Emerging Market Cyclical Decline, Developed Market Previous Investment, Looks Bigger Than Greece

I've never witnessed a candlestick in the Dow Jones Industrial Average of today's kind. What's more is that this candlestick formation is common among all indices and heavily traded stocks. Learned observers seem to have a common opinion that this is not only unusual, but also historical.

The bizarre dynamic happened with market futures opening with indications of a significant decline, 800 points down for the Dow. Next was a climbing opening for the Dow, reaching about only 400 points negative, then a nose dive of up to 1,100 points. That is a capitulation to sell. Then I saw the sellers capitulate to higher pricing and the Dow reached a point of being down only 140 points.

Volatility shot through the roof, and the prices of options also shot up. Then down, then up. In fact liquidity in options seemed rather slow due to the rapid and extreme movement in index pricing. Such pricing difficulty presents complication for one seeking to open a new position at this time. Even exiting a profitable position was difficult today. But really not bad at all, with these price movements. Essentially, the exits got clogged today, then the entry got clogged, then market makers didn't want to undersell the market or oversell the market.

Market pricing at this point isn't just an issue of a couple day's sentiment. Reality is in the equities of China collapsing. China is the 2nd largest single country economy in the world. By itself, China's stock can do what they do. But when China's stock market makes significant moves, one must search for implications. The most ready implication is confirmation of pricing discrepancy between China's real GDP performance against China's equity earnings performance.

Perhaps China's stock market got well ahead of itself. And maybe China's policy makers realize that.

What appears to be most concerning for U.S. markets is emerging market currency decline, due to cyclical demand declines. This dynamic pressures pricing of all commodities. Should emerging markets really be entering the decline aspect of their economic cycle, the yield hungry investors from developed economies provided substantial debt to the emerging markets. Today, the combination of emerging market debt and emerging market cyclical decline bring a ration of reality to U.S. equities. That seems to be what we see.



 

China is Once More Disturbing Markets

I trade the markets, and I've found an unsettling development this week. Where last week I found the markets respond in deep decline to China's currency devaluation, that same market came back the next day in a seriously bullish action. In fact, the market closed up considerably. This last price action happened on Wednesday of last week.

Since Thursday of last week, the major indexes are flat. Essentially, the bulls showed major resilience, but no capacity to follow-through over a few days now. Same with the bears, which got their back broken on Wednesday of last week.

Otherwise for the Dow, Walmart guided down and Home Depot outperformed. I think Disney was downgraded, by someone (ESPN cable issues). Disney owns the franchise. Yet, the only proprietary franchise merchandise I care to get off ESPN is during college football season (cancel and reconnect).

Looking at Monday, the indexes were up and finished with a little rally at the close. That looked bullish going into Tuesday, and looked promising for a follow-through increase. But on Tuesday morning, the indexes were down, and finished the day down, and more pointed is the indexes were down only marginally.

Today of August 19, for the first time in several days, a significant decline was observed in all indexes. Such a decline was not linear. Rather, the decline occurred after a major rally, but the push up ended in considerable decline given the range since last week.

Causation certainly appears to be China and it's stock index losing 6% on Tuesday, only to lose 4% today but find a 1% gain at closing today. This leads to the appearance of the Chinese government support of their stock market not being the salvation once thought.

Probably more concerning is that the People's Bank of China released more money to their associated central banks than since January 2014. That by itself is meaningful. Especially when this release of funds occurs at a time after a currency devaluation.......How much money did China expend in preventing a collapse of their currency. How much more money will be needed for a second resetting down of currency price.

Perhaps an appropriate question is whether China devalues again. Market pressures seem to want more devaluation. And, China wants their currency to reflect markets. Their stock market, however, isn't so much based on a market. Large stock holders can't sell and the government today took a step back on Tuesday from supporting prices. Perhaps China's troubled state owned enterprises are buying stock to support the market. Yet, if China follows the policy of their currency, and remain consistent with their stock market intervention limitations, that stock market is going to follow market influences in a fashion similar to their currency.

Further Chinese yuan/renminbi devaluation only increases the cost of China's bloated foreign currency debt. It also makes China's exports comparatively cheaper. Between the two "onlys", which is more powerful?

By devaluing a currency, a country makes debt burdens more difficult for domestic businesses that hold foreign, especially U.S., denominated debt. This situation namely arises in China for its property development businesses, which seem to be a Potemkin village. However, most of this debt is held by state enterprises, which is ultimately China's corporate debt, and not the state held debt.

Memorial Day

Given Memorial Day, we must remember those forever loved, now lost, in the service of our Country.

https://www.youtube.com/watch?v=BB2Ad04mukI

Just last Monday, Fed Chair Yellen said equity prices are high. Yes, that seems to be a rational conclusion. After all, the S&P 500 P/E appears around 20, plus some change. Nonetheless, I hear that historically such a number isn't too high.

