Friday, 27 March 2015
Last updated 21 min ago
Jan 23 2009 | 4:00am ET
By John R. Taylor Jr. -- Despite the problems involving Citibank and Bank of America in the last week, the American morning television shows are now bored with the crisis in our banking and credit generating system. They are ignoring the continuing disintegration of the global financial structure, spending their time discussing money saving strategies or giving tips about how to keep one's job during hard times.
The public’s focus on the status of the banks and the automobile companies peaked with their ‘rescue’, and has now shifted to pinning the blame on this or that group of managers or owners, and the outrageous sums they were paid. Everyone is acting as though the game was finished, and all that’s left to do is analyze the play by play – but that is wrong. The sheer panic of last fall and the desperate attempts by Paulson and Bernanke to control the implosion have receded into memory to be replaced by the moderated tones of President Obama and a sense of calm.
With the new team, it seems we can accept our losses, realistically assess our new position, and plan our way back from this financial trough. Unfortunately, this is all a mirage. The current economic situation has deteriorated dramatically since late November when many of the financial markets made their low. In the U.S., unemployment has climbed sharply higher in the past two months, bringing at least a 30-year high into range, and inflation has disappeared at 0.1%, a level last seen in 1954.
January’s numbers are sure to show deflation. This was the worst Christmas season in memory and retailers are dropping like flies. Although the U.S. trade balance improved sharply, the other side of the coin is that global exports have fallen off the cliff; in Asia declines of 30% in the fourth quarter are common. Industrial production in many countries is now more than 10% below the level of the year before.
Automobile sales in the U.S. were down over 35% in November and December, results that were known only after the markets made their low, and some are forecasting sales for 2009 at a 9.0 million pace, about half the rate of two years ago. Because the trajectory of the current data is so sharply down, we can be sure unemployment will rise and bank credit losses will follow.
Also, commercial real estate losses, which always lag the business cycle as long leases cushion the blow of the cyclical decline for many months, will bring more financial misery to the banks.
The reality is we are still in the first half of this recession and the market calm of the past two months will be punctuated by new crises. Confidence in Washington’s ability to fix the economy is very shallow and the addition of Obama to the mix cannot have much of an impact in the next few months.
Today, the credit and the equity markets are trading steadily but volume is thin and nervous as buyers have no interest and sellers are hoping for better prices. The recent decline in volatility is a sign the uptrend is exhausted, not that we are returning to better times. Absent crises, poor earnings and bankruptcies should hobble the equity market in the next few weeks, and once the trend turns down some of the sellers will cave in, driving prices lower.
This will be good for the dollar, as it should rally because the global banking system is still unable to provide the liquidity necessary to carry out global business. The resulting scramble for dollars could take the EUR/USD to new five-year lows.
The equity market is poised to begin another decline and it is our expectations the next leg of this long unwinding will take prices down into March. The longer-term picture calls for equities to continue lower into the beginning of next year and our target for this decline is the 500 to 550 area for the S&P 500.
We would expect a slightly more aggressive decline in Europe and slightly less in Asia. Indicators such as the put/call ratio and the VIX are signaling to us the equity market has either just begun its next decline or is about to do so. The put/call ratio at the start of the year was the highest it has been since the all-time equity peak in October 2007. Volatility is also very low while volume has been poor, an indication of a tired upmove that is about to cave in.
As the equity cycle has been calling for a high in the middle of January, we believe all the pieces are in place. Our next cyclical low is in the second half of March, so we are prepared for a break to new multi-year lows. The dollar has been negatively correlated with the equity market, so the probabilities favor dollar strength. The EUR/USD, shown on the attached chart, should drop into the same time period reaching new multi-year lows.
Although there is a low due in late March or early April, the EUR/USD could see a further low in the late summer as there is another cyclical low expected at that time. The dollar, and currencies in general, should break away from the equity market between six months and eighteen months before the equity market makes its low.
The last dollar peak in February 2002 was seven months before the U.S. equity low in September and 13 months ahead of the European equity lows in March 2003. As equities should bottom in early 2010, or perhaps somewhat later in the year, a dollar peak this summer would fit the cycles just perfectly.
John R. Taylor, Jr. is the chief investment officer of FX Concepts.
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