Broken Mirrors

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Here's another issue of Market Shadows for your pleasure, as Stock World Weekly is summer vacationing.

Broken Mirrors

Introduction

Zero Hedge quoted David Rosenberg today, discussing six key influences which have variably weighted effects on the stock market, depending on the period:

"These six items are liquidity, fund flows/positioning, technicals, valuation, sentiment, and the fundamentals. They continue in the aggregate to provide a very murky picture, but the fact that the market has hung in following last week's massive gains tells me that the first two factors are dominant at the present time."

Liquidity – QE-Infinity will keep that flowing. David's research suggests that every $40 billion of QE added to the Fed's balance sheet adds about 20 points to the S&P 500.

Fund Flows – hedge funds have been underperforming and now have to buy stocks to keep up appearances.

Technicals – Our take has been rather bullish recently. There's an unavoidable subjectiveness when looking at charts, and our admittedly bearish biases tend to fight against a clear read. (Not so much with Allan's trend following system which provides computer-generated signals.)

Excerpts from the newsletter

The US stock market is an imperfect and increasingly useless reflection of the US and world economies. So while economic numbers have been poor-to-neutral, and conflicts have been escalating across the globe, the US stock market has remained gleefully disconnected from the turmoil.

Factors that were once associated with rising stock prices are less relevant today than they were in the past, and although the US economy has been weak, economies of other countries are in worse shape.

At the heart of the problem, the world's financial system is resting on "enormous, complex financial structures that can inflict tragic consequences" when they fail. These financial structures are very difficult to regulate and control. Ideally, our politicians and financial sectors would take action to prevent these structures from posing serious dangers, but reform not only hasn't happened, efforts in that direction have been wholly unsuccessful.

Simon Johnson and Peter Boone summarized the explosive situation in an insightful article examining the risks spreading from the Eurozone to the already ailing US and Japan. They point out how the world's political and financial systems are continuing to build up their financial monstrosities rather than suppressing them. The Eurozone is hemorrhaging most now, but other nations are not far behind.

“The continuing crisis in the Eurozone merely buys times for Japan and the US. Investors are seeking refuge in these two countries only because the dangers are most imminent in the Eurozone. Will these countries take this time to fix their underlying fiscal and financial problems? That seems unlikely.

“The lesson from all these troubles is clear: the relatively recent rise of the institutions of complex financial markets, around the world, has permitted the growth of large, unsustainable finance. We rely on our political systems to check these dangers, but instead the politicians naturally develop symbiotic relationships that encourage irresponsible growth… There are more crises to come and they are likely to be worse than the last one." (The doomsday cycle turns: Who’s next?)

The global economy is impossible to fix without radical measures, and it's arguable whether even radical measures would succeed. Nevertheless, the bandaids that the world’s central banks are progressively applying, in ever greater amounts, are propping up the US stock market on the back of inflated money supplies, as central banks race to devalue their currencies the fastest.

Last week, author John Rubino noted how trouble in different regions is taking center stage:

“Geopolitics — that is, guns, bombs, and ideology — pushed finance off the front burner. In the East China Sea, for instance, everyone has inexplicably become obsessed with a few barren islands and is apparently willing to trade blood for rocks…

"On the South China Sea, China is a rising power and Japan is declining, which is, historically, a recipe for trouble. They do a huge amount of business together and it’s odd that either sees a confrontation as a profitable venture. It’s certainly costing both parties in terms of lost production and street security. But they’ve decided that this is the time, and public opinion seems to favor a confrontation, so here we go.

“Then of course there’s the Middle East eruption over an obscure parody film. The video set off an explosion that was waiting for a lit match. (Anti-American protests continue throughout the Middle East) If not this, something else would have set it off. The West simply has no business occupying that completely incompatible part of the world, and when the true price of oil is calculated to include the cost of Middle Eastern entanglements we’ll find that it’s vastly more expensive than any other fuel. The southern half of the US could be covered in solar panels for less than we’ll spend on cleaning up this mess in the coming decade.

“And last, but definitely not least, Israel seems to be inching towards the launch button over Iran’s nukes… It’s not clear that there’s a peaceful solution, given the demographics. Muslim populations are soaring and electorates are becoming more resentful and fundamentalist. Israel won’t accept nuclear weapons a few hundred miles away, and the US has absolutely no idea what to do, and no money with which to do it.”

"Financial crises produce geopolitical crises." The reckless borrowing of trillions of dollars over the course of decades leads to bankrupt nations, impoverished peoples, rage and social unrest. Overt conflicts threatening violence correlate with intensifying financial stress. We're witnessing this drama play out now. (A Bankrupt World Is An Unstable World)

US naval presence in the Gulf is “soaring to a concentration not seen since the last Gulf war.” (Head Of Iran's Revolutionary Guards: "A War With Israel Will Occur") According to the commander of Iran's Revolutionary Guards, Israel will eventually go beyond threats and attack Iran. (Reuters)

Speculating on Spain, Zero Hedge reported, “The one thing that will force countries to request a bailout is the inevitable outcome of soaring budget deficits: i.e., running out of cash (as calculated here previously, an event Spain has to certainly look forward to all else equal). Which simply means that sooner or later Mariano Rajoy will have to throw in the towel and push the red button, knowing full well it most certainly means the end of his administration, and very likely substantial social and political unrest for a country which already has 25% unemployment, all just to preserve the ability to fund its deficits, instead of biting the bullet and slashing public spending (and funding needs), which too would cause social unrest – hence no way out.” (First Spanish Bailouts Conditions Revealed: Pension Freeze, Retirement Age Hike)

On hostilities brewing between China and Japan, Zero Hedge commented, “Any attempts to drag the US into the conflict will backfire severely on Japan. But for a country which has already demonstrated an abysmal lack of tact in foreign relations comparable to the one in the period 1930-1950, layering mistake upon mistake is to be expected.

“Of course, all of this is well-known, as is the reality that the situation will escalate until someone has to decide whether to truly push it to the next level, or step down, humiliating his country in the process, something Asian states have never been too keen on. What, however, was the most important article in today's Pacific Rim press is this one which has nothing to do with Japan, and everything to do with China's expanding zone of influence: ‘China's top security official on Saturday made a surprise visit to Afghanistan, the first time in 46 years that a Chinese leader set his foot on the soil of this landlocked Asian country.’” …Could this have anything to do with a poppy-seed and opium trade power vacuum, and up to $1 trillion in "untapped minerals"? (China Officially Warns Japan Not To Infringe Its Territorial Sovereignty; Japan Reciprocates).

The situation in Asia is also intensifying as Taiwan has entered the already volatile dispute.

Also in Market Shadows: Broken Mirrors