Archive for September, 2010

Stronger Chinese Yuan Not Cure-All for U.S. Problems

Thursday, September 30th, 2010

If you have followed the car business over the years, you remember the cry from Detroit in the 1980s, “The Japanese have an unfair advantage and need to let the yen appreciate.” The thought process was that if the yen appreciated, people would stop buying Mazdas and Mitsubishis and instead buy Chevys, Fords, and Chryslers. The present day China-United States currency debate has a lot of moving parts, but is also very similar to the Japan-U.S. situation in the 1980s. No one single factor, including the relative value of the U.S. dollar vs. the Chinese yuan, is driving the massive trade imbalance between the United States and China.

If you have ever wondered why the Chinese currency is referred to as both the yuan and the renminbi, the distinction between yuan and renminbi is analogous to that between the pound and sterling; the pound (yuan) is the unit of account while sterling (renminbi) is the actual currency.

The Long View of China’s Currency appeared in the September 21, 2010 edition of the New York Times. David Leonhardt did an excellent job of providing a historical context in terms of the complexities of the currency markets. We suggest you read the entire article; excerpts are provided below:

Spend enough time with Chinese officials and economists, and you will hear a story about the Japanese yen in the 1980s. Back then, Americans were upset about Japanese imports flowing into the country, just as they are upset about Chinese imports today. So the United States pushed Japan to let the yen appreciate…Tokyo complied, and the yen surged almost 50 percent from 1985 to 1987. Yet the imports kept coming. The trade deficit with Japan actually widened to $108 billion in 1987, from $94 billion in 1985. The rising yen wasn’t enough to halt the growth of companies like Sony and Toyota. They had too many advantages, including lower labor costs.

“Renminbi appreciation may not have a big impact,” Fan Gang, an economist and former government adviser, said last week at a meeting here with American economists and policy makers, “or an impact at all.”

And it’s true that a stronger renminbi would not be a quick fix for our economic problems, as appealing a notion as that might be. The yen isn’t the only parallel here. The renminbi itself rose 21 percent against the dollar from 2005 to 2008, and the trade deficit continued to widen.

But there is also no question that China’s currency remains undervalued, probably by 20 percent or so. The economics are simple enough. The huge demand for Chinese goods should be driving up the price of its currency, but Beijing has been intervening to prevent that. Getting China to stop will be crucial to correcting the global economy’s imbalances. A stronger renminbi will help China’s people — many of whom are hungry for better living standards, to judge by the recent labor strikes — buy more goods and services, and it will also help the rest of world produce more. But change is not going to happen overnight.

But there are two main reasons that a stronger renminbi probably will not lead to a rapid hiring increase in the United States…The first is that China and United States aren’t the only two countries in the world. Basic parts can be made in poorer countries, like Vietnam….The second reason not to view the exchange rate as a cure-all is that economies, like battleships, tend to turn slowly. Companies rarely move production in a matter of weeks.

In terms of the financial markets, the CCM BMSI closed basically unchanged yesterday at 2,377.

Housing Not Out of the Woods Yet

Wednesday, September 29th, 2010

All markets ultimately are driven by supply and demand. In terms of how prices are set in markets, the most important factor is the desire/conviction of potential buyers relative to the desire/conviction of potential sellers. Conviction is highly dependent on the scarcity of the given product or service. It is difficult to make a case that strong conviction from buyers will soon resurface in the housing market. After a bubble, human nature tells us buyers will be gun-shy for years to come. Tech stocks were laggards after the 2000 dot-com bust; we can expect residential housing to be a lagging asset class during the current economic and credit cycle.

Supply continues to be a problem in the U.S. housing market. A healthy housing market tends to have between five and six months of inventory available based on the rate of sales. As of August 2010, we have 11.3 months of inventory for existing homes. The news is a little better on the new home front with 8.6 months of inventory available for sale. With government subsidies slowly having a lessened impact on seasonally-adjusted numbers, housing data will have a lack-of-tax-credit drag for a few more months.

Additional headwinds facing housing are large amounts of shadow inventory and tighter loan standards. Shadow inventory speaks to the house down the block that has been vacant for two years, but has not yet been foreclosed on by the bank. Once the bank forecloses on the property, it will hit the market, adding to the already bloated inventory. Shadow inventory remains a significant source of supply.

The worst is probably over for housing, but price declines of roughly 10% from present levels would not be surprising as sellers have little negotiating power in most markets. As we have all known from the beginning, the natural law of supply and demand, not government subsidies, coupled with time, will eventually work off the excess inventory of homes. From where we sit, the best case scenario for housing in the short-to-intermediate term is the muddle-through scenario. The muddle-through scenario would be acceptable for the financial markets since housing would not put additional strain on economic growth. Until the months-of-inventory figures come back in line with historically balanced markets, it is premature to forecast significant gains on the residential housing front.

The CCM Bull Market Sustainability Index (BMSI). closed Tuesday at 2,477 (see chart in Monday’s post for the significance). The daily CCM 80-20 Correction Index closed at 387, which is not alarming relative to significant market peaks prior to a prolonged correction in stocks.

