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May 24, 2007

When Greenspan Talks, Do People Still Listen?
by Econotech

Rather than a longer article on "big picture" issues with extended supporting quotes from the mainstream media, for timeliness this shorter piece simply consists of three quick e-mails I sent out this morning on the current state of global equity markets.

"Greenspan Worried Shanghai Will Burst, Fears 'Dramatic Contraction'"

As most of you know, Investor's Business Daily, IBD, is a newspaper read by many equity investors/traders. Its front-page right-hand lead large headline this morning says, "China Syndrome? Greenspan Worried Shanghai Will Burst, Fears 'Dramatic Contraction'" The text goes on to say: ""China’s stock boom "is clearly unsustainable," Greenspan told a Madrid, Spain, conference via satellite. "There is going to be a dramatic contraction at some point.""

U.S. stocks sold off just a little after Greenspan's remarks, but, for now, complacency continues to rule the global financial markets. It's easy to slough off Greenspan's warning as just another in a recently increasing chorus from financial leaders about growing risks in global markets. E.g., in its "The Big Picture" daily market analysis on the front page just below its story on his comments, IBD says: "Greenspan may still influence the Street, but he hasn’t been a great market timer."

In my articles since the May 2006 sell-off (starting with June 2 "Did May's Sharp Global Market Sell-off Signal a Major Trend Change?" link), I consistently have stated my opinion of a global "market in confirmed rally," to use IBD's current view. For the past week or two, global markets have been consolidating their large gains off their Feb 27 sell-off.

That said, this probably is not the best time for complacency about global risks, expressed in terms of glib attitudes about market timing prowess.

Again, I reiterate that many clear warnings about global financial risks, including the China stock market and private equity/m&a debt bubble, increasingly have been given by financial leaders in recent weeks (starting around my April 4 article, "When Citibank Chief Exec Talks" link). These are usually buried in stories in the Financial Times and Bloomberg, so you may not be fully aware of them. E.g. the May 23 Financial Times had a long full page good summary article on page 11 by their two market analysts titled, "Snapping point? As markets approach all time highs, some think they are starting to look overstretched."

I simply call these serious warnings to your attention and suggest that you might give them your consideration with respect to protecting your investment capital.

In addition to the ongoing U.S. housing recession (see my April 13 article, "When Leading Fund Mgr Talks," link), two other big shoes that everyone is waiting to hear if/when they drop is a botched private equity or m&a deal, both on pace to smash last year's huge totals, and another sharp one-day China sell-off that wasn't almost immediately greeted by even more manic buying, as have the last two in Feb and April (not to rule out something similar in India and other emerging markets).

A seasoned investment pro, Doug Kass, wrote May 22 on TheStreet.com's Street Insight, that the chairman of Blackstone, a leading private equity firm, "Stephen Schwarzman is likely to top-tick the private-equity market in his sale of a $3 billion minority stake to the Chinese government and a $4.75 billion stake to individual and institutional investors."

The proverbial "ringing of the bell" at a major m&a market top (UAL aborted lbo in 1989, AOL-Time Warner merger in 2000) won't be clear until retrospectively. Trying to protect against, let alone calling, tops of such huge uptrends as emerging markets and private equity, or bubbles, depending on your bias, is obviously very difficult,

This is especially true this time around, because both China's and other emerging markets and private equity debt and derivative/structured finance deals are much more opaque, deliberately so in the case of the latter (including to regulators), to the vast majority of American equity investors, including professional, than the U.S. housing and tech bubbles, which they lived through and had intimate working knowledge of.

That may make it more difficult for them to tell whether it really is "different this time."

Finally, I would note that the "alpha," risk-adjusted excess return (relative to the S&P 500 and U.S. interest rates), of the EEM, emerging market (MSCI) etf, is now back to zero. The alpha of this etf/index was extraordinarily and consistently positive from Sep 2004 to May 2006. That has been much less true since the sell-off of the latter date.

The price momentum of EEM also looks like it might be topping on a longer-term weekly chart. So, if there currently is no longer positive alpha in emerging markets, then why take the risk of the momentum indicators rolling over, why not protect the enormous gains many investors have in emerging markets?

That might seem to be the question that could be forming, even if unconsciously, in the minds of momentum investors who have piled into the emerging markets. If that thought, or gut feeling, crystalizes into action, then a sharp correction might ensue, as it did last May-June.

Starting with Goldman on May 10, a few leading i-banks have now expressed their opinion that a correction in China's extremely frothy equity markets is overdue.

Nasdaq 100 Short-term Momentum Waning?

Attached is a 60-day, 60-min chart, courtesy of Prophet.net, of QQQQ, the Nasdaq 100 etf (reflecting U.S. tech stocks). Left click on the chart to expand for better viewing.

This is a short-term chart, I often send out 4-year weekly charts. I chose short-term this time because this timeframe shows the rally since the one-day Feb 27 global sell-off, and chose the Nasdaq 100 because it gets so much speculative money (etfs of emerging market, international developed market, energy, material, and industrial stocks are the market leaders, and retail, homebuilder, and financial stock etfs are also critical).

QQQQ has been moving sideways to slightly upwards since around 4/30, the longest stretch of consolidation on this chart. It has just today broken through the bottom of its regression channel (blue lines). It has done so without going to the top of the channel, unlike on the two previous occasions, but rather stopped at mid-channel. Also, it has not been generating as much positive trend momentum, shown by the "true strength index," as it did in April. (For those who care about the extremely short term, QQQQ is now "oversold," shown by the "stochastic momentum index" at a low.)

These may be little warning signs that QQQQ momentum may be slowing. I repeat, "may." If you step back and look at the long-term charts of the key sectors I mentioned above, which I'm not showing here, it's too early to "call a top" in their etfs.

But especially given how over-extended global financial markets are in every timeframe -- five years from the Oct 2002 lows, since the Jun-Jul 2006 lows, and from the Feb 27 2007 lows -- it is currently very prudent to be on watch for any and all signs of little momentum shifts right now. E.g., short term, equity markets usually rally into holiday weekends, such as next week's Memorial Day, failure to do so would also be another little red flag.

Industrial Metals Prices Decline

Attached is 3-year daily chart of the Goldman Sachs industrial metals price index, courtesy of StockCharts.com (prices of the metals, not the stocks of companies that produce them). Left click on the chart to expand for better viewing.

These industrial metals prices are highly sensitive to both real changes in actual global cyclical industrial production, and to speculative capital flows betting on such future changes. Because of their cyclical and speculative sensitivity, it is helpful for equity investors to keep an eye on this industrial metals price index.

Since the beginning of May, there has been a minor sell-off in industrial metals prices, but without a corresponding correction in global equity markets. In contrast, in early May 2006, a simultaneous sell-off began in global industrial metals and global equity markets. That sharp sell-off followed a far more manic run-up in industrial metals prices preceding it. Right now, the China equity market is in a huge run up, and other global equity indexes are making new highs.

The recent rally in industrial metals prices has short-term "support" around 500, right around the 50-day moving average (blue line at 495). If this support is broken, then that is another red flag of a potential negative shift in momentum in global markets.

Conversely, if industrial metals prices hold above key support, especially its 200-day moving average (red line), and then continue their rally of the upside "break-out" in early April 2007 from its nearly 1-year sideways consolidation, then that is further confirmation that "this time is different" and that we are in some sort of "new era" of extended global prosperity (if not peace), led by the huge booms in China, India, and other emerging markets.

Also of course bearing close watching is the dollar, which has had a little short-term bounce back to its 50-day moving average, just above critical long-term support, and gold for inflation/deflation hints.

Econotech

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