Reality is that in the past, even with equity bubbles, there was the prospect for increasing business propositions. Namely, the internet in early 2000's. A bubble occurred, popped and finally did realize a profound growth potential. Which by the way created super technology to create the banking bubble realized in 2008 with Lehman and others.

Now, banking is probably way too conservative on lending criteria. Yet they have to be to comply with capital requirements and the balancing of equity versus lending. That dynamic leads to stunted growth in capital development in business.

We also have a condition of net loss of jobs globally, due to automation. That obviously leads to a net loss of consumers. I've mentioned previously what Henry Ford did for his company, and the market, many decades ago.

Today, consumers remain as real as they did yesterday. So often, a corporation will automate a job once held by a human, to be replaced by a machine. Like I've said, the machine doesn't buy any products, while the human will ultimately by products, if not a Ford pickup.

To make sales, one needs buyers. Therein resides the difficulty of this present day economy. Corporate revenues, a.k.a sales, are flat to down. That does not simply imply a flat buyer of products, it screams a flat and down buyer of products.

O.K. I will play the game.....who the hell do you sell to when all jobs are gone.....How about selling to call center folks all day long. Thank God they can hire a plumber.

Tell you what, after lifting about a ton for exercise and running a few miles, there is nothing I adore more than a  McDonald's hamburger and french fries. No ice cream, I save the appetite for meat and potatoes. I get my ice cream in the morning. If I wake up in time.
 

Fed Did Talk Down the Dollar, But we are Bid Up All Other Assets

You got me. The Fed statements were....shall I say very dovish. In fact, I heard substantial commentary that the Fed came out unexpectedly dovish. My view is that the Fed talked down the dollar overall, with immediate market results. Perhaps the Fed took a page out of the ECB's play book, is what it looks like.

What disturbs me is how equities went wild on a fatter hog rally. Reality is, the Fed will not be pumping more cash into this system. The ECB will be pumping cash into the euro system. How does that cash translate into U.S. dollars given the current trade difference of currencies between euro and U.S. dollar? Not like it used to be.

People that make a living off this stuff will have to play the game. In the mean time, I recall Chair Yellen saying equities aren't BEYOND historical norms. Does it really take pricing beyond historical norms to prove a problem? Prevention of bubbles is the first teaching to learn. Second is deflate the apparent bubble in order to prevent an explosion.

Certainly a bubble was occurring with the U.S. dollar. That was talked down today by the Fed, and good work. That is the best thing I can take out of the historical message. Otherwise, it's bid up on other asset's high prices.  

Where Will Markets be Upon Fed Remarks: Disappoint Equities and the Dollar

Tomorrow at 2:30 Eastern Time, the U.S. Federal Reserve will hold its press conference that will announce its monthly decision. This meeting is especially crucial due to whether the central bank will increase interest rates or not. Most particular in investor curiosity is guidance, or language of some sort. From the Fed suggesting when the inevitable rate increase will likely occur, to when it might not occur, are the signals. That is, will the interest rate increase happen this year or next, or this Spring or Fall. Also of note are indications of under what circumstances a rate increase might occur. These matters are of considerable import in bull/bear market debates.

Where the Fed has been using a word, being "patience", on their timing of increasing interest rates, market consensus is that the Fed will eliminate the word "patient" from their often elusive "message" to the markets. The entire question does reside in how the Fed fills the hole left behind from abandoning "patient". Does the Fed replace the idea of patience with "light this candle" and rush interest rates (unlikely, they look like s.m.art.). Or does the Fed say they are going on light throttle touching increases, to see how the ship flies. Or, do they speak with a big stick and walk lightly with a month to month review of interest rate increases. This approach would really be learning how to fly through this unprecedented valley of history.

Ultimately, given the rise in the U.S. dollar and the rise in U.S. equities, the Fed needs to disappoint both asset classes. Increases in the U.S. dollar have been untold for nearly a half century. The rise in U.S. equities produce a consensus regarding a needed correction of considerable depth outside of channel up trajectories. Look at IPO's (especially among technology companies), falling earnings projections, sustained stock pricing, and challenges to revenue quality.

Small capitalization stocks see a weakness as well. How many services do these small cap companies offer to the employees of big capitalization companies? Or, how many services do these small caps offer to the big caps? Or, how many small caps are looking to be acquired by a big cap? These are drip down feelings for small caps, if big caps get hit too hard with our global environment.

To further make the point, for a big cap company to appropriately acquire a small cap, a condition of health should exist in the big cap. Consequently, a disturbing condition would occur should a big cap start acquiring small caps to help hide global weakness produced by dollar strength and declining global demand. By the way, dollar strength and weakening global demand are trends that don't look very transitory, unless the Fed acts to arrest the dynamic in some fashion.

Looking at actual influences on Fed decision making, perhaps a look at the last CPI data will help on perspective.

