A Reversal in Global Financial Markets

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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Greg Canavan+
for Markets and Money

Greg Canavan is a Contributing Editor at Markets & Money and Head of Research at Port Phillip Publishing. He advocates a counter-intuitive investment philosophy based on the old adage that ‘ignorance is bliss’. Greg says that investing in the ‘Information Age’ means you now have all the information you need. But is it really useful? Much of it is noise, and serves to confuse rather than inform investors. And, through the process of confirmation bias, you tend to sift the information that you agree with. As a result, you reinforce your biases. This gives you the impression that you know what is going on. But really, you don’t know. No one does. The world is far too complex to understand. When you accept this, your newfound ignorance becomes a formidable investment weapon. That’s because you’re not a slave to your emotions and biases. Greg puts this philosophy into action as the Editor of Crisis & Opportunity. He sees opportunities in crises. To find the opportunities, he uses a process called the ‘Fusion Method’, which combines charting analysis with more conventional valuation analysis. Charting is important because it contains no opinions or emotions. Combine that with traditional stock analysis, and you have a robust stock selection strategy. With Greg’s help, you can implement a long-term wealth-building strategy into your financial planning, be better prepared for the financial challenges ahead, and stop making the same mistakes that most private investors do every time they buy a stock. To find out more about Greg’s investing style and his financial worldview, take out a free subscription to Markets & Money here. And to discover more about Greg’s ‘ignorance is bliss’ investment strategy and the Fusion Method of investing, take out a 30-day trial to his value investing service Crisis & Opportunity here. Official websites and financial e-letters Greg writes for:

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