A holiday shortened week and some wild swings toward the end were not enough to move the major indices very far from the unchanged mark. On a weekly basis they closed flat in North America and Europe, although Asian markets finished considerably lower.
The inability of Dubai World to repay its debts is what gets the blame for the late week selloff. But I am more inclined to believe it was simply jumpy speculators, fearful of losing their gains before the end of the year. Whether or not this event proves to be of any longer term importance largely depends on market participants' willingness to see that Dubai is not alone.
In fact, Dubai is a relatively small shoe among those waiting to be dropped. Excessive debt levels are everywhere. In many cases debt levels and leverage are higher than they were prior to the 2008 credit crisis. The only thing that has changed is sentiment. Popular sentiment is that governments will bailout banks that get in too much trouble; that large companies will be assisted in rolling over their debts; that overleveraged companies will be able to "earn" their way out of their problems in a recovering economy; and that increasing debt servicing burdens do not pose as barriers to any of the above.
As soon as perception is changed, the deleveraging of 2008 will continue anew. None of the problems were actually dealt with expediently. They were merely swept under the rug - given "lifelines." But those lifelines expire. So when the sheer mathematics of the situation meet the expiring lifelines that were given in the panic of 2008 and early 2009, the result will be unsurprising. (Abu Dhabi gave a similar "lifeline" to Dubai last year)
Dubai could serve as a stark reminder of this reality. Or it could be again rolled over and swept under the rug for another year. We've seen warning shots like this before. Remember back to June of 2007, when two Bear Stearns hedge funds blew up. This was quickly made to disappear while stocks continued higher for a few more weeks. Then another big shock in August. And again new highs for stocks into October. Thus, I would avoid taking this recent event as the long awaited "catalyst" for a move lower. I would instead watch for signals of contagion in credit markets. Are CDS spreads blowing out on other sovereigns early this week? Greece, Ireland, Spain, Italy, Mexico, Pakistan, Latvia, Saudi Arabia and numerous eastern European nations should be given extra attention this week.
Unless credit contagion is plainly visible early next week, I would be wary of a short covering rally that takes us to immediate new highs. But if nothing else, this recent incident has given us confirmation to the existence of a massive US Dollar carry trade. On Thursday night, the US Dollar spiked higher as speculators got spooked. Nothing else was spared. Gold was down $60. S&P futures were down more than 40 points. Oil dropped $5. And the phenomenon was worldwide.
Considering this is a technical update, I'll post a few charts before closing out.
First up is a chart of sentiment. It is the Investor's Intelligence bull:bear ratio. As you can see, the percentage of bulls relative to bears has reached a new extreme for the rally. This is typically a contrary indicator. (note: numbers are as of Nov 23rd)
Last week, I pointed out that the BKX (Bank Index) was underperforming and was poised to make a large move. It again underperformed this week. Below is an hourly chart of the past 3 months. Below its November lows, things start to get ugly for this index. Signs of credit stress should show themselves in this index first. Falling share prices in the banks will beget talks of more writedowns (not to mention coming accounting changes at end of year). And more writedowns will beget talks of further government assistance. The mere mention of this will absolutely crush improving social mood. And I don't believe further assistance will be politically possible. The big banks remain insolvent. That is the way they will inevitably end up. Attempts to paper over this reality appear to be unravelling.
I mentioned the Aussie Dollar last week as a carry currency. It weakened further this week. But the New Zealand dollar, while considerably less liquid, is also one to watch for signs of tense carry traders vacating their positions. It got creamed on Friday and is deserving of some attention in the event of followthrough.
Japanese banks are some of the most susceptible to falling asset prices. And they still have not worked through the bad debts racked up in the 80s. The Japanese Nikkei has been falling while the Yen rises to new highs. This is extremely painful to Japanese exporters and there are serious cracks between the new Japanese government and the central bank. Something could crack here too.
Have a great week!
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