by Lance Roberts
CNBC: Global Markets Roiled by Nikkei's 7.3% Slide "Financial markets around the world were roiled Thursday after Japanese stocks suffered their biggest slide since the country was hit by a devastating tsunami more than two years ago. Several reasons have been blamed for the 7.3 percent fall in the Nikkei index to 14,483.98, including a spike in Japanese government bond yields and unexpectedly weak Chinese manufacturing figures."
That was the news that dominated the financial headlines today around the globe this morning. However, while the selloff was certainly large in magnitude, the largest since the nuclear disaster in 2011, it must be put into some sort of context. The chart below shows the Nikkei 225 going back to 1981.
There are numerous points that are worthy of consideration:
1) While the Nikkei has had a parabolic rise since the implementation of "Abe-nomics" the current rally failed at the long term downtrend resistance.
2) As shown in the callout - while the Nikkei did suffer its largest drawdown since 2011 it has hardly registered a blip when compared to the entirety of the recent advance. If this did indeed mark the top in the Nikkei the correction still has a long way to go just to reach the 12-month average.
3) The rise in the Nikkei pushed the markets well beyond 3-standard deviations above the 12-month moving average which is simply unsustainable. As with the U.S. markets - such extensions will ultimately lead to a reversal. However, reversals do not occur without a catalyst. The problem is that by the time you realize what the catalyst is - it will be too late to react.
4) The extreme divergence from the 12-month moving average, as shown at the bottom of the chart, is at levels that have normally been associated with major market tops. While such extreme deviations are important it does not mean that the markets are going to crash immediately. It does mean, generally speaking, that the majority of the advance is already complete and the risks, without a correction first, outweigh the potential for returns.
The Big Picture
While Japan has entered into an unprecedented stimulus program (on a relative basis twice as large as the U.S. on an economy 1/3 the size) there is no guarantee that such a program will result in the desired effect of pulling the Japanese economy out of its 30-year deflationary cycle. The problems that face Japan are similar to what we are currently witnessing in the U.S.:
- A decline in savings rates to extremely low levels which depletes productive investments
- An aging demographic that is top heavy and drawing on social benefit schemes at an advancing rate.
- A heavily indebted economy with debt/GDP ratios above 100%.
- A decline in exports due to a weak global economic environment.
- Slowing domestic economic growth rates.
- An underemployed younger demographic.
- An inelastic supply-demand curve
- Weak industrial production
- Dependence on productivity increases to offset reduced employment
The unanswered question remains as to whether, or not, monetary policy can generate economic recovery. The world's central banks have "bet it all" that it will indeed work. The problem, as is always the case is such monetary experiments, remains the unintended consequences.
The lynch pin to Japan, and the U.S., remains interest rates. If interest rates rise sharply it is effectively "game over" as borrowing costs surge, deficits balloon, housing falls, revenues weaken and consumer demand wanes. It is the worst thing that can happen to an economy that is currently remaining on life support. Japan, like the U.S., is caught in an on-going "liquidity trap" where maintaining ultra-low interest rates is the key to sustaining an economic pulse. The unintended consequence of such actions, as we are witnessing in the U.S. currently, is the ongoing battle with deflationary pressures. The lower interest rates go - the less economic return that can be generated. An ultra-low interest rate environment, contrary to mainstream thought, has a negative impact on making productive investments and risk begins to outweigh the potential return.
The mistake that Japan is likely going to make is believing that if they can generate some inflation for the economy that they will have the ability to cap it at 2%. This is beyond naive and is likely to end very badly. The following video from Christine Hughes sums the entire situation up very well and is worth watching in its entirety.
The point here is that the current blip in the Nikkei is likely going to be short lived as liquidity injections continue to artificially inflate assets. However, as in the U.S., parabolic rises in asset prices eventually lead to extreme corrections. If the "grand experiment" in Japan does indeed fail, which is what I suspect will eventually happen, the ramifications on the U.S. markets are likely to be quite severe.
The two charts below show the current extension of the S&P 500 Index. The first chart shows the S&P 500 as compared to its 3-standard deviation range above and below the 50-week moving average. Currently, the index is at levels, much like the Nikkei, that have denoted major market peaks.
The next chart shows the deviation of the S&P 500 price above its 50-week moving average. Here, also, the index is at historically high levels.
So, what does the "crash" in the Nikkei mean? Most likely not much in the near term as long as "Abe" and Bernanke continue to push liquidity into the financial markets. The current bias for assets prices remains to the upside as investors remain completely agnostic towards risk. Despite a threat of war from North Korea, weakening global economics, deterioration in the Eurozone, a slowdown in China or a slowdown in corporate earnings - investors remain solely focused on Central Bank interventions as a driver of asset prices and a complete hedge against investment risk.
"With central banks fully engaged in lifting asset prices through monetary policy - what could possibly go wrong?"
However, in the end, it will be the realization of "fear" that drives volatility substantially higher leading to the rapid deflation in asset prices. In this case Roosevelt was wrong - it is the "lack of fear" that we should fear the most.
No comments:
Post a Comment