Brexit, Trump....What Next?

Brexit, Trump....What Next?

I don’t have an extensive knowledge of Chinese curses, but one I do know is the expression ‘May you live in interesting times’. This curse is based on the fact that in human history, ‘interesting times’ have tended to coincide with upheaval, disorder and conflict. In many of the developed parts of the world we have had an unprecedented period of relative calm and stability, and in this post I will look at the changing political scene over the last few months, what it forebodes and whether ‘interesting times’ lay ahead.

My last post back in June on the eve of the Brexit decision spelt out the situation ahead of the critical vote regarding the future of Britain, and concluded that an independent Britain, free of the diktats of the European Union was a better option than being saddled to a flawed euro project that would shortly be going over the edge of a cliff. It is now clear that a majority of the voters agreed with that sentiment as the Leave camp won the vote by a slim margin of 51.9% to 48.1%.

Any hope that a result would bring an end to the bitter disagreements between the two sides however has completely evaporated, with the following weeks and months being marked by political turmoil within Britain, increasingly hostile comments from some European politicians and an ongoing legal challenge designed to prevent the British Prime Minister Theresa May from triggering a formal exit without the approval of Parliament. The binding referendum may not end up as binding as the ‘Leave’ voters envisaged.

Whilst the Brexit aftermath held the news headlines for a while, it was soon relegated as the race for the US Presidency took centre stage. The contest has been compelling viewing right from the start. From the nominee process, through the race itself and the final vote, with the Trump victory coming as a complete surprise to so many people and the subsequent reaction so similar to that in Britain post Brexit.

So are there similar themes with these two results and can a greater understanding of that connection shed some light on what we will face over the next few years? 

The simple answer to those questions is yes.

For the specifics of our current issues we need to go back to the start of the 1980’s. As we are all aware, the decades since have witnessed a huge number of changes in many aspects of people’s lives, but some have been particularly influential:

·        a massive uplift in housing values leading to wealth for some, but increasing financial strain for many others;

·        a general movement in manufacturing and production jobs from developed to less developed countries leading to a reduction in the number of jobs available for the lowest skilled;

·        an increase in mass migration as a result of religious and geo-political tensions leading to increased competition for lower grade work, stagnant wage growth and most importantly, an increase in racial and religious intolerance;

·        an increase in the ‘consumer society’, with the stampede for new, more or better, fostering general dissatisfaction with one’s lot.

·        an upsurge in the level and extent of political corruption leading to an increasingly angry and discontented electorate.

Obviously these trends have not influenced every country, region or individual equally, but they have provided the driving force that has led to this division within our societies.

If we now look back at the Brexit vote, it is easy to see where these Leave voters came from. They were the huge numbers of people that have seen their living standards drop, their jobs dry up, their neighbourhoods forever changed by massive immigration, their power to change the system stolen from them by lying, corrupt politicians on all sides; and their cries of complaint silenced by a political elite that didn’t want to hear it, and that actively labelled as ‘racist’ anyone that voiced it. Locked into this cycle of despair, is it any wonder that when an opportunity came about for a protest vote they grabbed it with both hands and said ‘Up Yours!’ to the establishment.

If we now apply this thinking to the US election the parallels are obvious. Trump won because he got the protest vote from those Americans that are not doing well. The regional voting split in both Brexit and the US elections bear this out. With Brexit it was the areas that have been hit hardest that voted to leave, and the harder they have had it over the last few years the higher the leave vote. With the US it was the same story. After years upon year of elections creating absolutely no change for the majority of the working class in the US, finally there was an opportunity to vote for a non-establishment figure, and they took it.

Yes, I know that Trump ran as a Republican, but in reality he is an independent because his wealth allows him to be. With every other president they are already in somebody’s pocket before they even get to the Whitehouse. From the moment they walk through the doors of the Whitehouse they lose any ability to reform the system, whether they were genuinely minded to or not. It’s Trump’s ability to act independently along with comments like ‘draining the swamp’ that scared the Republican elite into supporting Hillary against Trump and the interests of their own party. They would rather have seen a Democrat in the Whitehouse than see someone finally get a grip on the corruption and end their gravy train. This is precisely the kind of behaviour that many voters are sick and tired of, and only reinforced their belief that a vote for change was needed.

We can now see that it is the leaving behind, economically speaking, of a large part of society that creates the conditions for what will follow. As the wealth gap widens over many years, the feelings of disenchantment and animosity grow, resulting first in disengagement from and an apathy towards the political process, but finally in feelings of anger and rebellion that manifests in large voter turnouts and support for change in the political system that has failed them.

