Muddling Through Shanghái

By John Mauldin

Sep 05, 2015

 

“He who knows when he can fight and when he cannot, will be victorious.”

– Sun Tzu
 

A couple of weeks ago I was complaining about 47,000 China reports clogging my e-mail. The number now feels like it is well into six figures (perhaps a slight exaggeration). Maybe my memory is going, but there wasn’t nearly as much China talk on the way up. Funny how that works.

Is China collapsing? I think parts of China are under severe pressure if not outright recession, and clearly the stock market is a disaster. Anyone who bought Shanghai or Shenzhen stocks on margin this year is probably on the brink.

That said, China itself is not collapsing. There are parts of China that are doing just fine, thank you very much. It does have serious problems, though. The Pollyannas and the Cassandras are both wrong. The change in tone in the Financial Times is quite amusing. Their recent hyperbolic, bearish section called “China Tremors” is a case in point. Of the last 30 articles on China on their website, I found less than a handful that were positive on China. My take? China will muddle through, at least for the near term.

China is in transition, a transition that was clearly telegraphed if you have been paying attention. Our recent book on China (A Great Leap Forward?) clearly laid out this new path. Today we are going to talk about this precarious, difficult transition, which may impose profound impacts on much of the rest of the world. This transition is going to change the way global trade has worked in the past. There will be winners and losers.

But first, a brief comment on today’s employment report and how it impacts the need for a rate hike by the Federal Reserve in September. I offer a little different perspective on the coming decisión.

To Hike or Not To Hike – That Is the Question

Today’s unemployment report was lackluster, as has been the case for the initial reporting for the last two Augusts. Both were revised significantly upward – August 2012 was eventually revised up 96,000 jobs, while August 2013 saw a final revision upward of 69,000 jobs, and August 2014 saw a final count of +213,000 jobs. Part of the reason for the major revisions is that only some 70% of the potential survey participants actually responded (hat tip Joan McCullough). Evidently the United States is becoming like Europe, and we are all going on vacation in August. Or at least the department personnel responsible for handling employment figures are. Expect to see significant upward revisions in the coming months, just as July saw another 30,000 added and June saw a plus 14,000.

This report was not so ugly that it would take the breath away from hawks wanting to raise rates or force doves into agreeing to a rate increase. Nothing changed, really. That is illustrated by the two articles below that were side-by-side on the New York Times website within an hour of the release of the report (hat tip Brent Donnelly). Everybody got to see what they wanted to see.


I can’t remember a time when there was such serious disagreement over what the Federal Reserve should do regarding a rate hike. I have been in several groups of analysts and economists in the last few months, and I must confess to being surprised at the split in opinions.

Upon reflection, I think I can actually understand both positions. First, the Fed keeps reiterating that they are “data-dependent” – thus the focus on every little bit of data, no matter how trivial. Let me see if I can explain why both sides can feel they are right and then why, to my way of thinking, they are missing the point.

On the side of those who feel that a rate hike should be postponed at the September meeting, it must be remembered that most rate hikes are in anticipation of an economy beginning to pick up speed. The Fed has said they want to see low unemployment, and under the leadership of Bernanke and now Yellen, they have a 2% inflation target. Remember, their congressional mandate is to promote stable prices and full employment.

While unemployment did drop to 5.1%, that is a “soft” unemployment figure. The participation rate is down. The number of part-time workers wanting full-time jobs is still high. And the new employment trend is not encouraging.

August's gains were well below trend. The average of the previous five months is 211,000; for the previous six before that it was 282,000. The yearly employment gain, 2.1%, is off 0.2 point from the late 2014/early 2015 rate. The private sector gain is 60,000 below the average of the previous six months. (The Liscio Report)

We are not close to 2% inflation; and, frankly, it doesn’t look like we’re going to get there for a while. The economy is, at best, stuck in a low, Muddle Through gear (as I predicted years ago); and getting back to a stable 3% growth rate, let alone the occasional 4–5% that we used to see, seems out of reach. The dollar is strong and getting stronger and is not only holding down inflation but also, anecdotal evidence suggests, slowing down exports in various sectors of the economy. There were those who argued that a bubble was developing in the stock market, but it appears the stock market is taking care of itself to make sure it doesn’t become overheated. There is no need to pile on to see if we can drive asset prices even lower. Further, we are just in the beginning of a housing recovery. Why raise mortgage rates, etc., at the beginning?