Short-Term Scenarios for Stocks and Risk Assets

Tuesday, September 28th, 2010

Yesterday in Markets Tentatively Bullish on Economy, Mid-Terms, and Earnings, we focused on weekly and monthly charts, which are more relevant to longer-term investors than daily charts. On a daily chart of the S&P 500, we see three basic scenarios in the short-term:

  • Market pulls back and finds support somewhere in or above the yellow box below, which stands between 1,090 and 1,117.
  • Market continues to advance and does so with convincing breadth and volume, which may bring in some additional funds from the sidelines.
  • Market pulls back on higher volume and weak breadth (advancers vs. decliners). Under this scenario, the odds of taking out the yellow box on the downside will increase. If the yellow box is taken out, it is possible we reenter the trading range between 1,040 and 1,131.

Short Term Market Scnarios - S&P 500 and Stocks - Technical Analysis

Regardless of which scenario or variation of the basic scenarios plays out, the longer-term outlook remains tentatively bullish. Flexibility has been and will continue to be important until we see some buying conviction or selling conviction in the form of volume and breadth.

Markets Tentatively Bullish on Economy, Mid-Terms, and Earnings

Monday, September 27th, 2010

Last week’s financial market action is trying to incorporate future outcomes related to the economy, mid-term elections, and earnings season, which kicks off with Alcoa on October 7th. Currently, a bullish bias exists relative to these outcomes, but there is little conviction behind the bullish bias.

A study of the markets can give us a good indication of the composite forecast of all market participants. The recent advance in the financial markets, and the S&P 500’s weekly close above 1,131, offers a mixed bag in terms of the market’s outlook. Price, or the value of an index, is always the most important factor to monitor when assessing the conviction of buyers relative to sellers. However, secondary indicators and market volume can help us understand the risks associated with, and the possible sustainability of, any market advance.

The current advance in risk assets should be respected and markets could surprise on the upside. However, the lack of conviction and participation behind the current move puts our assessment into the “cautious and somewhat skeptical” camp. Having exposure to the current move is fine, but diversification and risk control must be part of the equation as well.

As we outlined in Investment Contingency Plans on 9/14/10, we continue to favor a mix of:

  • No double-dip / inflation / money-printing assets: Copper (JJC), silver (SLV), gold (GLD), emerging market stocks (EEM), and materials (IYM) (XLB).
  • Slow economic growth / more conservative assets: Consumer staples (XLP), utilities with a decent dividend (XLU), and broader based growth indexes.
  • Deflation / double-dip assets: While the double-dip scenario remains the lower probability scenario, we must respect it. Having some cash, CDs, dividend-payers, and fixed income exposure can help reduce the risk associated with the holdings above.

The weekly chart of the S&P 500 shows the clear break above 1,131 last week. The fact that we closed above 1,131 on a weekly basis makes the move more significant. The weekly MACD also has been able to maintain a bullish crossover for a few weeks. Bullish indications on a weekly chart are more significant than those on daily charts since they speak more directly to longer-term market trends and the conviction of buyers vs. sellers.

Stock Market's Tentative Bullish Move

We use the CCM Bull Market Sustainability Index (BMSI) to monitor the market’s overall health. Last week’s action moved the BMSI into the low-end of a very attractive range in terms of the S&P 500’s historical risk-reward profile (see green area in upper-right portion of the BMSI table below). It is possible we slip back down on the BMSI, so the green risk-reward profiles are not a signal to throw all caution to the wind.

Stock Market's Tentative Bullish Move - Risk Reward of Markets technical profile

The monthly chart below of the S&P 500 shows two more bullish indications in the forms of the MACD Histogram (top) and Full Stochastics (bottom). Bullish indications on a monthly chart are more significant than those that appear on weekly or daily charts, especially to investors with longer-term time horizons.

Stock Market's Tentative Bullish Move - Monthly Bullish Signals and Resistance

Intermediate-Trend For Stocks Is Up

Friday, September 24th, 2010

While the markets do not have a firm backing from buyers and it may not feel “bullish”, the fact of the matter is the intermediate-term trend in the S&P 500 is currently up. The basic definition of an uptrend is a series of higher highs and higher lows, which are exactly what we currently have in place (see green arrows). The orange arrows show possible areas of buying support if the trend is to remain intact. Our job is to observe, with an open mind, what happens should the market approach the orange arrows. For now, the trend remains up, not convincingly, but up nonetheless.

S&P 500 Key Stock Market Levels

Below is an updated chart from yesterday’s S&P 500 Has Possible Support at 1,121, 1,116, 1,100, and 1,060. The yellow and green boxes represent areas to watch should the markets correct further in the coming days. A break below 1,100 is far less important than a break below 1,060 in terms of preserving the trend.

S&P 500 Possible Support Analysis - Key Stock Market Levels

The CCM Bull Market Sustainability Index (BMSI) closed Thursday at 2,176, in the low-end of bullish territory.