If we now look around the world we can see that there are numerous countries that mirror what Britain and the United States have experienced over the last thirty years, and their populations will likely be feeling the same way. The opinion polls in many European countries are supporting this view, with support for independent or anti-establishment parties rising steadily. The upcoming elections in France, Netherlands and Germany will likely reshape Europe in a way that would have felt unthinkable only a year ago.

 I think there is a distinct probability that the voters in these countries express their dissatisfaction with all that has occurred over the last few years and vote out the incumbents, replacing them with politicians of a more nationalist, populist persuasion. This will put Europe in the bizarre position of a European Union strongly pursuing a federalist agenda, whilst the member countries move increasingly away from it.

In theory this shouldn’t be a problem, as the agenda for the European Union could be redrafted to better represent the changing outlook of its member states. However, back in the real world, the European Union has been pursuing its own agenda for years, and could care less about the opinion of the average European citizen. We could easily therefore be in the position of the European Union heading in one direction, whilst the people of Europe head increasingly in the other. This is not a recipe for a happy ending, and unless the elite of the European Union accept that they are at odds with the will of the peoples of Europe, then it threatens to pull Europe apart.

When and if that time comes, we would like to think that these people in power could accept the result of the democratic process, however much at odds it is with their own personal views, and however detrimental to their personal ambitions. However, Brexit and Trump’s election have shown us that it is unlikely to be the case. These people of influence and power do not relinquish control easily, especially when it means an end to their time at the feeding trough.

But wider still, the reaction we have seen from those on the losing sides in the aftermath of those two events paints a very unpleasant picture of what we can expect. We seem to have lost the ability to put ourselves in someone else’s shoes. To see the world from their perspective and understand those things that have shaped their decision making, even if we disagree with it. The wailing and gnashing of teeth and the level of vitriol from some of those on the losing sides has been incredible. The sense of loss, of frustration and fury at the defeat has seen some verbal attacks of an intensity and ferocity that seems completely disproportionate. We are seeing almost no attempt to understand why the majority of people voted how they did and simply resorting to labeling all of them racists, red-necks etc. Instead of coming together and moving forward, opinion is polarizing further, and creating rifts that will be hard to heal.

In the case of President Trump, it’s his lack of credibility that prevents many opponents from accepting his victory. The view shared by many of his opponents that he is a sexist, misogynist, racist, narcissistic, egotist means they are still dumbfounded as to how anyone could vote for him. They don’t see him as a good candidate or as a viable president of the US, and certainly not the best person for the job. But on this issue they are really missing the point. The majority of people didn’t vote for Trump (or Brexit for that matter) because they weighed up the arguments and thought that was the right decision. Instead, they saw what the establishment wanted and voted against it. It was a protest vote, pure and simple. In fact in regards to the US election, had Donald Duck been running rather than Donald Trump he would still have got in because it wasn’t a vote for anything, but against the establishment. And there was no greater establishment figure than Hillary Clinton.

In the big scheme of things it is pointless to debate whether Trump is the right man for the job. Will he be a good President? Judging by how he acted throughout the election process, almost certainly not. But would Hillary have been any better? That depends on where you are in the societal pecking order, but the answer is probably better for some, not for others.

 It is important to realise however that irrespective of who is running the show, the outcome is baked in the cake. Those Americans that have been left behind and been silent for so long, have finally woken up and spoken, and the word was ENOUGH. They are not going to go away. And no amount of dragging the chain by those in power that have profited for so long will prevent it happening. Whether it is Trump or whoever follows him, the momentum for change is building. It is the same situation in Britain, and the trend will move throughout Europe to the rest of the world.

Brexit may have been the first indicator that something was different, but Trump’s election has shown that it was not a one off. The opportunities for citizens to express their disapproval will come thick and fast this year, and it will likely have some profound effects in ways we are only just beginning to understand. 

It would seem that ‘interesting times’ do indeed lie ahead.

The Markets

As you can probably guess, these trends will have huge impacts on financial markets. My long term views of rising Stock Markets, US Dollar, Precious Metals and Global Interest Rates are partially derived from my big picture view of the wider global economy. I am overdue for an update on these markets but I felt this post was important in establishing the political backdrop we will face.

I hope to get another post out by early February.

Regards

Paul

Brexit and the Future of Europe

Brexit and the Future of Europe

Over the last few weeks the news media has been awash with discussion and debate over the outcome of the upcoming UK vote on European membership – or ‘Brexit’. With the two sides fighting an increasingly hostile battle to convince voters ahead of the referendum scheduled for June 23^rd.

On the one hand the Remain camp argues that leaving would be hugely damaging to the UK economy and leave it as a fringe player in European and Global politics. Conversely, the Leave camp counter that leaving would actually boost the British economy, restrict the number of illegal immigrants entering the country and enable it to self-govern, unfettered by European interference.