In such an environment, why would you raise rates in order to keep the economy from overheating? The last thing we seem to be doing is overheating, let alone even getting to a slow boil. Instead, we may already be cooling down. If the economy does start to pick up and inflation becomes an issue, we could raise rates then as fast as we would need to. Or so Kocherlakota and his friends on the FOMC say. And thus we should postpone a rate increase until we see a reason for it. Kind of like, don’t shoot till you see the whites of their eyes.

Those who think we should raise rates likewise have an array of data to support their case. GDP grew 3.7% in the second quarter. If you take out the weather-related first-quarter 2015 GDP figure, GDP growth is running well over 3%. Given the global headwinds currently buffeting economies, that’s about as good as it’s going to get.

This economy has weathered tax increases and the abrupt changes of Obamacare, as well as a significant drop in capital spending related to oil production and has “kept on ticking.” If there is a recession in our near future, as David Rosenberg points out, it would be the first recession ever that did not see consumer spending or employment go down for the count.

We’ve always been able to find negatives in the unemployment rate. Even if unemployment were somehow to ratchet down to less than 200,000 per month, it will be for only two quarters at the most; and it may be that before the end of the year we will be under 5% unemployment.

We just set a record for all measures of corporate profits in absolute terms. We finally set a new record for real disposable personal income in July, again in absolute terms. As Jim Smith says,

What all this means is that when the FOMC meets on September 16 and 17, they will be looking at a US economy in which more people are employed than ever before, earning more money than ever before, producing more goods and services than ever before, and with personal consumption expenditures and corporate profits at the highest levels ever seen. If that is not a prescription for finally raising the Fed Funds rate, then I can't imagine what it would take to get them to move. (source)

Despite the significant slowdown in the oil patch, the level of investment in the second quarter was almost 4% higher than last year. Businesses are optimistic. Even given the turmoil in Canada, China, the Eurozone, and the rest of the BRICS, and even though global trade is beginning to fall off a little bit, the US economy seems to be doing quite well in spite of it all.

What else do you need in order to begin to normalize rates? Inflation is under control and according to most Fed economists seems to be ticking higher. Unemployment is moving lower. The economy is doing quite well. If not now, when? How much better do you want things to get before rates are taken back to something close to normal?

I must confess that I personally lean toward the latter argument, but I have a few additional reasons for thinking the Federal Reserve should act in September. As I have presented in previous letters, there are real reasons to think that low interest rates are not only creating malinvestment but also encouraging companies to use financial engineering and to buy their competition rather than purchasing the tools of production and actually competing head on. These behaviors distort an economy over the long term. They frustrate Schumpeter’s forces of creative destruction.

Further, what policy tools does the Federal Reserve still have available if we enter a recession? I admit that doesn’t seem to be a likely possibility today, but there are many potentials for exogenous shocks to the US economy that could cause a recession. Further, in the history of the United States we have never had a period longer than nine years without a recession. This recovery, relatively weak though it is, is getting long in the tooth. Do we want the Fed to confront the next recession with another round of massive quantitative easing as the only policy tool left to deploy? When their own research shows that QE wasn’t very useful and when we can clearly see the distortions caused by QE in emerging markets around the world?

The Federal Reserve is functionally incapable of not feeling the need to “do something” in the midst of a recession. If the only tool they have is further massive quantitative easing, they will use it. Damn the distortions, full speed ahead!

I would not argue for a rapid rate hike. In fact, I would prefer 1/8 of a point at every meeting, rather than the typical quarter point. But there is no reason not to raise a quarter of a point at this meeting, skip a meeting to make sure everybody can take a deep breath, and then raise once more before the end of the year.

I mean, really? Does the Fed think this economy is so fragile that it can’t take a lousy quarter-of-a-point increase in interest rates? The Federal Reserve needs to begin to restock its policy tool chest now. While I personally think we are a long way from ever seeing 5% Fed funds rates again, a 2% rate can probably easily be absorbed if it comes slowly. And that rate would give the Fed some policy tools when, not if, we enter the next recession.

