The US Isn’t Leading The World This Time

By Greg Tolpigin | More Articles by Greg Tolpigin

I noted in my March 17 column of the ongoing downside risks for the US dollar against the Yen and how tentative it looked technically for another leg to the downside. The past week has seen further weakness that is also dragging the Nikkei lower. The same has occurred with the Euro rallying and now being a drag on European equity indices. The large exporters are suffering as their native currencies appreciate and this weighing on share prices.

As a result this is creating a situation where currency movements (amongst other things) are going to create a divergence between the performance of global equity indices. I noted last year that by switching to a bearish view that it would be likely we would see the next correction in market’s and even a ”crisis” occur outside the US. 2008 was all about the US.

This time I gave the suggestion of Emerging Markets being the epicenter of the next correction. Three decades of capital inflows are reversing, sovereign defaults are a substantial risk as Governments are unable to fund debt obligations with commodity prices hovering at decade lows and corporations in these countries have over leveraged themselves during the historic “good times”.

But this may not be correct. It could be. I am only speculating. But what I do know is that with the Federal Reserve turning more cautious on raising rates in 2016 from four times to now indicating two times, the US dollar has weakened and thus shifted the vulnerability of equities from emerging markets to Europe and Japan.

My point is this. We cannot look to the US to be the catalyst of weakness in the global markets. The US does not have negative rates. They have inflation not deflation. They have an economy that is growing, albeit at an anemic pace, employment growth and a financial system (plus corporations) that have been recapitalized and solid balance sheets. So the US is likely to be dragged lower rather than be a leader in taking markets down. I am still concerned about the US for reasons I have repeatedly discussed but from a trader’s point of view the focus needs to be on which markets are leading.

Let’s look at exactly what I am talking about here. Firstly Japan. The first chart shows the sharp slide in the US dollar against the Yen as it downward trend accelerated in the past week once the 111 support level was breached. It hit 108 overnight. Notice as well that no rally in the currency pair was able to surpass the 30 day exponential moving average (in green) and thus has maintained an overall negative bias.

The decline in the USD/YEN has dragged the Nikkei with it, falling 8% in the past week. It is now clearly trading below its exponential moving averages and each of these (10,21 & 30) are all heading lower as well. During such phases momentum can be very strong and any look back at the chart below will prove this, just take a look at the sell off at the start of this year.

Japan continues to struggle with deflationary pressures and really is the world’s largest financial experiment. Debt levels are astronomical and for all the stimulus pumped into their system, has resulted in zero long lasting positive effects.

Europe again is a similar circumstance just a little more diluted. Their economic woes have been well documented and the recent move to negative rates has yielded a stronger currency (not the result the European Central Bank would have expected) and weaker equity markets. Economic stats have shown no improvement either.

Below the German DAX has also failed to hold above its cluster of moving averages that were up to this point acting as support from the February recovery. The failure here shows that momentum has stalled, turned negative and it will take a substantial catalyst to revive this index again. Much like Dec 2015 when an identical reversal occurred that led to the sharp sell off to start 2016. The same patterns and weakness is evident across the region’s other national indices.

Now let’s turn to the US. We can use any of the major averages – Nasdaq Composite, S&P 500, Russell 2000 or Dow Jones – they are all still above their moving averages. While we had our first close below the 10 day moving average (the first signal a trend is slowing or stalling), there is still a clear outperformance here. Which underpins my earlier message – the US is not going to be the place where warning signs will emerge like we had in 2008. Volatility in the US will be the ripple effects of a big collapse elsewhere. While the strength of the Yen and Euro are headaches for Japan and Europe, US dollar weakness is unwinding a 2014 and 2015 problem for the Federal Reserve and large US exporters.

I am not bullish the US. I am just less bearish than other regions. I am negative equity markets from a macro perspective globally. My long positions are all driven at the micro-company level – bottom-up if you will. Macro trends are clear headwinds for global markets in 2016 and I explained last week how these will continue to see long-end bond yields continue to fall and yield curves flatten as negative interest rate policies fail to achieve their objectives.

Warning signs for another downturn equity markets are unlikely to begin in the US. The traditional focus on the US driving global market direction during this next phase for markets may not prove to be as timely in the past nor as profitable when looking to profit from volatility. The best returns from the short side will be from those countries with fewer options left for how their central banks can help restore growth.

This only further cements one of my other views that I have warned repeatedly about – banks. They are the worst performing sector in 2016. The current environment for banks is the worst of the worst. Low growth, low or negative interest rates, rising defaults, over-leveraged and indebted consumers and asset prices that are at or past their peaks and intense competition affecting margins is possibly the worst combination possible. In 2008 the near collapse of the US financial system was one of swift and sharp proportions that required unprecedented Government intervention. Unfortunately the current environment is the exact opposite – death by a thousand cuts. The shocks to the sector will be slow moving and because each specific negative factor is not major when viewed in isolation, the reality is that when viewed in unison it is a weight that will drive share prices lower.

Both macro and micro trends are negative for the banks globally and there is nothing in sight that suggests these conditions will improve. The upcoming earnings season for US banks and local banks will contain a few negative surprises. Just don’t get caught thinking that current dividend payouts are etched in stone. Like voters, shareholders seem have a short memory too. Banks in the past have had some very difficult time.

Greg Tolpigin

About Greg Tolpigin

Greg Tolpigin has over 20 years of experience as a proprietary trader and high-level strategist for the major investment banks including Citigroup, Bankers Trust and Macquarie Bank.

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