The debate has been long on rhetoric and short on substance and it took the tragic murder of the British pro Remain MP Jo Cox by a supposed Leave fanatic a few days ago to force a rethink by both sides, and take some of the bitterness out of the argument.

Unfortunately, whilst both sides have been busy shouting at each other, it has been increasingly hard for the voters to get any unbiased information in order to make an informed decision, with the ‘facts’ put out by one side, quickly refuted by the other.

 It is incredibly hard to quantify the ‘benefit’ that the UK has obtained from being in the EU. It will always be open to a large degree of interpretation and the truth will be in the eye of the beholder. The answer probably lies somewhere in the middle, not as bad as the ‘Leave’ camp claim, and not as good as the ‘Remain’ camp counter. But in reality, there really is no point in striving to answer that question. What’s done is done, and the most important questions now are What does the future of the European Union look like? And is Britain better off being a part of it?

I have spoken in previous posts about the outlook for the European Union. Back in April 2013 when Cyprus was generously ‘bailed out’ by the Troika (the European Commission, the ECB and the IMF) I wrote the following:

‘The bottom line in all this is that the Euro project was flawed from the start. It was sold to the citizens of Europe as a financial amalgamation that would enable all the countries that participated to grow their economies and flourish, and although that certainly was a positive by-product, the main reason was to cement relationships between the major European countries (both financially and politically) so completely, that there would never again be another European war.

Unfortunately, because it was driven by politicians with an agenda rather than people that understand financial markets, major mistakes were made, including the decision not to amalgamate all the countries debts into one, creating a single Eurobond market.

These mistakes sowed the seed for the disaster that we now face.

Because it is still politically motivated, European authorities will continue on the same course, stating categorically that something won’t happen, until of course it does, forced to make harder and more unpalatable choices, as the process grinds on to its inevitable conclusion.

The real tragedy in all this is that as a result of the design flaws in the original concept, and the troika’s rigid adherence to a political ideology, it will likely foster the exact sentiments that the entire Euro project was designed to eradicate, with harmonious relationships and a sense of unity, replaced by distrust, anger and a move towards nationalism.'

As the global economy has slowed and the European bloc fallen into recession, we have indeed seen these predictions come true, with rising civil unrest, increasing distrust of the political system and stronger nationalistic feelings manifesting in many countries, even those thought of as being at the core of Europe , France and Germany. These pressures will only increase as the process unfolds.

Whilst the fundamental picture is not good, it is always handy to see how the financial markets are assessing things. The long term health of a country can often be forecast by looking at the performance of its currency relative to others. The currency rate is driven by global money flows moving across the globe looking for relative advantage. For example, if global investors see the US prospects as looking bright relative to other countries, they will sell their domestic currency in exchange for US dollars in order to buy the US denominated assets they think will perform, be they Real Estate, Stocks or Bonds etc. As a result we see the US dollar rally in relation to other currencies, and the greater the perceived relative opportunity the greater the out-performance will be.

If we now look at a long term chart of the Euro, the picture is sobering. I have used this chart in previous posts but it doesn’t get any better the more you look at it. In it we can see the entire history of the Euro from its inception in 1999, falling to its low in 2000 followed by its rally through the boom years of the mid 2000’s to peak in 2008 with the GFC, before trading lower and collapsing through 2014. Since then it has been consolidating, but that is where the good news ends. The chart is indicating a bearish price objective of 71.32 and whilst there is no guarantee it will reach this level, P&F charts can be uncannily accurate in their predictions. Either way, this chart is very bearish and a close below 105.90 will open the euro up to a very big move.

The implications of this chart are huge. Were the euro to collapse as this chart is indicating it would be catastrophic for the Eurozone economies and have profound affects around the globe. Unfortunately, in my opinion this ties in with the fundamentals of how the Eurozone political powers have been operating. Their adherence to a political dogma blinds them to the repercussions of their actions. Whilst the people of Europe become less enamoured of the European project and more nationalistic, less trustful of their elected representatives and less tolerant of the systemic corruption within these entrenched political bodies. The political bodies themselves are taking an increasingly hard line on individuals or countries that refuse to fall in. The people and their elected representatives are taking different paths and it can only end in tears.

It seems that the future of the Eurozone is already set - there is pain on the horizon. Britain has a choice, it can remain tethered to the fortunes of the Eurozone come what may, or it can take its chances on its own. Whilst that may not be anyones idea of a utopia, it is a damn sight better than the alternative.

I know what I would do

A Brief Pause or the End for Equities?

 A Brief Pause or the End for Equities?

