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One Last Burst of Optimism?
11:40 AM MDT | March 29, 2010 | By SIGMUND FLOYD
In the past month, US and European shares staged an impressive recovery off their lows of early February. On March 16, the S&P 500 followed the Nasdaq’s lead to break out to a new post-crisis high at 1159, 74% above its crisis bottom. Public participation in the US market is increasing according to several measures. The rally in commodities off the lows of Q4 2008 is also picking up again, with key industrial commodities (copper, nickel, aluminum, tin, gold, silver, platinum, oil) back above their 50-day moving averages and at or near double-tops. Comparing prices in US dollars for copper, oil and gold at end Q1 2004 with current prices, copper was at approx. $1.3/lb vs. $3.37 today, oil was at $35/barrel vs. around $80 today, and gold was at $420/Troy oz vs. $1110 today. Thus, the US dollar has lost more than half its value compared to the corresponding period of the last recovery (Bull Markets beginning in March 2003 and March 2009). The implied inflation rate in dollars based on these three commodities is a mind-boggling 17%/year over this 6-year period.
In short, following a brief hiatus, exuberance about global economic recovery seems to be bursting through once again, inflation bogey notwithstanding. However, the odd man out is China – the Shanghai stock market, after spending a brief period above its 200-day moving average after Chinese New Year, fell back below that key benchmark on March 4. On March 16, the US Federal Reserve announced it will continue to maintain interest rates low for an “extended period”, leaving the language of its policy statement unchanged. The Fed has been playing a massive game of chicken with its counterpart, the People’s Bank of China – despite growing concerns about the CPI, which reached a 16-month high in February, it will be difficult for the Chinese Government to raise rates as long as the Fed maintains its easy-money stance, as by doing so it would create additional upward pressure on the Yuan from undesired global “hot money”. Not surprisingly then, the Fed’s reiteration of its policy boosted Chinese shares by around 2%.
The high-stakes drama that is playing out between China and the US on the Renminbi carries hazards for both sides. The reality, which seems to be recognized neither by the US Administration and its acolytes nor by the minority party, is direct pressure will fall on deaf ears. In a recent Op-Ed piece the influential liberal economist and 2008 Nobel Laureate Paul Krugman called for a temporary 25% US import tariff if China fails to take action. However, if the US were to act on this prescription, it would in all likelihood trigger a global currency crisis. In reality, China must engage in a very difficult balancing act to revalue the RMB without causing a meltdown in the already vulnerable dollar. Instead of being politely requested to cooperate in a coordinated bilateral move (which might have a chance of working, but appears to be politically impossible for partisan-dominated Washington to initiate) China is annoyed to find itself instead being roundly castigated for what it sees as a major contribution to stability of global financial markets.
Notwithstanding the current optimism in Western markets, it is difficult to accept the view promoted by the Obama Administration that the US is on a stable recovery trajectory capable of sustaining a multi-year Bull Market – the favorable comparisons with 2004 seem likely to end fairly soon. While forecasting is always risky, we find ourselves solidly in the camp of those like Nouriel Roubini who see a high probability of a double-dip recession: too much structural damage has been done to the US economy in the form of permanent layoffs and foreclosures for “natural healing” – all that is being offered by the criticism-sensitive Administration - to work. Judging by Chinese Premier Wen Jiabao’s comments last Sunday, it seems “Uncle Wen” thinks so too – he explicitly warned the Chinese people to be prepared for such an event.
As we indicated in our February commentary, over the past year or so, the Chinese stock market has been a reasonably good barometer for the health of the global economy - or at least global stocks. It is hard to imagine a global Bull Market in which China doesn’t even participate, let alone lead - yet its behavior in the first month of the Year of the Tiger has not been very encouraging - barely up 1% from its pre-Chinese New Year close and still down 7% for 2010. If the Chinese market can’t pull out of its doldrums soon, we would incline to the view that perhaps after one more round of highs global markets will see a reversal in the coming months, confirming a well-known Wall St. adage: “Sell in May and Go Away.”
Sigmund Floyd is President of Valushar, a management consultancy focusing on strategy and tactics for multinational companies operating in