The Good, the Bad and the Ugly

Fri, Nov 4, 2011 - 2:57pm

Back in June I highlighted some troubling developments occurring that suggested the global economy and financial markets were at risk. Some of those developments proved to be early warnings as to what lay ahead before the July-October swoon. Since the October bottom most equity markets have recovered and it appears an update is in order to see if the key markers that warned of the global and financial market trouble ahead have improved. A quick chart review below will show a mixed bag of the good, the bad, and the ugly, which unfortunately provides a mixed picture at this point. Before we commence, however, I recommend playing the following audio in the background to accompany your reading experience.

The Good

Perhaps one of the most encouraging developments over the past few months is that the South Korean Kospi Index held its bullish 2008-present channel after a brief dip below and appears to continue to be in a bull market. This is encouraging in the sense that the Kospi provides a great read on global growth, and China in particular, given that most of their exports end up in China. While the Kospi has held its bullish trend channel, it remains below its key 200 day moving average (200d MA) and is thus not out of the woods. A failure to exceed its 200d MA followed by a subsequent break of its channel would pose an ominous sign for global economic growth.

Click here to enlarge

Source: Bloomberg

The USD broke its bearish trend channel that began in the middle of 2010 and looks to trending in a slightly upwards sloping bullish trend channel. While most investors perceive a strong USD as a sign of bearishness, this is not always the case as the USD rallied in late 2009 to early 2010 alongside the general stock market. The reason why I am putting the USD in the “good camp” is that a strong USD puts downward pressure on commodity prices which in turn reduces inflationary pressures that eat into discretionary consumer spending and corporate profit margins. The reduced inflationary drag on the consumer and corporations is one of the chief reasons I cited previously (“A Window of Opportunity”) for why we may see a manufacturing rebound heading into 2012. So, I perceive a gently advancing USD as a good thing as it is a tailwind to 70% of the US economy, consumption.

Click here to enlarge

Source: Bloomberg

The Bad

Since China is seen as the global economic growth juggernaut, it is disturbing to see the Shanghai Index of Chinese stocks stuck in a bear market that began in 2009 when their government began to raise interest rates and bank reserve requirements. That said, the Shanghai has so far successfully retested its 2010 lows as well as held the 2005-2009 trend line. The Shanghai will need to be watched in the weeks ahead to see if its recent lows hold and potentially signal China’s bear market is over, which would imply that China’s economy may accelerate, and with it global growth. However, a break of the 2005-2009 trend line and 2010 lows would likewise send a very bearish message.

Click here to enlarge

Source: Bloomberg

The fact that the CRB Commodity Index broke its multi-year bullish channel and remains in a bearish trend means the global economy is still not out of the woods. Crude oil prices are also signaling the same message and we would need to see a significant improvement in oil and commodities in general (CRB) alongside China’s stock market before the all clear is given for global growth to reaccelerate.

Click here to enlarge

Source: Bloomberg

Click here to enlarge

Source: Bloomberg

The Ugly

Perhaps the most disturbing sign of faltering global economic growth is seen in emerging equity markets and commodity-sensitive equity markets. The MSCI Emerging Market Index decisively broke its 2008-2011 trend line and has fallen sharply over the last few months and remains firmly within a steeply falling bearish trend. There has been serious chart damage to emerging markets and they will need some time to repair, indicating that global growth may still be weak for some time.

Click here to enlarge

Source: Bloomberg

A few key country stock markets that are highly linked to commodities and global growth are confirming the weakness seen in their emerging market cousins, with Canada, Brazil, and Australian stock markets all firmly within bearish trends.

Click here to enlarge

Source: Bloomberg

Click here to enlarge

Source: Bloomberg

Click here to enlarge

Source: Bloomberg

Here in the US faltering UST yields are also signaling weak economic growth. The yield on 10-yr UST remains within an accelerating down trend and shows no signs of a turnaround in yield as would be expected with an economy on the mend.

Click here to enlarge

Source: Bloomberg

The commodity that shows a more worrisome picture than the CRB Commodity Index or crude oil is copper. Copper has fallen sharply in recent months which typically occurs during significant global slumps as was last seen in middle of 2008, indicating it is too soon to say the global economy is on the mend.

Click here to enlarge

Source: Bloomberg

Summary

When surveying key global markets and commodities, it is safe to say that the global deceleration that began earlier this summer has not ended and perhaps more time is needed before global growth finds its footing. Based on recent strength in the USD and weakness in commodities, the global economy is getting a much needed relief from the heightened inflationary pressures seen earlier in the year. It is this softening in inflationary pressures that is likely leading to the rebound in the markets seen over the last month. This weakened inflationary backdrop is likely to remain a tailwind for the global economy for the next few months as highlighted in a previous article (“A Window of Opportunity”), and if the forecasted improvement in manufacturing going into 2012 does materialize, then the bad and ugly charts above may have time to heal and form solid bottoms from which to advance from. However, if the charts above do not improve that would signal that the improved inflation outlook is not enough to arrest the negative economic momentum that began in the middle of the year. For this reason tracking the key commodities and equity markets cited above will prove key to determine if the bullish stabilization scenario plays out or if the recent improvement is just a pause before bearish momentum resurfaces.

About the Author

Chief Investment Officer
chris [dot] puplava [at] financialsense [dot] com ()
randomness