All financial assets move in long wave cycles from undervalued to overvalued and back again, but whilst the duration of these cycles varies across these asset groups, irrespective of whether it is commodities, equities , bonds or real estate, they all move in a similar way. During the movement from undervalued to overvalues, prices rise in a long term 'bull market', punctuated by severe corrections or counter-trend moves along the way. Once the over valuation has reached an extreme, the market reverses, and enters a 'bear market' where prices once again start their long descent.

We can see this illustrated in the chart below.

 

 During the 'bull market' phase, as prices rise and the fear of the preceding 'bear market' is forgotten, investors emotions slowly move from depression through hope, optimism and exitement  to reach their final state of euphoria and greed.

However, whilst this journey might seem simple, due to these counter-trend moves the reality is very different. Whenever investors become too bullish, too confident and too convinced that a trend is in place, a correction will take place that will shake their beliefs and re-introduce a touch of fear into their lives, Is the bull market over? Will prices continue to fall? The bull market will shake some investors off its back and then continue onwards and upwards until investors once again get too bullish. This is why it is so important to monitor things like the Committment of Traders (COT) reports, as they can give great insight into the level of bullishness in a market give indications as to when a counter-trend move might begin.

We can see how these counter-trend moves have impacted the S&P 500 Index since the start of the current cyclical bull market in 2009.

These corrections are normally fast and furious, exactly the kind of conditions needed to inspire fear amongst investors, and during the month of August we have seen counter-trend moves in a number of markets, among them Equity markets, the US dollar and Gold. In the next chart of the S&P 500 Index I have extended the data to include the entire move since the 2009 lows and we can see how long it has been since a serious correction took hold, it was clearly long overdue.

Because of the severity of the latest correction, especially last weeks volatility, investors have once again begun to question whether the bull market is over. The answer is possibly, but I doubt it. Bull markets finish when the public get sucked in due to the constantly rising prices. This stampede of investors leads to spectacular price rises and a 'blow-off' phase, typified by 'this time is different' thinking and to coin a phrase from Alan Greenspan, 'irrational exuberance' (see chart below). Thus far we have not witnessed this, and allied to my belief that as the global economy unfolds money will flow into US Equities as a safe haven leads me to believe that equities will recover and go to new highs.

However, just because the market should rally to new highs doesn't mean it can't have a bigger correction now. If we look at the Point & Figure chart of the S&P Index below we can see that the rally from last weeks low at 1870 has paused at overhead resistance in the 1990 area. 

 The market is now at a critical juncture where either the panic will subside and prices will continue to grind higher, or the market will roll over again and test the lows. Should the sell-off resume, the 1870 low will provide the first point of support, followed by 1830 and 1740. It is also worth noting the bearish price objective of 1621, and although price counts tend to be more accurate when they occur in the direction of the major trend (which in the case of the S&P is up) we should not just disregard it.

  Having waited so long for a correction to materialize, it is unlikely to be over so soon, and the probability is that there is more volatility ahead. Should we retest the lows and go lower, keep your eyes on the support levels and the 'talking heads' on TV. 

When they start saying that the bull market is over, it's time to buy!

The Greek Euro Death Roll

The Greek Euro Death Roll

Like a poor story line from a soap opera, the Greek euro saga seems to have been playing out for years. On a number of occasions the warning signals have flashed amongst talk of imminent defaults, Greek economic collapse and the resultant chaos in the Eurozone, only for some political agreement to be cobbled together and the endgame kicked further down the road.

The crisis started for Greece back in 2009, badly affected by the fallout from the GFC, Greece struggled to pay back its sizeable debts. Concerned by the possibility of a Greek default, international investors stopped buying any more government debt, cutting off the usual funding stream and forcing the government to borrow yet more money from the EU and the IMF. This borrowing in turn also needed repaying with interest, and as the repayment dates loomed more borrowing was needed to fund the repayments from these previous loans, the downward spiral was set and Greece and the Eurozone became locked in a financial death roll. 

Over the years since 2009 the effects on the Greek people have been profound. Part of the terms of the initial bailout was that Greece implement a policy of severe austerity in order to get their borrowing under control. This has resulted in economic hardship, civil unrest and political turmoil as successive governments have been caught between the demands of the eurozone on one hand and the people's resistance to austerity on the other. It must be remembered of course that the Greeks have hardly been innocents in their own demise, with decades of rampant corruption, endemic tax evasion and financial mismanagement laying the foundations of disaster long ago, however it is the actions of the European Union and the IMF, more interested in their own preservation than in the welbeing of Greece that has compounded the problem.

