The Stock Market Trend is Broken
Stock-Markets / Stock Markets 2010 May 09, 2010 - 11:15 AM GMTBy: Peter_Navarro
In my last newsletter several weeks ago, I noted a continued bullish trend. However, I also said that:
“Despite the market's bullish trend, I continue to be cashed out of most of the stock market and have shifted a significant chunk of my assets into a new piece of real estate.”
My personal cash call, which went against the grain of the market from a technical perspective, was made on the basis of pure fundamentals. That, in fact, is often the flaw with technical analysis. It misses key market turning points.
Whether this is a turning point and the start of a downward trend or, as many of the talking heads have tried to portray it, simply a 10% market correction remains to be seen. However, the "this is only a market correction" chatter is extremely dangerous. It assumes that the market will simply go down 10 or 15% and then you will have a green light to go back in. Ergo, in this view, with you should be doing now is buying on the dips and accumulating bargains.
From a retail investor’s point of view, this is just plain stupid. The reason this is stupid is that none of these talking heads talking correction have any clue as to why this market is going down. They view the recent dip as a technical correction rather than something more fundamentally wrong.
From a retail investor's point of view, the best thing to do -- and the only thing to do -- right now is to stay out of the market until the trend reestablishes itself. In this regard, I did a very interesting segment last Friday on CNBC that talked about the different incentives facing retail investors versus institutional investors -- and what is implied by those different incentives.
Small retail investors -- and I include people with up to several million dollars in the market -- have the great advantage of being nimble and flexible around market turning points. There's absolutely no reason not to make a move the cash because liquidation of one's complete portfolio can have no impact on market prices. Moreover, small retail investors are not required by any covenants to be committed to the market.
In contrast, consider an institutional investor like a mutual fund. A large, high-growth mutual fund may have extremely large positions in stocks like Intel or Apple or Cisco. If that fund tries to liquidate all of the shares in any of those stocks in a single day, the large liquidation will likely weigh heavily on the price and cost that mutual fund some profit points as he tries to exit. At the same time, many mutual fund managers must cope with the forced requirement of having his or her fund mostly in stock positions rather than on the sidelines in cash.
You should see immediately now from these observations why it is never in the best interests of an institutional fund manager to come television as a commentator and recommend that people sell their stocks. (In the worst-case scenario, you may well have a talking head telling people to buy on the dips and grab great bargains even as that very same fund manager is liquidating positions in those stocks, essentially selling on the rallies he or she helped fuel with "buy on the dips” commentary.)
So to reiterate: if you are a small retail investor, use your flexibility to stay on the sidelines when the market trend is indeterminate or in a downward bearish direction. And be very wary of any advice you hear about "buying on the dips" or going bargain-hunting when the trend is down or undefined.
As for the market trend, here is what I think is going on from a macro point of view. With the yield curve flattening and with the stock market trend broken, the financial markets are casting some significant doubt on the strength of the global economic recovery.
The best way to think about the global economy is as a three-legged stool consisting of Asia, Europe, and the Americas. Right now, and this may seem surprising, the Americas may be the strongest leg of the stool.
Particularly in the United States, we seem to be in the midst of a reasonably good recovery -- although GDP growth rates at this stage of recovery are far below historical norms. Asia, too, has been doing relatively well. That said, there are growing doubts about the Chinese economy, which is coping with significant bubbles in both the stock market and real estate market -- but China at least continues to appear to be booming.
That leaves Europe. The message here is that the real story in the headlines is not about the "Greek debt crisis" but rather about the death of the euro as a reserve currency -- and the likely stagnant economic growth in Europe that may follow for some years.
Right now, the euro zone has 16 countries that have adopted the euro. My prediction is that there will never be a single additional country that will join the euro zone. This is because the recent Greek debt crisis has exposed the folly of any country surrendering both its fiscal and monetary policy in order to join the euro.
The biggest part of that folly is Germany. German sensibilities about fiscal and monetary policy are totally out of tune with the rest of the European continent. In a nutshell, the Germans prefer austerity and export led growth to a reasonable level of consumption and a more balanced economy. Hence, as much of the rest of Europe has gone stagnant -- and wrecked their balance sheets in the process -- Germany runs a huge trade surplus and a relatively small budget deficit. Of course, its leaders want everybody else in Europe to do the same thing -- but the German model only works because of its "beggar thy neighbor” export strategies. So it is all a nonstarter -- and a huge recipe for continued conflict. Memo to the world: there are really good reasons why it has always been Germany that starts world wars in Europe. The Germans are different from everybody else -- and have a low tolerance for the rest of Europe to conform to the German will.
On the euro question, it's not just that no additional countries will be joining the euro zone anytime soon. It's also that some of the countries in the euro zone must eventually leave under the weight of their weak economies and large budget deficits.
In fact, at least some, or perhaps all of the so-called "Piigs” -- Portugal, Italy, Ireland, Greece, and Spain -- will find that the only way for them to restore economic growth will not be through the austerity measures crammed down their throat by the Germans and the IMF. Rather, it will be through currency devaluations that make their exports relatively more competitive. However, such competitive devaluations cannot happen until a country exits the euro and regains its sovereign control over its currency and monetary policy.
So here's the bottom line: no more countries joining the euro and some countries eventually leaving. Because the financial markets understand that the euro is effectively dead as a reserve currency, it is placing its bets accordingly. Hence, the dramatic fall in the value of the euro against the dollar.
The biggest picture here is that the euro zone faces turmoil for years to come. Much of this turmoil will come from the internal contradictions spawned by the German conundrum. A likely result will be a rate of economic growth lower than it would otherwise be. However, if the European leg of the stool is weak, there will likely be not enough support for global economic recovery over time.
As to why we specifically care about whether Europe is weak -- and whether the euro is weak -- it's all about global trade. A weak Europe buys fewer Asian exports and fewer exports from the Americas. In this way, the two other legs of the stool are hurt.
So to answer the question posed by the title of this newsletter -- what just happened -- it wasn't about a fat finger computer glitch. It was about the recognition by financial markets that something is rotten in Denmark -- and the rest of Europe.
So let me reiterate my bottom line: this is not the time to be buying stocks. Watch the markets carefully and get your buying list ready. But don't jump in with both feet until the trend is reestablished.
Navarro on TheStreet.com
Click here to review my videos on TheStreet.com.
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Professor Navarro’s articles have appeared in a wide range of publications, from Business Week, the Los Angeles Times, New York Times and Wall Street Journal to the Harvard Business Review, the MIT Sloan Management Review, and the Journal of Business. His free weekly newsletter is published at www.PeterNavarro.com.
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