Thursday, January 7, 2016

A brief note on the markets

 - by New Deal democrat

I am writing this note primarily for our progressive readers who follow us from That Other Place.  With the Chinese stock market tanking again overnight, one thing that is nearly certain is that there will be a collective Doomgasm from the usual suspects.  The ones who dismiss the stock market when it goes up, because it is a casino, stocks are overwhelmingly owned by plutocrats, it's a bubble, blah blah blah; but are in steamy arousal when the market goes down, because this is The Big One!  Is there a legitimate basis for concern?

Concern, yes.  DOOOM, no.

My sense of the current volatility is that it is similar to last August.  China is unwinding, in somewhat amateurish fashion, a stock bubble, as prices on the Shanghai Exchange more than doubled between late 2014 and early 2015:

That unwinding almost always leads for forced selling, as those who have been caught on the wrong side of stock price movements have to sell to cover their bets.  They will "sell their winners," i.e., assets which are more liquid and less affected -- the perfect example of which are US stocks.  In August, this selling reached a crescendo with a 15 minute 1000 point drop in the Dow that caused astute domestic traders to back up the proverbial truck and buy.  The best gauge of this better informed local investor is to watch corporate insiders.  Here's what they've been doing in the last year:

In case it hasn't already leapt out at you, it is nearly a mirror image of the Shanghai index over the same period.  As of the most recent week, US corporate insiders are very bullish on their own companies' stocks - just as they were during the brief August downturn.

So can we have another big mini-crash like we had last August?  Sure.  Does it mean the US economy is sinking under the waves?  Almost certainly not.

That being said, the US economy is holding its own, but it has taken on some water in the form of a shallow industrial recession, that is partly the OIl patch, and partly the due to the huge strengthening of the US$, harming exports and making imports more competitive.  [NOTE: the decline in gas prices is a net boon to the US. But this time it was accompanied by a surge in the $, which has had the larger effect.]

The biggest danger from China is that it aggressively devalues the Yuan against the US$. causing another upward surge in the dollar's trade weighted value.  At some point a hyper-strong dollar would affect manufacturing so badly that it can outweigh the still-positive US services economy, as shown in yesterday's ISM non-manufacturing index.  But we are not there yet, and it is far from certain that we get there.