Increased tensions between the US and China are taking its toll

Increased tensions between the US and China are taking its toll

25 May 2020 from Carlsquare

The increased tensions between the US and China should be sufficient to get the market on the case, regardless of the Corona virus or not. China is preparing new stringent laws for Hong Kong residents, which, among other things, prohibits criticism of China. The last time this legislation was in progress in 2003, the penalty scale included the death penalty for this type of criticism. But it was withdrawn after massive protests. In this case, the Corona pandemic may play into the hands of the Chinese leaders as public protests have been pulled down due to the risk of infection.

However, the United States has responded by preparing sanctions and prohibiting trading in Chinese equities. There is also a debate in the White House that the United States should conduct a nuclear test to underscore the seriousness to both China and Russia. This should be the first test in 28 years, according to a Washington Post report. The spread was quickly killed as too stupid, but still shows what overtones that still exists in world politics.

That said, this would be enough to cause the stock exchanges to collapse. But the markets are still upheld by the central banks’ support and a hopeful hope that we will wake up one morning and discover that the Corona virus was just an evil nightmare.

Above is a schematic illustration of stock market developments since the early 1990s. Had the Fed not intervened after the Lehman crash in 2008, the world would probably have gone into a depression, so the strategy was certainly correct. Unfortunately, the central banks have never withdrawn their support. On the contrary, they have been quick to add new support every time a crisis appears. There was a crisis in September 2019 that was not reported at all in the media in which the Fed made recurring interventions in the US repo market. This was probably done to save some large hedge funds from crashing.

We have trouble understanding the point of constantly saving the big banks and hedge funds. This is since they adapt their models to this and continues to take too high risks, but this is a topic for another time. Let us just state that central banks and heads of states continue to live according to the slogan: “Not On My Watch”, which means that they will always try to save the world economy from crashes as long as they are themselves responsible. It is difficult to see that any legendary central bank governor like Paul Volker should be allowed to return before the economy has really crashed and we have a galloping inflation in the system.

The graph above is from Deutsche Bank/ZeroHedge and shows how much the central banks have pushed into the system to save the economies. Although the individual countries’ contributions vary over time, the accumulated effect is in a rapid growth and coincides well with the price performance for the S&P500 in the USA.

According to the prevailing discipline, there is only one way for the stock exchanges which is still upwards.

Even before QE1 in the spring of 2009, we wrote that it was time to buy shares when the Fed was expected to introduce these support purchases, which occurred a month later. During all the downturns, we have so far reasoned that everything depends on the confidence on the Fed, i.e. this policy works while the confidence in the central banks remains. The criticism of the central banks during this crisis is almost completely blown away. No important person criticizes the politics, so the gigantic support seems to work.

However, we have never foreseen a crisis of this magnitude. Now the statistics are starting to roll in how extensive the crisis really is. There are very few persons who seem capable to receive the information. The sun is shining, it´s time to launch all the boats and pick up the outdoor furniture if it´s not already done- but now there is going to be a tsunami of bankruptcies.

According to the graph above, the statistics for bankruptcies (filing for Chapter 11 in the US) are still at a normal level, but these statistics seem to be lagging. There is a strong correlation between bankruptcies and unemployment and if this is true, the wave of bankruptcy lies ahead of us. Several big names like the car rental company Hertz have already thrown in the towel. This is the next step that is going to hit the car industry severely.

In the US, only 25 percent of tenants in malls have paid their rent for April. Now the landlords send out a demand letter, cancel the agreements and so on. But since there is no queue of new tenants, it is quickly established a saying: “The only thing worse than being a retailer right now is being a retail landlord”.

The new big question is: Can the central banks’ support purchases keep the stock market under arms despite the huge exclusion of companies expected and despite all the security policy concerns that are put on top of this? The corona virus has not only challenged the economy, it appears to be a total trend shift in global politics, creating a wide divide with the United States on the one hand and Russia and China on the other. In between we find Europe and the rest of the world faltering, while developing countries and deeply indebted nations will ally themselves with the block that offers the best credit.

So even though the climate is getting colder, it means that we all know that the weather can continue to be good.

The S&P500 index has rebounded from its bottom just under 2200. The bounce has reached 61.8 percent Fibonacci and is dangerously close the MA200, i.e. 200-day moving average, which is about the span of the last year. Mass media in the US will spin if the S&P500 reaches this level.