The EU is determined to keep Greece inside the monetary union. It cannot allow the Greeks to default on its debts whatever the cost to the Greek people, as a Greek default would open the door for Portugal, Spain, Italy and a host of other countries to renege on their debts and the entire Euro experiment would die. However in spite of using increasingly large carrots and sticks in order to force the Greeks into compliance, the Greek people are becoming increasingly vocal in their opposition to the restrictions imposed upon them, and it is my belief that if not the current government,ultimately they will elect a government that will take them out of Europe whatever the cost. 

One of the ways we can see how the financial markets interpret the risks to the eurozone from a Greek default is through the currency. As a general rule, the more confidence international investors have in a country or economic zone, the more money they will move into that currency in order to invest in its bonds, equities, property etc. Conversely, as confidence wanes, these assets are sold and the money is then moved out of the currency into something with a better return, like US Dollars for example. The movement of the currency acts as a barometer, enabling us to interpret what the future might hold.

Here we can see a chart of the Euro relative to the US Dollar.

It shows us the high in the Euro prior to the GFC and the subsequent multi year trading range ending with a break below the 119/120 support in December of last year. Subsequently it dropped like a brick until finding some support in March, since when it has managed to stage a recovery. We can see from the oversold readings on the RSI indicator at the bottom of the chart that the price collapse from the 139 level was extreme and that a rally was overdue, however longer term the price move has done serious damage to the outlook for the Euro, something we can better see with the next chart.

Here we have a Long Term Point & Figure Chart of the Euro.

I have talked in previous posts about the predictive powers of a P&F chart and that whilst it isn't infallible, it can be incredibly accurate. Here we see the entire history of the Euro currency and it is clear that the breaching of the 119 level has triggered a downside count of 71.32. This is an incredible target and suggests a virtual implosion of the eurozone in its current form.

We know that since March the Euro has rallied from very oversold conditions and the next chart gives us a shorter term perspective to help gauge how much longer the rally might continue.

Here we have a shorter term P&F Chart of the Euro showing that the rally target of 113.24 from the March low has already been met, and that there is likely to be resistance around the 115 level. We also know that should 115 be broken and the rally continue, the old support level of 119/120 would provide serious overhead resistance.

When we look at these charts collectively they seem to indicate that whilst there is the potential for a further Euro rally in the short term, the medium to long term outlook is extremely negative. Although the downside count of 71.32 is extreme, when we consider the cascading effect from a Greek debt default it is not hard to imagine such a scenario and the implications of such a move would indeed be catastrophic for many people and businesses, it might well pay to consider what alternatives you might have should you be holding Euro denominated assets.

It must be stressed that the move is highly unlikely to occur in a straight line, there will be falls and rallies however the potential for a panic move cannot be ruled out, especially when the Greek domino finally falls.

Whenever Greece ultimately defaults it will lead to years of economic hardship for its citizens, however it is what it portends for the rest of Europe that is really worrying

Oil: How low can she go?

Oil: How low can she go?

 

 Oil has been taking an absolute hammering over the last few months, falling from around $110usd a barrel in July to below $60usd currently. This correction has been caused by a combination of factors including an undermining of the traditional oil business dynamic by the explosion in US Shale Oil development, a general lack of demand for oil due to a slowing global economy, with demand according to the Organization for Economic Co-operation and Develoment (OECD) currently at 15 year lows. High levels of stockpiled oil around the globe, and lastly, liquidation of speculative long positions on oil by investors who thought the price would rally and have been caught long and wrong.

The bad news for the oil market is that the first three of the factors mentioned are likely to persist for some time yet, and certainly in the case of oil demand I would expect it to fall substantially from here as the next leg of the GFC starts to bite and undermines the global economy still further. In the case of the speculative liquidation we can see how this is developing by using the Committment of Traders Data (COT) that is published weekly by the US Commodity Futures Trading Commision (CFTC). This data covers a whole range of markets and breaks the ownership of futures and options in each particular market into three categories, commercials, large speculators and small speculators. We have used these charts previously as they can offer great insight into where a market might be heading because of the tendency for commercials to consistently get it right, and for the speculators to consistently get it wrong!

Here we can see the current COT data for crude oil.

We can see the extreme short position by the commercials in July of this year when oil peaked (signified by the red bars), and the fact that they have bought back those shorts and reduced their positions as the speculators have sold out. However, they still hold a sizable short position even after the price falls we have seen, and the general picture is not compelling that a sustainable bottom has been reached. I would expect to see the commercials close out all of their shorts and possibly even go long before the true bottom is found.

