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Are US Markets Following China's Weakness?


If so, the S&P 500 is about two weeks from reaching its high.

Yesterday's Notable Technical Developments

  • Morning stock market gains were erased by the time the FOMC decision was released. Following the Fed's decision, stocks rallied to make new daily highs (see below chart).

  • Bonds also gained, and the benchmark 10-year Treasury closed at a yield of 3.65%, down five basis points.

  • The dollar did not fare well. The DXY gave up Monday's gains and closed below its 3.5-month uptrend line.

  • While dollar weakness gave a boost to oil and gold, more interesting was the inability of the PowerShares DB Commodity Index Tracking (DBC) to make a new high in the afternoon.

  • Add all this up and you have currency, commodity, and debt markets concerned about the vitality of the economic recovery, while stocks continue to float on air.

Click to enlarge

Market Internals: NASDAQ
(Figures are rounded)

Key Charts

A stronger dollar has been a boon to the smaller growth stocks of NASDAQ and the Russell 2000; meanwhile, international markets have lagged and China has slumped

Click to enlarge

International and emerging markets haven't fared as well as US equity markets of late. While the Russell 2000, NASDAQ, and, most recently, the S&P 500 have all made new 52-week highs, many foreign markets have lagged. Price appreciation in the shares of smaller growth companies is quite characteristic of the early stages of an economic recovery, as smaller companies are faster, leaner, more agile, and devoid of debt. They're typically first to experience revenue and earnings growth as the economy rebounds. A strengthening dollar only serves to widen the performance gap between smaller and larger companies. Large-cap, multinational companies are negatively impacted in two ways. First, when they convert foreign currencies (from international sales) to dollars; and second, as they face stiffer price competition from imports (cheaper due to the stronger dollar).

Maybe this is why the S&P took a bit longer to make a new 52-week high and the Dow has failed to do so. This relative outperformance by the Russell 2000 and NASDAQ should continue as long as a US recovery is on track. If the recovery appears unsustainable or is derailed, expect the more defensive names found in the Dow and, more broadly, the S&P to gain favor.

International markets have fallen in line behind US leadership. This is somewhat surprising given the seemingly unanimous belief that faster growth can be found abroad. Perhaps this is a sign of just how dubious this recovery is. Many foreign economies are still closely linked to the performance of the American economy.

China's leading the US? We may find out in two weeks!

Click to enlarge

More surprising, and possibly more telling, is the notably weak Chinese market. The iShares FTSE/Xinhua China 25 Index (FXI) is down more than 11% since peaking in mid-November and is in a clear downtrend. To be fair, FXI doubled off its October 2008 low before this recent retreat. But, downtrends are downtrends until they're broken. And take note of the timing of FXI's bottom and top, and the duration from trough to peak (see above chart). Its low came in October 2008, four and a half months before the S&P bottomed. Its recent high -- November 2009 -- was four months ago. Will the S&P follow suit in a couple of weeks and begin to trade lower? The FXI's move higher lasted nearly 13 months; the S&P is now 12.5 months into its bull run. Again, will US markets begin to follow China's lead in the next two weeks?

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No positions in stocks mentioned.

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