What’s wrong with this picture?

Written by Bruce J. Clark

April 16, 2019

Questions that successful traders constantly ask themselves are “given what I know, are markets behaving as I expected?” and “Is my thesis solid, or does something not fit?” They are always looking for tell-tale signs that either confirm their bias or, more importantly, serve as warnings. The near-vertical run in the major equity indices over the past 14 weeks has left a lot of investors pleasantly surprised. Almost everyone hopes for more. But the smart ones will become even more vigilant for what could potentially go wrong.

Leading the charge in equities this year is China. With most of the major central banks either sidelined or impotent, the Chinese are doing all of the heavy lifting in the effort to reflate global markets in 2019. And they haven’t disappointed. Bank lending in China surged to an all time high in January, leading a 40% year-on-year increase in social financing over the course of first quarter. This is the policy equivalent of throwing the proverbial kitchen sink at the economy. No wonder their stock market is up 30% on the year. It’s also helped create a rising tide that has benefited global asset prices in general. By this measure alone equity markets are responding logically, and favorably, to massive monetary and fiscal stimulus. But will it last or is it just a sugar high?

Yesterday the Organization of Economic Cooperation and Development (OECD) warned of the long-term consequences of current policy in China by piling up too much debt and stealing growth from the future. https://reut.rs/2V4L1JN Normally these agency reports don’t get much play but it does serve to highlight the predicament that the central banks have found themselves in. A decade (and trillions of dollars in stimulus) down the road from the last recession many regions still don’t have sustainable recoveries.

To this point, a potentially significant red flag was raised by news this week that Australia is considering rate cuts to offset a weakening economy and slowing inflation. https://bloom.bg/2VPLaxE Canada may not be far behind. http://bit.ly/2v7O4SL This is significant as both regions have well-earned reputations as leading indicators for the global macro-economic condition. Because each depends heavily on international trade and commodities prices, if reflation (and the Chinese recovery) is for real it will show up in their respective currencies. So far, it’s not.

Gold offers a similar warning to asset bulls. If reflation was robust it would be rising. Instead, the chart looks ugly (see below).

Divergences between reliable benchmarks like the Aussie dollar, the Canadian dollar and gold, and the prevailing positive news flow in equities is the market’s way of telling you to pay attention. Trend changes show up in the form of subtle price discrepancies well before it becomes obvious to the folks on CNBC. Good traders take note knowing that these discrepancies may just be meaningless blips on the radar, or they may mean everything.

Gold
China Shanghai Index (yellow) and the Australian Dollar (blue)

Author: Bruce J. Clark

Bruce Clark is a thirty-five year veteran of the financial markets, both as a trader and as a journalist. After a career as a principal and proprietary trading manager for some of the world's largest banks, he began writing about markets for Thomson Reuters in 2012 as a senior financial market analyst, working out of the New York and Washington, DC bureaus. He is presently a Washington, DC-based editor for MT Newswires and a special contributor to ConnectedtoIndia and The Capital.

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