Because of oil's pivotal role in todays society, being used in everything from pharmaceuticals to fertilizer and plastics to clothing, as well as its obvious role as a transport fuel, this drop in price has been welcome news with the price falls acting as a tax cut and boosting the cash in our pocket in a very direct way. According to Bank of America this windfall may be the equivalent of $1 trillion worth of stimulus, no small sum! Unfortunately, the benefits aren't distributed equally, with the stresses found in many of the current oil exporting countries, many of which are either experiencing civil unrest like the countries of the middle east, or are becoming increasingly aggressive in their dealings with their neighbours, like Russia. Most of these countries are entirely reliant upon oil revenues to keep their economies operating, and with oil at $58 many of those countries are financially underwater. This rising tide of unrest, either internal or external, allied to a severe constriction in revenues moving forward does not bode well. During most of the oil price correction many equity markets have rallied, enjoying this oil-based tailwind, but as the fall has became a rout, these fears over the resulting macro issues have grown and overwhelmed the earlier exuberance. The fall in equities  over the last few days has directly stemmed from the unresolved question - how low can oil go?

So with a view to answering that question, lets have a look at the current chart of crude oil.

We can see that oil is close to a previous line of support around the mid 50's, we can also see how extremely oversold it is on both RSI and Stochastics, levels last seen at the  lows of the GFC. Should those levels give way, the next major support is the 2008 low of $37.57, and should that fail, hang onto your hat!

Whilst these charts give us some idea of levels where support might be found, and how oversold oil currently is, they are no use for giving us a potential target price. 

For that we have to turn to point and figure charts.

Here is a long term chart of Light Sweet Crude, a particular type of crude oil that is predominant in the US. When I first saw this chart I amost fell over as it is showing a downside count or target of $8.95, which seems incredible. I therefore ran multiple P&F charts over different scales and durations and a figure around $8 to $9 appeared a number of times. This is concerning on a number of levels, the fact that the targets appear on multiple charts  gives it more substance, but most importantly, if we actually reach $9 it means that all hell has broken loose in terms of the global economy.

Before we get too carried away, I have to say that P&F charts are not infallible, circumstances can change, targets can be cancelled out and prices can just fail to reach the target. But they can also be incredibly accurate and provide information that no other type of chart can provide. 

Whilst the $9 downside target certainly came as a shock I can certainly foresee the reasons why it might happen. Apart from the systemic problems outlined at the start, there is also the issue of a rapidly appreciating US dollar which will continue to exert downward pressure on all commodities, including oil. This, allied to the pending collapse in sovereign debt markets and a deflating global economy are more than enough ammunition to drive oil much lower. You should also not be surprised to hear that commodity prices are themselves cyclical and we are currently in the down phase of that particular cycle.

We at least now have an understanding of what might happen, the key will be the support levels. If the mid 50's can hold and a concerted rally occur there is a chance that the technical damage can be undone. My gut feeling is that oil will go much lower, though not necessarily in a straight line and not necessarily now. 

Have a wonderful Christmas and a Happy New Year, see you in 2015

Correction Time - Its Finally Arrived

Correction Time – It’s Finally Arrived

Back in May I wrote a post called 'Seasonality and the Stock Market'
http://kiwiblackers.blogspot.co.nz/2014/05/seasonality-and-stock-market.html
which explained that statistically, stock markets are weakest during the May to September timeframe. I also discussed that although the markets were still rising, they were losing momentum and that because the rally had gone on for so long without a major correction, there was a good chance of one developing over the next few months.

The US equity markets rallied for another couple of months until succumbing to a short, sharp correction in July. Whilst this made investors nervous, the 4% correction was nowhere near enough to bleed off excessive investor optimism, and they returned to the markets driving them to new all time highs in September. However throughout this period the internal dynamics of the markets had continued to deteriorate, with fewer and fewer stocks participating in the rally, and many technical indicators flashing warning signs. The markets may have been at all time highs, but they were on very thin ice.

Whilst the equity markets have powered ahead, a number of storm clouds have gathered. In Europe, the same old problems are rearing their head with many of the economies in recession and the entire eurozone in danger of falling into outright deflation due to the ineffectual financial management of the European Central Bank (ECB). This fear of deflation is leading to speculation that the ECB will have no choice but to launch a massive wave of quantitative easing (QE) to attempt to boost the eurozone out of a deflationary slump, a move that up to this point in the GFC the ECB has refused to make. This combination of a faltering eurozone economy and the risk of ECB money printing has exacerbated the flow out of euros and into US dollars, helping to drive the dollar to it's longest consecutive week rally in history.

Global unrest is continuing to grow, with separatist or democracy movements rising in the UK, Spain, South America, Syria, Hong Kong and other parts of Asia. As well as the ongoing conflicts in Ukraine, the Middle East and of course the battle against the Islamic State. More of these conflicts will flare up and intensify as the global economic situation worsens.

Lastly, the fear is rising as Ebola continues its deadly creep across the globe. This is playing out in a predictable manner with initial apathy replaced by concern, concern replaced by fear, and finally once the horse has bolted, fear replaced by panic. How bad Ebola proves to be only time will tell, but my insticts are telling me it is going to get a whole lot worse before it gets better.

