With the Dow above 18,100 and crude oil surging 4.35 percent, today one of the greats in the business released a powerful piece warning a major market just experienced the equivalent of a black swan event.
Bert Dohmen's Wellington Letter: "This week news out of China propelled the China stock market as never before. This spread to the Hong Kong stock market and then to related markets such as oil and some commodities.
It was a well-coordinated attack on the bears. The government announced multiple changes designed to counter the negative news and the credit crisis. This may be a game changer for many markets for a while. Here are the items:
1. Effective last Monday, China-based mutual funds are permitted to trade Hong Kong stocks. The Hong Kong market soared 3.3%.
2. From the Hong Kong side, global funds can buy Shanghai-traded stocks via a relatively new link. So far, about $20 billion went from Hong Kong to Shanghai. The target amount is twice that. The ISHARES CHINA 25 ETF (FXI) was up over 6% today.
3. The head of the People's Bank of China, Zhou Xiaochuan, said economic growth had slowed more than expected. Therefore, you can bet there will be further stimulus.
4. The central bank lowered the minimum down payment requirement for second home buyers from 60% to 40%.
5. Zhou also said something very powerful: regulators will have room to act with both interest rates and "quantitative easing”. In other words, they are ready to push interest rates way down.
All this caused massive short-covering, together with investment buying domestically and from abroad. Of course one ever knows how much of the foreign buying came from off-shore entities related to the China government.
The chart of the ETF investing in the “China 25 index”, the FXI, shows a 4 standard deviation move. That’s the equivalent of a crash, except in the other direction. Note the plunge in 2011. That was a plunge similar but opposite to the surge, but somewhat milder. A 4 standard deviation move is a Black Swan event.
The plunge in 2011 was quickly reversed. The lesson may be that this week’s surge may also be quickly followed by a sharp pullback. After all, this won’t change the fundamentals.
However, the psychological effect is important. The government will now manipulate stocks. Housing will get a short term boost. The other Asian markets may see a ripple effect.
It’s obvious that China now fears a recession or worse. They had done smaller liquidity injections into the banks the past year, but the economic deceleration is worsening. The credit crunch in China is serious. Last year China's economy grew at the slowest rate since 1990. And that is assuming the official GDP numbers are not fudged.
The emerging markets rallied along with China. This means that a potential debt crisis in the emerging markets is postponed. The China stimulus is expected to spill over into the other Asian markets.
However, it won’t change the growing dollar-denominated mountains of debt.
The actions in China were probably known by insiders and acted on for the past week or two as China, commodities, oil, and precious metals rallied.
The oil rally was the most unnatural at a time when inventories are growing at least three times more than had been expected. However, extraordinary stimulus in China advances the perception of a possible economic strengthening in Asia and a resulting increase in oil consumption. During the past decade China accounted for over 90% of the increase in global oil consumption.
This is sufficient reason to re-analyze our investment posture. We believe it could be a game changer for a while. As with any stimulus, eventually all this will fade out. Perhaps this boost will last 4-6 months. No one can know.
However, buying stampedes are usually not the time to get in. A professional waits for the inevitable pullback. He looks at more important data on what is really happening with money flow over the next week or so. Just looking at gains caused by position reversals of highly-leveraged players and then following the herd when emotions run high is usually not wise." To subscribe to the Wellington Letter CLICK HERE.
***ALSO JUST RELEASED: The Economy Is Now Accelerating On The Downside CLICK HERE.
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