Stock market trend: Too uncertain to call
Two weeks ago I called a market top, and the market proceeded to move up. In response, I covered my net short positions and remain in cash. I continue to ponder whether I was too early in my call or flat-out wrong.
To ponder this with you, some first principles here: (1) Speculate, never gamble; (2) the stock market is a leading indicator of the economy; (3) Use both technical and fundamental analysis to identify the trend of the market, a sector, or a stock.
On (1), right now, the U.S. stock market remains close to a coin toss on a bullish or bearish direction. Therefore, a fully invested long or short position right now is a gamble with close to 50-50 odds rather than an intelligent speculation. Therefore, it is still better to be in cash than eke out a few percentage points either way at the resumption (or break) from trend.
On (2), the stock market remains a gamble because of continued uncertainty over the viability of the economic recovery. Both Europe and the U.S. face the same issue: Will consumers follow through on a recovery that is investment-led and spurred on by expansionary fiscal and monetary policies? As this issue resolves itself, the market trend will better reveal itself.
In the same vein, while both the U.S. and Europe are now officially out of recession with positive GDP growth rates, they face the same issue: How long will growth remain below potential output? If it is through 2010 and beyond, that’s a tough environment for a bullish uptrend.
On (3), the underlying fundamentals remain a mixed bag. In the GDP equation, both business investment and government spending are highly expansionary. Exports remain suspect, however, not just for the U.S. but for most countries around the world. In this dimension, only China and German seem to be strong net gainers in this dimension. Meanwhile, as noted above, the consumer is the big imponderable.
As for the underlying technicals, there are several things that define what appears to have been a bullish follow through last week. First, volume continues to be higher on down days than up days – suggesting “distribution” in the face of an alleged resumption of the bullish uptrend. Second, it was primarily the Dow where follow through was observed: As Market Edge notes:
Last week saw the DJIA record a series of three new recovery highs culminating in Wednesday's close at 10291.26. However, each of these moves to higher ground were non-confirmed in that the majority of the broader based indexes that we follow failed to follow suit. In fact, the only index that also posted a new recovery high was the S&P 500 when it closed at 1098.51 on 11/11/09. Such non-confirmed moves by the DJIA typically occur at meaningful tops and cannot be taken lightly. … The list of negatives continues to grow suggesting that the recent strength in the blue chips is not only suspect but probably unsustainable.
My bottom line is that I remain skeptical of this market.
On other matters, President Obama is in China this week. The oped below summarizes my views on what is the single most important issue that needs to be discussed.
Why Currency Reform is the Most Important Obama-Hu Issue
As the two most important presidents in the world are meeting this week – Barack Obama and Hu Jintao – they must realize this: The pernicious economic co-dependence of the U.S. and China not only threatens the long term prosperity of both countries. It also threatens to usher in a new wave of protectionism and derail the global economy.
In their co-dependence, China needs U.S. consumers to fuel its export-driven growth while the U.S. government needs China to finance its burgeoning budget deficits. What drives this pernicious relationship is China’s de facto hard peg of its own currency, the yuan, to the U.S. dollar.
China’s hard peg to the dollar finances U.S. budget deficits because in order to maintain the peg (about 7 yuan to the dollar), China must recycle billions of U.S. dollars back into U.S. Treasuries. Through this recycling process, China has not only become America’s mortgage banker. China also facilitates a dangerous and unprecedented lack of U.S. fiscal and monetary restraint.
China’s hard peg to the dollar drives China’s export-driven growth because it results in a yuan that is undervalued by more than 30%. This undervalued yuan acts as a significant indirect subsidy to Chinese exports and a hefty tax on U.S. exports to China. Working in combination with other Chinese mercantilist practices such as direct export subsidies, the result of China’s hard dollar peg has been both a huge and chronic U.S. trade deficit with China and a collateral loss of millions of U.S. manufacturing jobs.
Manufacturing jobs are critical to long term U.S. economic recovery because they pay more and create more jobs downstream than service sector jobs. A revival of America’s manufacturing base – impossible until the hard peg is lifted -- is equally essential to spurring the higher rates of technological innovation necessary to boost productivity, wage growth, and the purchasing power of American consumers.
Eliminating China’s hard dollar peg is equally critical for the long term growth of the Chinese economy. The current hard peg prevents China from developing its own domestic economy because the artificially cheap yuan depresses the purchasing power of Chinese citizens. However, a robust Chinese consumer is critical to long term growth. Over the long term, China will no longer be able to depend on increasingly budget-constrained European and U.S. consumers for its now export-driven growth.
It is not just the U.S. and China being victimized by China’s hard peg. As the U.S. dollar has declined in value and dragged the yuan down with it, Chinese exporters have gained competitive advantage relative to manufacturers across the globe.
In Europe, as the dollar has fallen hard against the euro and taken the yuan with it, Europe’s trade imbalance with China has reached record proportions. Moreover, sluggish growth is forecast through 2010, in large part due to sluggish exports.
China’s hard peg has likewise taken a harsh toll on many Latin American countries and their export industries. The reaction has ranged from capital controls in Brazil to repeated currency interventions in countries from Columbia to Peru to halt the slide of the dollar and yuan.
The case of Peru is instructive. As the most avowed free trader in Latin America, Peru has opened up its markets and signed free trade agreements around the world. In the process, as the U.S. dollar and yuan have fallen, Peru has lost 75% of its local apparel and textile market to the Chinese – a key source of employment in a country renowned for its cotton.
Most broadly, the failure of President Obama to directly address the issue of currency reform with China now threatens to usher in a new wave of global protectionism. Indeed, even as the Obama Administration has twice now refused to brand China a “currency manipulator,” it has approved steel tariffs on key manufactured goods from China such as tires and steel pipe.
In ducking the currency manipulation question, Obama has effectively outsourced trade policy to individual American industries now under siege from China. The likely result of this “second best solution” to reforming U.S.-China trade relations will be a flood of new dumping complaints from American industries, a dizzying round of new tariffs and countervailing duties, and the predictable retaliation of China.
The global economic recovery must inevitably stall without the revival of the American manufacturing base, the emergence of a robust Chinese consumer, and the vitality of export industries in countries around the world. The stall will come all the more quickly if a full-blown trade war breaks out. For all of these reasons, there is no issue more important than currency reform as Presidents Obama and Hu sit down in Beijing this week to discuss the future.
Peter Navarro is a professor at the Merage School of Business, UC-Irvine and author of The Coming China Wars. www.peternavarro.com