Mr Market is in the bear camp

PORTFOLIO POINT: From commodity prices to US employment and housing figures and even the Baltic Dry Index, the news is bad, and the market agrees.

Have you ever noticed how two economists can draw completely different conclusions from the same set of data?

For example, I interpret the decline in the US ISM and the falls in the performance of manufacturing indices in China, South Korea, India and Taiwan as evidence that the global economy is cooling.

The bulls will not use the word cooling or slowing; they will simply say that we are growing at a more moderate pace.

The bulls say the US unemployment rate dropping to 9.5% from 9.7% means everything is pointing in the right direction. I disagree.

The reason the headline number dropped was because there are huge numbers of people that have stopped looking for work. In the US, if you haven’t looked for work for four weeks you are not counted as unemployed. The federal census workers that got laid off last month, and the roll-off of unemployment benefits later this month, will see a lot more people sticking their hand up for job.

On top of an unhealthy employment backdrop, Pending Home Sales came in at –30% in May from a prior figure 6% in April. I can’t see it any other way: the US economy is starting to roll over.

However, it’s actually irrelevant how I view it or how you view it. What’s relevant when you’re investing or trading is how the market views it and the market views it badly.

Check out this chart of the Baltic Dry Index, which tracks the shipping prices of major raw materials such as coal, iron ore, metals, grains and fossil fuels on 26 routes and is often viewed as a leading indicator of economic growth.

The Baltric Dry Index has dropped 45% in the past four weeks; and on top of that, the S&P 500 broke down through the crucial February low this, week falling 17% from its April highs. This is after we had a Dow Theory sell signal in May, Dr Copper plunged 20% to go into a bear market; China plunged 20% to go into a bear market; commodities such as lumber were down 40% and nickel was down 28%. Meanwhile, the bond market continued to attract buyers, pushing yields to new lows and the Volatility Index (VIX) broke up above its 200-day moving average.

My point is that the market has spoken and that extreme caution is warranted from here on.

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The market is grappling with many issues, from sovereign default to a collapsing Chinese stockmarket and poor figures out of the US. However, I think the big issues are the austerity measures being proposed by the G20 nations and financial reform.

This from The Economist: “Economic policy-making, like hemlines, has fads. Last year the leaders of the G20 group of big economies led a global Keynesian boost, pledging fiscal stimulus worth a combined 2% of world GDP to prop up demand. At their most recent gathering, in Toronto on June 26–27, the club’s rich-world members pledged “at least” to halve their deficits by 2013. Though they left themselves wiggle room, the change of tone was clear. Thanks to Greece’s sovereign-debt crisis, which has terrified politicians, stimulus is out and deficit reduction is in.”

The market knows that austerity measures are not growth measures; markets don’t like less spending and higher taxes.

I believe the stockmarket is going lower. However, if you are in the bullish camp, there were perhaps a few signs on Friday that we might be due for a relief rally. If it happens it will be the rally to sell.

First, 10 year US bonds are yielding 2.97% and the Dow Jones Index is on a yield of 2.87% and has a price/earnings (P/E) multiple of 13.51, on Bloomberg’s data. I still don’t think that is a cheap enough P/E or high enough yield to warrant buying stocks but global money managers might.

Second, the VIX actually dropped 8% on Friday night going into a three-day weekend, which means traders were not as worried about buying protection on a plunge in the S&P.

Third, the EURJPY exchange rate (euro/yen), which is often seen as lead indicator of the risk trade, finished off its lows for the week on Friday night. When EURJPY falls it is a sign of risk aversion and when it rises, it is the opposite. EURJPY actually rallied on Thursday and Friday of last week. Now these are tentative signs at best, but it would be remiss of me not mention them.

I thought I would include a monthly chart of the S&P 500 going back to 1980. Interest rates in the US (in fact in most places) peaked in 1980 at 20% and have been going down ever since. As you can see from the chart below, the S&P started steadily rising from that point on until we had the correction in 2000, before going on to make new highs in 2007.

The selloff from 2007 was brought on by the GFC and the rally from the March lows of last year was induced by unprecedented and massive global government spending. As the stimulus fades and austerity measures are introduced, we are going into the next leg down in equities that will take us to last year’s lows. The buy-and-hold strategy that did so well for so many people from 1980 right through to 2007 is a strategy past its prime. Baby boomers beware!

We may live in the greatest country on earth but we are not immune to these global forces. Our banks, corporations and governments are heavily reliant on offshore funding markets. We are also one big open-pit mine. If the Baltic Dry Index is telling us anything, it’s telling us that world trade is slowing.

You only have to look at the Chinese stockmarket and prices of many commodities to see that things ain’t that rosy. Or look at one of our best barometers for growth, optimism and leverage: Macquarie’s share price. It was the worst-performing stock in the top 20 last week, down 7.5%.

Ultimately, if you want to gauge how we are going, and how the rest of the world views us, take a look at our currency. On Friday night we lost ground against the US dollar, the euro, the yen and even the NZ dollar.

But the most telling of all was the oil price.

After climbing back above its 200-day moving average the rally died and oil was sold off in a most violent fashion, finishing the week as one of the biggest losers, down 7.8%. This smacks of deflation and the market is telling you to expect lower growth going forward. As such, I remain bearish stocks, bearish the Australian dollar and bullish Australian bond futures.

It looks like austerity has already arrived. Embrace it.

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Tom Lovell is a strategist with London-based futures broker ICAP.