Strongest perspective is to say that while the headline CPI from the BLS for January, last reported on February 26, 2015 was -.7%, and for the year ending January it was down -.1%.  But the story isn't over. Food for the months of July to last December held a run rate of price increase in the area of .3% to .2% and found a flat .0% in January, 2015. Overall, for the 12 months ending this last January, the rate of price increase for food resulted in 3.2%, well above a 2% Fed mandate. Out side of energy, most elements of the CPI increased more than 2% for the 12 months ending January. The increases beyond the Fed's 2% inflation mandate are:

Home food ending 12 months January increasing  3.2%.
Away food ending 12 months January increasing  3.1%.
Medical care commodities (same period)             3.9%
Shelter (same period)                                          2.9%
Transportation services (same period)                  2.1%
Medical care services (same period)                    2.3%

How about this versus petroleum, natural
gas and coal 's substantial decline: (shocked by this)

Electricity (same period)                                     2.5% (increase)

Keep in mind, energy in general has declined over the last year from 20% to 35%, depending on products. The meaning to be taken is that petroleum prices are essentially the only element that prevents the Fed from exceeding its inflation target of 2%. Last Fed meeting, Chair warned of "transitory" energy prices...meaning petroleum and gas. These two elements are children on the play ground of where the reality exists.

I've heard every day for the last 3 months about a bottom for petroleum, or no bottom. Petroleum is in a transitory dynamic driven by its own market cycle, which is a new cycle given U.S. production. Consequently, petroleum's influence on inflation can, and will, change based on that sector's response to the market.

These facts show the importance of the service industry in the U.S. and its association with the real U.S. economy. Looking at BEA reports, services in the U.S. have exceeded goods in sales by about 50%. Further, most of the above GDP areas that are exceeding 2% inflation are service industry related. Consequently, most of the U.S. economy is motoring above 2% inflation. It's only when one factors in giant drops in petroleum that one sees a muted disinflationary environment. Taking out the oil influence, the U.S. is experiencing a level of inflation generally well above the target of 2%.

Why oil is transitory are common and daily debates on where, when, who and at what consequence any price of oil will be realized. These debates could finally be realized on the side of inevitable market stabilization. Any stabilization will probably be increasing petroleum costs, that add to existing inflation that already exists through other areas of the economy. Overshooting the target by the Fed is their risk at this point. After all, petroleum is going through a cycle that will be self-correcting by its own giant market, without the Fed raising or lowering rates.

Where Fed Chair Yellen mentioned transitory energy prices in terms of interest rates, it appears real. Tomorrow's announcement seems to be setting up to be more aggressive than just removing the word patient. More like, see how the motor works on an aircraft never having reached this elevation.

Reality is, the U.S. dollar needs to be disappointed by "not enough", equities need to be disappointed by "too much", and bonds need to hold ground by warming up to their month long yield increases. At least until the Fed's next review of circumstances. Perhaps, if the buck gets talked down a little, with enough doubt on movement, equities will perhaps respond. Bonds can be let down at their choosing in their own confusion. Let's see how it plays out.

Markets Now Seem Risk On, But Fundamentals Have Not changed

Did you see that market reversal? It looked so bearish, but then there was a complete pattern change. How about that. Once oil stopped its fall, everything went risk on. While I absolutely agree that American innovation is at work every day, I can't agree that the American company is an island unto itself.

The American consumer is proving tepid, except with, of all things, SUV cars. I like any vehicle with a wide foot print and a comparatively low profile. I like this feature for safety reasons. That really limits my options to a couple of companies.

Looking at the chart of the U.S dollar, we can see stability. Take a look:

From oil and the U.S. dollar, compare high risk assets, such as high yielding bonds:



We do have a risk on attitude. My posit is that two causative points exist for a rally in risk on assets. First, and for some reason, a bottom in oil has been thought to be found. Excluding fires and strikes, the fundamentals have not changed in oil. Where gas pricing can be seasonal, the fundamentals also have not changed. Even if SUV sales increased, reality is this idea of "subprime" vehicle loans. Frank reality is, versus the real estate market, those vehicles get repossessed over night and sold the next day. Second is why not buy in a bull market where any news is good news, despite U.S. multiples advancing on stock pricing.

Confusing the issue is the drop in U.S. treasury values. Stated otherwise, the spike in U.S. treasury yields. Look at the 10 year:



Any person with a conscience can see that rise in the 10 year yield, which means a drop in the price of the 10 year U.S. Treasury Bond, is a whole bunch really fast, despite trends and changes in fundamentals.

The guard to put up now is despite no real change in economic fundamentals over the last month, one should become cautious. This looks so much like a strange head fake to be caught on an over-head cross punch, if you've ever boxed. Maybe not. But look at the fundamentals.

Looking at currency markets, we are seeing in equity and debt markets, what I think is a bull's head bounce on risk assets, not a real issue that will deviate from stronger cross market trends. I could certainly be wrong.

Always remember, I offer opinions only, no investment advise. For investment advise, learn from ideas and ask of the person holding your money.