BarroMetrics Views: The Forgotten Index

It is difficult for those living in Australia, Singapore, Hong Kong and China to comprehend impact the ‘Sub-Prime’ crisis had on the US and European economies, especially in relation to jobs. As a friend said to me the other day: “Recession, what recession? I’d call that the “Phony Recession”. (He was extending an allegory to the Phony War).

The reason why the countries mentioned above did not feel the recession was because of China. It stepped in and filled the void. Now with Goldman Sachs, Greece, Portugal, (Italy next?) and Spain hogging the limelight, the state of the Shanghai Index and Chinese economy seems to have gone unnoticed.

When the Sub-Prime hit, China like the USA went a massive quantitative easing. but unlike the US, Chinese efforts fed into the economy. In 2008 and 2009, the Chinese loosened the purse strings. Now the chickens are coming home to roost. Official figures show an inflation rate that is starting to be worrying; anecdotal evidence portrays an even grimmer rising inflation rate.

Figure 1 shows the 13-week swing (quarterly) of the Shanghai Composite Index. It topped later than the S&P and bottomed earlier. But whereas the S&P has gone on to increase another 23% since Aug 7 2009, the Shanghai Index topped out on that date i.e.  whereas it was showing relative greater strength prior to Aug 2009, since then it has been relatively weaker.

The question is why?

The answer can be found in the inflation rate. When inflation raised its head in China, the government implemented restrictive measures that it subsequently withdrew when the Index tanked. Since then, and until recently, the ‘fight inflation’ measures have been on a ’stop-go’ basis. Each time the measures were perceived to have stopped, the Index rallied, but only again to decline on fresh restrictions.

However, two weeks ago, the Chinese announced some strict measures and this time it appears that they mean it - at least that’s the apparent interpretation of the Shanghai Index.

Since the announcement, the SI has fallen 9.8%. And more importantly from a technical view, the Index has accepted below the bottom of the Value Area suggesting a test of the (Daily) Primary Buy Zone at 2744 to 2628. If that gives way, we can expect a retest of the Oct 2008 lows at 1652.

If the Chinese economy starts to decline, we can expect to see this part of the world would follow.

Now, if the US is to have a real recovery rather than what John Mauldin calls a statistical recovery, it needs a strong China so that this part of the world can take its exports. This won’t happen if China weakens. And, to add to the US woes, the problems in Europe plus Bernanke’s determination to avoid paying for the sins of prior bubbles, suggests we’ll see the FED behind the inflation curve.

The current steep yield curve is warning of inflation - just like the inverted yield curve warned of the 2007 recession.

My view of the US stock market has not changed. The best we can hope for is a repeat of 1966 to 1982. If the FED acts too late to stem inflation, that sanguine view may well prove incorrect.

Figure 1 13-Week Shanghai Index

Figure 2 Daily Shanghai Index

Figure 3 DJIA 1966-1982; 2002 to 2015 (?)

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