I think we can all agree that the main culprit for the 6% decline last week in U.S. equity markets was the decline in China’s currency and the downward volatility in their stock market. What is still up for debate is whether or not that volatility in their stock market had anything at all to do with anything NEW that’s going on in their economy. I think it’s safe to say that the Shanghai Composite’s 70% ramp from early February 2015 to its late June highs had little to do with investor optimism about a re-acceleration in China’s slowing economy, and I suspect the index’s subsequent round-trip of that run, resulting in a 40% decline (and counting) has little do with an impending economic disaster.
The Chinese stock market has become sport for retail investors. But a look at the 5 year charts shows that long biased equity investors may be engaged in a death-match. There is little technical support (or sentiment support) below 3000 in the Shanghai Composite for another 15% (or two daily trading limits!):
Obviously I have no idea whether or not Chinese stocks breakdown from here, but I suspect they do. I guess what’s more important for today is that while the equity index closed overnight at a 3 month low, right on that important support level, our equity futures have found some footing after a very disappointing close on Friday. I suspect we see the S&P 500 down at some point today. I would be surprised if we find a near term bottom on a day like today.
As for what should be driving the train here in the U.S.? Well it’s the economy stupid. Unfortunately for that hot December U.S. Jobs print on Friday, it’s the global economy trumping domestic, or fears of a deflationary global slowdown taking the lead. And, if you thought the start of January was volatile, I would bet that the month goes out with a bang as U.S. earnings will soon be the focus and then of course the FOMC meeting on January 27th. Two things on this front. First, I suspect that management’s of U.S. multi-nationals are as uncertain about the near future than any point in the last five years. So I would expect forward guidance to be muted at best. Second, I think it’s safe to say from the volatility in U.S. equity markets since the FOMC’s first rate increase in 9 years back on December 16th that the Fed didn’t not exactly nail the end to ZIRP, at least in their message. If they are to become more dovish despite what appears to be a solid (current) jobs picture, equity investors will likely be spooked. If they stand their ground on rate increases, equity investors will likely be spooked. All hunky dory right?
I think it makes sense to prepare for lower lows in large cap U.S. stocks, despite the likelihood of fierce counter trend rallies. If you are gonna stick with the ol’ buy the dip mantra that has served so well since the start of QE, then here are the levels to be cognizant of:
Green – 2100: line in the sand on bear market rally, sell take profits, lay into short.
Orange – 1865ish: August low, coming to a theater near you.
Pink – 1820: Ebola, global growth scare lows Oct 2014.
Red – 1740: 2014 global growth scare low low.