If we controlled the trading desks at the largest US investment banks, we would push the index above MA200 to suck as much simple money out of the market as possible, and then move away the carpet by, together with other colleagues in the market, selling maximum volumes of everything. It is a simple trade for the big trading desks: it is just a matter of first tricking the flock into the upswing and then to dump the market at the right time so that it can be linked to any statement from the US or China concerning the trade war. Cynical? Yes, but the market is nothing but cynical.

We do not state that this will be the case, but it is important to be aware of the risk of this development.

Another thing affecting the stock market in the short term is the seasonality.

The intention is that you should “Sell in May and stay away”. Above is the statistics for the S&P500 over the past 20 years. The summer months are not strong, although apart from June they have a generally positive development.

If you reduce the period to the last five years, this effect disappears, so you should obviously take all this with a pinch of salt.

What is interesting is that QE1 was introduced in the spring of 2009 and thus we should be able to get an interesting cross-reading on how the summer 2009 developed:

Following an initial upturn, the indices fell back during the summer months. But it regained momentum from a bottom in July, during an unusually volatile summer.

From the above, the VIX index is visible during the same period and with the spread of the central banks’ money in the system, the markets calmed down. There is a peak though during July 2009 when the market bottomed out.

You might ask what the conclusion of all this is?

Indeed, the central banks have heavy ammunition that they do not hesitate to use. The Fed has already passed all the support gathered in QE1 to QE4 and is learning dual support even from current levels. This means that the stock market will increasingly free itself from the underlying economy. In other words, it is a game you should play with distinction, being aware that it is in this type of market that wealth is both being destroyed and created! Tech companies, especially those with SaaS models, are still in the winning hole. If you believe in a continued upturn, you can enter the other extreme and buy airlines, Argentine pesos or bonds, as they become relative winners, under extremely high risk.

Amazon is not a pure SaaS-company but offer this business model under its cloud service offer, AWS:

The Amazon share is however trading in a scary bearish rising wedge with negative divergence between the share price and MACD. It looks like the risk can be found on the downside.

The 2-hour-graph shows how the S&P500 index is in a rising channel that is slowly narrowing. There are no sell signals in sight.

The FAANG stocks are close to their all-time high (AHT) in the rising channel, with ATH as the resistance.

An important signal is that the Chinese stock exchange indices fell hard last Friday. They tend to be ahead of the rest of the world for a couple of months. The correlation with the European stock indices such as German DAX and Swedish OMX is very high. This is probably a trend that can continue when US managers are forced to sell China holdings. On the other hand the Chinese state does not want to lose its face and therefore stands as a buyer.

It is a disgrace if the above trend continues because it would show US as the winner and China as the loser.

When studying the global stock exchange indices, they again spread apart with the US at the top and France at the bottom.

This may be a mirror of the central bank support that has so far been the largest in the US and Japan with Europe slightly behind. The EU now introduce its support.

The DAX index does not pass through the gap without new energy:

Swedish OMX looks just as sad and can not even get through 50 percent Fibonacci:

A very important parameter for the stock exchanges is that the USD fell throughout the period after QE1 was introduced. We do not see the same trend today, but the USD is still in a rising trend against the basket. EUR/USD below is trading below MA100 and MA200:

The WTI oil price is in a continued rising trend with EMA9 as support (note the last test on Friday). Can the oil price test the gap? It looks like a reverse head-and-shoulder that, if released, would give an oil price around MA200 at 45-50 USD per barrel:

This is not supported by fundamentals though, but the oil price is traded primarily on political statements and secondly on fundamentals. Brent oil is also testing the gap but is currently stuck below Fibonacci 38.2:

Bitcoin is losing momentum and is currently testing the rising trendline. In case of a break, MA50 around 8 236 serves as a first support level:

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This information is in the sole responsibility of the guest author and does not necessarily represent the opinion of Bank Vontobel Europe AG or any other company of the Vontobel Group. The further development of the index or a company as well as its share price depends on a large number of company-, group- and sector-specific as well as economic factors. When forming his investment decision, each investor must take into account the risk of price losses. Please note that investing in these products will not generate ongoing income.

The products are not capitalprotected, in the worst case a total loss of the invested capital is possible. In the event of insolvency of the issuer and the guarantor, the investor bears the risk of a total loss of his investment. In any case, investors should note that past performance and / or analysts' opinions are no adequate indicator of future performance. The performance of the underlyings depends on a variety of economic, entrepreneurial and political factors that should be taken into account in the formation of a market expectation.

08/07/2020 04:24:09


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