S&P 500 Has Possible Support at 1,121, 1,116, 1,100, and 1,060

Thursday, September 23rd, 2010

From the late August lows, the S&P 500 was up 10 out of 13 trading days. The market is due for a breather. As we mentioned in Monday’s Breakout in Stocks Was Fair-to-Good, Not Great, breakouts can fail, so the move above 1,131 needs to be monitored with some skepticism. We remain concerned about the fragile state of the markets. We will be watching any pullback in terms of breadth and volume, as well as how indicators hold up.

As of 5:15 a.m. ET, the S&P 500 futures have dropped below 1,131. There will be some fear-selling and some new shorts that come into the market if stocks begin to correct. As a result, a few days of weakness would not be a surprise. How the market reacts near the levels shown below will be important. With the information we have in hand, we would be more inclined to reduce risk, rather than increase risk, in the short-term. Our preference would be to make no moves for a few days, but we will have to see what the market shows us.

S&P 500 Possible Support Analysis - Key Stock Market Levels

Even though we thought the markets could rally as of the end of August, we only added relatively conservative positions in the form of consumer staples, utilities, and bonds. If we see a correction soon, these assets should hold up better relative to the S&P 500. As we described in the contingency plans video, the markets have many moving parts currently and need to be monitored with an open mind.

Bloomberg Video: S&P 500 back to 1,220, Gold to $2,200?

Thursday, September 23rd, 2010

We agree with most of this analysis. We are looking to add to our gold holdings if we get a healthy pullback. If we correct for a few days, Rick Bensignor’s comments may reduce some stress and anxiety. We are far from blindly bullish currently, but we do believe some patience is in order during any pullback in stocks and gold. A bounce in the U.S. dollar is also somewhat expected in the near future.

Video:  S&P 500 and Gold Septmber 2010

Our comments from earlier today apply as well.

Central Bankers Ready to Print More Money

Wednesday, September 22nd, 2010

The Bank of England (BOE) joined the Federal Reserve in stating they stand ready to print more money should economic data continue to point to lackluster growth and high unemployment. Since central banks can print unlimited amounts of money, investors will increasingly become interested in alternate stores of value, rather than relying solely on paper currencies. Gold, silver, oil, and copper should all attract attention as printing presses get ready for another round of quantitative easing in the coming months.

Many asset markets may be due for a breather, but as we close out 2010 asset prices do have some potentially positive drivers:

  • Economic data has been weakening, but not to a point where the odds favor an imminent double-dip recession.
  • Central banks have signaled they are willing and able to print more money.
  • Mid-term elections in early November should give businesses additional hope in terms of more market friendly policies.

With the S&P 500’s recent break above 1,131, we still believe some patience is in order. The CCM BMSI closed Tuesday at 2,251 (basically flat vs. Monday).

Monday’s Breakout in Stocks Was Fair-to-Good, Not Great

Tuesday, September 21st, 2010

We would give Monday’s breakout in stocks a B-. Everything looked pretty good in terms of market breadth and technical indicators. What drops the grade down to a B- is lack of overall volume. With the Fed on tap today at 2:15 p.m. ET, it may be too early to give yesterday’s breakout a final grade. We did very, very little in the way of buying yesterday. Breakouts can fail, so we will observe over the next few days with an open mind.

Technical Analysis Blog - Market Breadth

The CCM Bull Market Sustainability Index (BMSI) closed Monday at 2,234, into bullish range, but at a point where advancing markets have tended to take a rest (see red areas in table below). We would be more inclined to upgrade the current breakout if the BMSI can advance a little further in the next day or so. The longer the S&P 500 can remain above 1,131, the more relevant the breakout becomes.

Stock Market Blog - Financial Risk Reward

If a pullback in stocks occurs on strong volume and decidedly negative breadth, it would be another yellow flag (in addition to Monday’s volume). A pullback on tame volume with average market internals would be a good sign. After one day, the breakout so far looks like one that could advance further, but it does not yet look like something that will lead to a rapid and convincing move higher.

As we mentioned in the video on September 14th, we would classify our reaction to yesterday’s move above 1,130 on the S&P 500 as “cautious and skeptical” (see 2:00 of video). We are ready to put some more cash to work in a relatively conservative manner, but we are happy to make no moves if the market cannot (a) remain above 1,131, and (b) show some more conviction in the form of volume. Our breakout grade of B- is indicative of an “ok” breakout; decent, but far from optimum.

Hesitant Markets Await Fed

Monday, September 20th, 2010

With the markets basically flat on Friday, our comments from Friday morning still apply as we head into trading this week. The CCM Bull Market Sustainability Index (BMSI) finished last week at 1,993, with little change occurring between last Tuesday and Friday. We anticipate a relatively slow trading day on Monday with the Fed due to make an announcement at 2:15 p.m. ET on Tuesday, September 21, 2010.

This morning’s Wall Street Journal has a good story on “risk-free” Treasury bonds:

At the start of the month, with pessimism on the economy peaking, investors rushed to buy long-term Treasurys and dump stocks. For now at least, their timing couldn’t have been worse. Since then, 10-year Treasurys have lost 2.2% and 30-year bonds are down 6.9%. The Dow Jones Industrial Average has gained 5.6%. In their rush for safety, many investors may have forgotten that Treasurys are far from risk free. (Full Story).