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By HaleStewart January 26, 2014 5:09 pm
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International Week in Review: Emerging Market Sell-Off and US Profit Taking Edition

Last week, the biggest news was the rising fear of a slowing Chinese economy.  Earlier in the week, Chinese year over year GDP came in at 7.7% -- a figure any country would love to print.  But in China’s case, it signals the increasing possibility the economy is slowing from its rapid pace of expansion over the past 15+ years,  Adding to the concern was the below 50 reading of the HSBC manufacturing index, indicated the domestic economy may be cooling further.  As the accompany chart shows, the overall pace of manufacturing growth – while positive – is clearly diminishing:

At the same time, US news missed expectations, with the biggest coming from the existing home sales market:

Total existing-home sales, which are completed transactions that include single-family homes, townhomes, condominiums and co-ops, increased 1.0 percent to a seasonally adjusted annual rate of 4.87 million in December from a downwardly revised 4.82 million in November, but are 0.6 percent below the 4.90 million-unit level in December 2012.

For all of 2013, there were 5.09 million sales, which is 9.1 percent higher than 2012. It was the strongest performance since 2006 when sales reached an unsustainably high 6.48 million at the close of the housing boom.

The market was expecting a print of 4.94 million.  As a result, the SPYs’ (S and P 500 ETF) sold off sharply on Friday, dropping through key support:

In addition, the emerging market ETF also took out key support:

Let’s place all of the above developments into a broader, macro-economic perspective. 

  1. The general consensus regarding China is the economy is slowing.  New leadership has acknowledged they need to change their economic focus from one dominated by exports and infrastructure investment to one built on domestic consumption.  The last GDP news falls right in line with this re-shifting. 
  2. The manufacturing number is one piece of monthly data which has a disproportionate market influence as it occurred at the "right" time – a time when traders have been looking to pull the trigger on trades moving funds from emerging market into developed markets.
  3. The sell-off in US markets is hardly fatal and shouldn’t be considered as such.  For the last 30 days, the markets have hit tremendous upside resistance (The SPYs have been running into the 184 level while the DIAs have hit resistance at the 164/164 level).  As the daily chart above shows, momentum has been decreasing for the last several months. 
  4. Underlying the move out of emerging markets is the Fed’s announcement they would begin the tapering process, which analysis believe will occur at roughly $10 billion/month.  This news is dollar positive, which in turn is pulling money from emerging markets.  Adding to pressure is that most emerging markets are net sellers of raw materials to China, which is trying to change the composition of its economic growth.

This week, the underlying fundamentals of the markets started to change.  While there has been continued talk for some time about the potential Chinese economic weakness, this was the first time traders acted on that assumption.  This explains the sharp drop in emerging markets.  The US markets sell-off is more the result of traders needing to ttake profits and being goaded into doing so by the underlying economic numbers -- namely, the weaker than expected reading in existing home sales.

Hale Stewart is a former bond broker who has been writing about economics and financial markets since 2006 on the Bonddad Blog.  He is also a tax attorney with a domestic and international practice while also forming and managing captive insurance companies for US companies.   You can follow him on twitter at:@captivelawyer



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