According to the financial media, this toxic brew of bad news was the reason for the current stock market correction. But as we know from previous posts, it is never the news that causes the move, it's the condition of the market. When the market is strong, bad news is constantly shrugged aside and discounted and the market continues to rally, or 'climbs a wall of worry' as it is known. However when the market is exhausted and ready to correct, almost any news will be interpreted as bearish and the market will fall simply because it is time for a correction.

Having reached those new highs in September the US equity markets have fallen over the last few weeks, with volatility increasing and volume growing as sellers start to overwhelm buyers. 

Let's have a look at a chart of the S&P 500 Index to see where support might lie.

 It is clear to see the fall of the last three weeks, and the increasing volume reinforcing the significance of the move (denoted by the three expanding red bars at the bottom of the chart). If we take the arbitrary 10% correction figure from the high of 2019 we get very close to the 1814 level that acted as support back in April. This area should the first real level of support, should this give way, we could see a short, sharp drop down to the 1737 level which would signify a 14% correction from the high. There is of course the 1904 level which is as yet unbreached, however I think the chances of this holding for any length of time are not good.

I have spoken before about Point and Figure charts and their capability to give price forecasts, so let's see if it corroborates the chart above.

We can see that according to this chart when the 1930 support level was broken, a downside count of 1840 was activated, meaning that the index should fall to this level and possibly further. We can also see the blue line of support currently at 1820. At this point I must stress that counts are not always reached but they are a useful tool when it comes to trading or investing.

Whilst I believe we have further to fall, I do not believe this is the major top that we know will come, the pieces are simply not yet in place. This is just an overdue correction before we take off to new highs and as such, it provides a buying opportunity.

As Safe as Houses?

AS SAFE AS HOUSES?

The debt fuelled excesses of the early 2000’s drove house prices in many parts of the world to incredible heights. When the bubble burst in 2007/8 it sent prices into retreat, and after a few years with corrections of up to 40%, valuations were (in some parts of the world at least) once again at fair value. Since then prices have generally recovered, as valuations once again rise to normal levels. However this recovery has been quite patchy with some areas recovering normally, some parts of the world soaring to post 2007 highs, and other parts of the world stagnating or falling further.

This recovery from low valuation levels is quite normal and part of the repeating cycle from low to high and back again that we witness in all asset groups. However, this specific nature of the global house price recovery is being driven by the increasing stream of money looking for a safe haven. Due to a combination of political uncertainty, higher taxes and a deteriorating economic outlook, this money, which is flooding out of China, Europe, Russia, the Middle East and Latin America is looking for an asset that is in a safe location and relatively liquid. As a consequence we are seeing high-end property booms in places like New Zealand, Australia, Canada, London and a number of cities in the US.

This phenomenon is causing serious distortions in those property markets, and with the top-end continuing to power away, the market is getting extremely stretched and out of balance in some countries.

Back home here in New Zealand, the effect is particularly acute as Auckland has a disproportionate effect on the NZ property market as a whole. With it being the centre of commerce for the country, the place where most migrants come and settle, and with almost a quarter of the country’s population residing there, what happens in the Auckland property market has implications for the rest of the country. As when house prices take-off, whatever the reason, the Reserve Bank resorts to raising interest rates to try and control it, and often what is right for Auckland is wrong for everybody else.

Despite many arguments in favour of a broad range of measures to combat excessive house price rises, the blunt tool of raising interest rates has been the default setting of reserve banks around the globe for many years. In previous posts I have commented on the need for changes in both the tax treatment of property investors, and changes in the rules for high Loan to Value (LVR) mortgages, as well as treating mortgage risk on the lending banks balance sheet differently. And back in October last year, the Reserve Bank of New Zealand (RBNZ) did finally introduce new restrictions regarding banks ability to lend at levels greater than 80% of the property’s value. This has had the effect of reducing demand amongst first-time buyers in the lower house price bracket where the high LVR’s are more prevalent, however its had absolutely no impact on the top-end, and because of the lack of restrictions on property investors, the potential beneficial effects of this policy change have been mitigated.

Also in New Zealand’s case, these effects are being compounded by the relative lack of new houses built over the last few years, plus the increase in net migration. And so we see the gap between the top and bottom of the property market continue to grow.

However, even if Governments and Reserve banks around the world developed and introduced cohesive policies to prevent excessive house price rises (which is highly unlikely), it still would not eliminate the current problem. These types of rules work fine during ‘normal’ economic periods where relative investment return is the driving factor -  if the return of one investment is reduced by taxation etc, money simply moves to the next best alternative. But when the economic landscape changes, the imperative becomes the return of your money, not the return on your money. This radically changes the mindset of investors and renders many of the normal rules obsolete.