Now, let’s turn back to China.

Repeat After Me: Chinese Stocks Are Not the Chinese
 
Economy

It’s easy to assume that a country’s stock market reflects the condition of its economy, but that is not always the case. Further, what the stock market really does reflect is the consensus estimate of an economy’s future condition. More specifically, stock prices reveal future expectations for corporate profits.

This generally applies to both the United States and China. One key difference, though, is that most American stocks represent companies that seek to make profits. In China, that isn’t necessarily the case.

The Chinese stock market includes many state-owned enterprises (SOEs), whose executives answer to bureaucrats in Beijing. The government views them as public policy tools. Everyone is happy if the SOEs make a profit, but profit is not the first priority.

If US stock prices generally tell us more about the future than the present, except in times of serious over- or undervaluation, then Chinese stock prices tell us even less about either.

Just as last year’s incredible run-up in Chinese stocks did not signal an economic boom, the ongoing decline does not signal an economic bust. The correlations aren’t just weak, they are nonexistent.

China’s official economic data is also questionable and would be so even if GDP were a precise measurement tool. As we discussed last week, it usually isn’t.

It is no stretch to say we are flying blind about China.

Fortunately, we have diligent researchers like Leland Miller of China Beige Book, whose research firm does the hard work of gathering reliable data each quarter from thousands of companies in China and assembling it in comprehensible form. His data shows that China’s economy has actually been in good shape since China stopped acting Chinese last year. But even then, you have to separate the Chinese economy into several categories.

China Good, China Bad, & China Ugly

Among the many letters and reports on China that I received over the last month, I’d like to single out an excellent research note that the team at Gavekal Dragonomics published last week, called “What to Worry About and What Not to in China.” I appreciated this piece, because it really helped me structure my worrying. I dislike spending energy worrying about the wrong things. Further, worrying about the wrong things can be dangerous. It’s when you are paying attention to the wrong things that what you should have been paying attention to jumps up and bites you on the derrière.

In the spirit of the Gavekal note, here is the good side of China. We’ll get to the bad and the ugly below.

Chinese real estate prices will stabilize. We hear a lot about China’s massive infrastructure boom and the resulting “ghost cities.” These aren’t just rumors. The government mandated the construction of entire cities to house the formerly agrarian population as it shifts to industrial jobs. Provincial governments earned as much as 80% of their revenues from land sales. Essentially, this is a process where they take possession of rural land that has very little value in price terms, declare it to be available for development, and can make profits several orders of magnitude greater than their costs. Nice work if you can get it.

The ghost cities will not stay empty forever. They will fill with people over the next few years (in some cases more than a few). The recent housing bubble is more a function of young people wanting to cram into certain popular areas. The broader internal migration will support housing prices even as the bubble areas pop.

It might be helpful to think of the Chinese ghost cities as analogous to the overbuilt condos in Florida. Prices in Florida did in fact collapse, and places were selling for a fraction of their construction cost. I wrote at the time that I thought they would be very good investments, because the number of people wanting to retire to Florida is actually a fairly steadily growing figure. Low taxes, good weather, positive infrastructure, excellent medical care – what’s not to like, other than it’s not Texas? Just saying…

While it will take time, those ghost cities will eventually fill up. Further, most of that real estate was bought with significant capital, often 50% or more. Those apartments, which are essentially shells because they have not been finished out, function more like stores of value or bonds than they do as traditional apartments. While the original investors may not get the inflation-adjusted returns they want, inflation will eventually mean that they will get some return on their investments. While this may not make sense to most of us in the Western world, given the Chinese experience, owning something that is tangible might make sense. The reality is that there are hundreds of millions of people who are going to want to find a place to live in China over the next few decades. That seemingly endless source of buyers will eventually turn the ghost cities into real ones.

Note: that doesn’t that all of the ghost cities will be developed. Some probably won’t, as they are too far outside the path of growth. But most of them have excellent infrastructure and connectivity to the rest of China. Think of how satellite cities developed throughout the South and Southwest of the United States. Admittedly, in the US this was generally a demand-driven process. In China it was a way to prop up GDP and actually create something tangible, unlike the ephemeral transfer payments and other congressional pork that the US used as “stimulus.” I would argue the Chinese are better off putting their money into some kind of infrastructure than we were putting ours into temporary, nonproductive stimulus.

