the Ottoman Turks. Clearly, Europe’s animosities run very deep.

Regards,

Greg Canavan

Editor, The Daily Reckoning

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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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