We will likely see this trend continue for some time, with the underperforming cities, regions and countries continuing to lag as money increasingly flows out of these places, whilst the outperformers race ahead as it is redeployed. It is important to understand that this process has got nothing to do with value, in the property hotspots of the world we left value behind long ago. It is purely about the weight of money, and whilst there is enough to levitate prices higher, it will continue.

My guess is that things will start to crack once we see the next global downturn, the second and much more damaging leg of the GFC sometime in 2016. Once it really starts to bite and finally affect the US, its safe haven status will be undermined. At that time, the money that has distilled out into these property hotspots will start to look for the exits. And is when we will see these incredible price gains unwind, brutally, if history is any guide.

If you are a property investor in these hotspots, I would recommend you pick your moment to leave the party very carefully.

If not, then just sit back and enjoy, it should make interesting viewing

Seasonality and the Stock market

Seasonality and the Stock Market

The adage ‘Sell in May and go away, don’t come back till St. Leger day’ is once again starting to resonate around equity markets. Originating in Britain in the early 1800’s the expression started because of the tendency for stock markets to under-perform during this 5 month period, and was a warning to be sitting in cash rather than be invested during this time frame.

 The phenomenon was caused by the mass exodus of investors and senior market participants on their summer vacations, which at that time of course included attendance at the five classic horse race events that occurred throughout the summer (commencing in early May with the 2000 Guineas Stakes, followed by the 1000 Guineas Stakes, the Epsom Oaks, the Epsom Derby and finally in late September the last of the five, the St. Leger Stakes). 

Whilst the expression had been known for centuries, very little statistical work had been done to establish its accuracy until 2002 when analysis from Bouman and Jacobsen showed that the effect had occurred in 36 out of 37 countries examined, and as far back as 1694 in the UK, it truly is a global phenomenon.

However, just because we know it is a factor in stock market performance does not mean it is the only factor. There are many reasons why the under-performing bias at this time of year can be overwhelmed by other, more powerful factors, not the least of which is whether we are operating in a secular bull or bear market. To highlight any differences, the two charts that follow show an averaged performance breakdown of the Dow Jones Index over the calender year, indicating how each month compares. The charts encompass different periods to show how the phenomenon compares during secular bull and bear periods.

The first chart shows the period from 1956 to 1982. The years from 1956 to 1966 were part of a secular bull market and witnessed a sharply rising stock market, whilst the the years from 1966 to 1982 were a secular bear period and caused stock prices to fall dramatically, resulting in the Dow Jones being virtually unchanged over this 26 year period.

Predictably we can see that during this period there is a noticeable fall through this May to September time frame.

 In the next chart we see how the Dow Jones performed during the period from 1983 to 2010, a period of time that saw the greatest secular bull market in history.

More surprisingly, even during this period of rampant stock market gains there is clearly an under performance during the May to September time frame, even continuing into October. Maybe Mark Twain was right after all when he observed that October is one of the most dangerous months to speculate in stocks, although he did add "the others are July, January, September, April, November, May, March, June, December, August and February." 

It appears therefore that regardless of whether the broader market is in bullish or bearish mode, the seasonal bias is still strong enough to register a noticeable underperformance during the May to September period.

So having established that we may well encounter a head wind for the next five months, are the US equity markets looking healthy enough to weather it? Well if we look at the chart below of the S&P 500  which is a broad based index and therefore a better indicator of the health of the entire stock market, the answer is possibly no.

We can see that whilst the index has been rallying since the turn of the year, the technical indicators on the chart have been falling (see the downward sloping red lines), this is known as a negative divergence and is a sign that the market's rally is losing momentum and that the potential for a correction is increasing. 

Another  worrying factor is the length of time it has been since a major correction occurred. Normally in strong market rallies we should expect the accompanying large corrections (around 10%) to bleed off the excessive speculative fervour and create the energy for the next move higher. However the last time we experienced a major correction was back in late 2011, and we are now well overdue for one (I have drawn a 10% correction target line on the chart above for reference). Buffering that argument is the fact that often as strong rallies reach their conclusion we often get less intense corrections, still, we should expect a correction of sorts even if it doesn't quite fall into the major category.

This potential for a market fall, allied to the time of year means we should be alert to the possibility of a reasonable sell down in equities over the next couple of months.

Should a healthy correction occur it will provide a great buying opportunity to get in for the final blow-off rally still to come as money flows into the safe haven US dollar and chases yield in the US stock market, propelling the indicies to new highs.

It may be time to go 'off to the races', but don't take too long a vacation.