China is shifting from investment to consumption. The phase of China’s emergence led by exporting and infrastructure growth is ending. The next task is to build an economy that relies less on exports and more on consumer demand and services. This path was detailed in our China e-book. It has been the plan for some time.

This process will continue to be ugly at times. Last week’s Purchasing Manager Index for Chinese manufacturing fell even deeper into contraction territory, where it has languished for six months. Services PMI also fell but not nearly as much; and more importantly, it continues to show a mild expansion.


I know this is anecdotal, but in secondhand conversation with a very-high-profile private equity group here in the US, they report that they have four significant investments in China. None are in the manufacturing area; all are in the services sector. The slowest of their companies is growing at over 20% per year, and some are doing significantly better.

The China of today is not your father’s China. Fifty percent of the economy is now services. That part of the economy is growing – and evidently growing enough to offset the contraction in the manufacturing sector. And we must remember that China actually added twice as much to its GDP in either dollar or yuan terms in the past year than it did in 2003 when its growth was a “miracle.” That helps to put their reduced growth in context. As I have pointed out, the law of large numbers requires that their growth will be slower in percentage terms in future years.

Room for More Stimulus. The Chinese government is spending big bucks to prop up the stock market and the renminbi through various interventions. Estimates vary, but $200 billion to date is a good guess. They will have to spend more. The good news, if you can call it that, is that they can afford it. There is, of course, reason to question the wisdom of trying to prop up a stock market – especially in the rather ham-handed (one is tempted to say “rookie”) way they have gone about it. More about this later.

Aside from its multi-trillions in FX reserves, the People’s Bank of China still has plenty of room for monetary stimulus. Short-term interest rates in China are over 4%, far higher than in most of the rest of the world. That means the PBOC can probably make several more small cuts without overly weakening its currency. Yes, I know that they devalued their currency a whole 2–3% recently. Given that the euro and the yen are down well over 30% against the dollar, I really find the overreaction in the West quite laughable.

The IMF says China has to float its currency in order to be included in the SDR (Special Drawing Rights). Okay, so they’re starting that process. As I have said repeatedly for the last four years, when they finally float their currency, the likely direction of the renminbi is down, not up. All the ranting of Donald Trump and US senators combined cannot push back the tide of what the market sees as the true value of the renminbi.

China’s banking system is also on a strong footing. Banks have little exposure to the stock market. Chinese brokers have very conservative (by Western standards) capital requirements. Gavekal says not to worry about a systemic crisis. (The Chinese shadow banking system is something else altogether. See below.)

Despite all this, China is enduring an economic slowdown that may get worse. We have plenty of legitimate worries. Now, here come the bad and ugly parts.

Idle Industrial Capacity. The transition from an investment-driven export economy to a consumption-driven service economy will take years. Further, it won’t be easy for those on the industrial side of the house. While it may be hard to believe, over the years China has lost more steelworkers than the US and Europe have. They overbuilt steel mills. It seemed that every province wanted its own mills, and their production capacity just grew too large. It likely still is too large.

The government hopes to reuse some of the idle capacity in its very ambitious (and quite expensive) “One Belt, One Road” or New Silk Road initiative. That strategy may help – as long as lower exports don’t slow down the plan. But that is a decades-long process and is unlikely to relieve much pressure over the next few quarters or years.

As every parent and employer knows, idle hands are never a good thing. You have to keep people occupied, or they will find suboptimal things to do. The last thing Beijing needs right now is a few million idle, i.e., unemployed factory workers. It is some somewhat ironic that China is facing the same problem as the US is: what do you do with excess manufacturing workers, and how do you help them transition to jobs in the service economy? I guess the best you can say for the Chinese is that the jobs in their manufacturing economy were not high-paying so the transition will not be as economically wrenching.

Chinese Stocks Are Still Overvalued. Calculating “fair value” is difficult for Chinese stocks. As mentioned above, many companies are subject to government interference. Data integrity can be a problem in others. We can’t always make apples-to-apples comparisons with non-Chinese stocks.

