Two Big Questions Overhang Western Stocks

by Nigel Bolton-Shaw on September 4, 2012

The Telegraph provides us with an article that focuses on central bank stimulation within the context of market performance.

It points out that central banking actions are increasingly constrained and thus gives rise to two big questions. We’ll pose them at the end of this analysis. First more about the Telegraph article …

Entitled “Technicals flash amber as ECB and Fed struggle to validate rhetoric,” the article makes the point that despite endless central banking efforts at “stimulation,” Western stock markets still display weakness.

It mentions a recent statement by Louise Yamada, an analyst who is considered “America’s oracle of technical analysis.” Yamada, we learn, watching markets head higher, is concerned because retail investors are not participating. It’s her opinion that much of the rally is “short-covering by hedge funds.”

In other words, a technical analyst is divining a technical reason for stock movements. Here’s some more:

The US index of transport stocks have lagged the Dow Jones industrials, a time-honoured warning sign. “There is no question that we have a Dow Theory sell signal in place. This is rare and needs to be watched carefully. It tends to accurate, eventually,” she said.

Morgan Stanley’s equity team says stocks are still cheap in historic terms but many of their “sentiment” indicators are nevertheless flashing amber to red … Europe’s stocks cannot seem to claw their way above a 12-month forward price to earnings (P/E) ratio of 11 …

“From a valuation standpoint, we are now close to peak levels seen over the past couple of years,” said Graham Secker, the bank’s chief European equity strategist.

The article goes on to point out how market averages have moved higher in a “heady summer rally.” And certainly this is true. Numbers tell the story.

The S&P 500 has risen 10 percent since early June; France’s CAC, 16 percent; Germany’s DAX, 15 percent. Italy and Spain’s markets are up by 20 and 24 percent since July, an even more compressed timeframe.

The explanation has little to do with fundamentals however as the US, France, Italy and Spain certainly cannot boast of healthy economies. Instead, we are reminded that both the ECB and Federal Reserve have been printing torrents of paper money.

The article calls this the “Draghi and Bernanke put” – named after the central bankers that intend to renew money printing. Neither put is a sure thing by the way, the article tells us. In other words, the stock market action may well retreat.

Additional stimulation is certainly the plan. Ben Bernanke said as much at Jackson Hole recently. Mario Draghi wants to buy bonds, too.

Ironically, the time for such stimulation may have come to an end. At least, the ability of these two powerful central bankers to do whatever they like when they like. European politics have intruded on Draghi’s intention. German Chancellor Angela Merkel wants political assurances before Draghi begins an aggressive money printing program.

And then there is the upcoming September 12th ruling of the German Constitutional Court on the so-called European Stability Mechanism. While this was once considered a rubber stamp, it is no longer, with German observers now speculating that there is up to a 40 percent chance the high court will declare the ESM illegal.

In the US, Bernanke is used to doing what he wants, but four years into his efforts at reigniting the US economy, nothing much has worked.

Additionally, domestic politics are militating against his free hand. Recent audits of the Fed have discovered that much of the US$16 trillion that the Fed supposedly gave out in “loans” around the world to stabilize the system in 2008 have not yet been paid back.

It is the season for presidential elections, and there is a lot of grandstanding and some legitimate anger on Capitol Hill. The article points out that despite her concerns, Yamada has not yet issued a sell alert. Instead she advises clients to “stay vigilant.”

The real puzzle is where do the markets land without renewed central bank stimulus. The basic averages may find bottoms considerably below where they are now. And it is from that lower series of averages that rebuilding may begin.

While stock averages are likely headed down sooner or later, there are signs that other markets have already worked through their downturn. An article over at Casey Research informs us that “Your Window to Buy Gold Below $1,700 Is Closing.”

Metals prices have been languishing; and it is perfectly possible that we may see a decline in Western bourses overall just as commodities and metals in particular make a comeback.

The big question, then, is twofold: (1) how far down markets will travel before they begin to consolidate? and (2) what kind of timeline is realistic?

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