Whatever yardstick you use, Chinese stocks are still quite richly valued, even after recent losses. The losses, recall, are simply the undoing of a rally that was never justified in the first place. It was a momentum-based rally in a market of retail investors who come to the stock investing with a gambling mentality.

It’s also worth noting that some Chinese stocks haven’t traded a share in weeks. Further, the government has forbidden insiders from selling in other cases, so it’s hard to know whether the index values and share prices we see are trustworthy right now. I suspect many are not. Which leads to the “ugly” part…

We Don’t Know Whom to Trust in China. Until 2–3 months ago, most China watchers believed that the country’s leaders had a thoughtful, comprehensive economic plan. I don’t know many people who think so anymore. I should note that in our book I was very clear that I thought the Chinese government was not prepared to deal with the nature of the transitional economic crisis they were faced with. None of the leadership has any true experience in dealing with major economic issues in a modern economy.

Walt Whitman Rostow wrote a book back in 1960 called The Stages of Economic Growth: A Non-Communist Manifesto. He outlined five stages that mark the transformation of traditional agricultural societies into modern mass-consumption societies. The first three stages are actually suited to top-down command-control governments. The fourth and fifth stages – at least according to him, and he has been proven right over the ensuing 55 years – can’t happen under the same type of government. There must be a bottoms-up, consumer-driven economy.

So when I say that China’s leadership has no experience in dealing with a modern economy, I mean it in that context. They’ve done a heck of a job for the last 35 years, especially given where they started. What they have done is unprecedented. So hats off. But just as we keep reminding investors that past performance is not indicative of future results, so should we be skeptical about the future quality of government decisions. And frankly, I did not expect the truth of that assertion to become apparent so quickly and so blatantly in China.

If the leadership did have a plan going into the stock market tumble, it must have gone out the window. The on-again, off-again interventions and conflicting statements could not have been part of any rational plan, unless the plan was to confuse everyone. They succeeded, if that was the case. They are clearly making up their game plan in the middle of the game.

In the space of about two months, Beijing reversed years of statements that had almost convinced the world that China really believes in market discipline. That PR campaign is now in shambles. The best-case interpretation is that the leadership is in disarray amid Xi Jinping’s corruption crackdown and unable to coordinate its messaging and intervention strategies – which is obviously not good, either.

Many people thought that at least the central bankers at the PBOC were competent and as immune from political interference as it is possible to be in China. No more. The PBOC may well have tried to assert its independence; but if it did, it failed.

The Chinese government is once again a “black box,” at least in terms of its economic policy. We don’t know who is making the decisions, nor can we be sure what they want to accomplish.

Just a few weeks ago, we all thought China wanted to float the renminbi so it could go in the IMF’s reserve currency basket. The IMF has bent over backwards trying to help China do this, even extending the review period by a year so China would have more set-up time. Beijing is not taking the hints. Either they have abandoned that goal or they don’t understand what they need to do to accomplish it.

Enter a Billion Dragons

As Worth Wray and I wrote in A Great Leap Forward?, China is engaged in a transition from which it cannot turn back. Well over a billion Chinese are in various stages of joining the modern world. Our planet has never seen anything like this, so it’s no surprise that the process is rocky. The transition will continue regardless, because China has no other option. If you want to know more about China, you really should get a copy of this book now. I priced it at a very reasonable $8.99 as an electronic book. It now appears that my regular book publisher, Wiley, is going to bring the book into print and will take over the e-book marketing, so prices will go up.

Investors want to know about China’s stock market and currency. Even after all of this year’s stimulus, the Chinese leadership still has plenty of ammunition. They can prop up the markets for a long time if they are willing to spend the money. Of course, that will drain reserves.

Beijing has always prioritized stability over free markets, and I think they will continue to do so. The risk they run is that shoving problems under the rug simply stockpiles them instead of solving them. Eventually they become unmanageable, and you have to throw back the rug and confront them. What that will look like in a Chinese context, I don’t know; but I bet it won’t be pretty.

Before we Yankees get too smug, let’s remember that we have our own black box over here, called the Federal Reserve. Its independence is also questionable at times, and it just spent the last six years interfering in our own economy via multi-trillion-dollar QE programs. What would we say if the PBOC did the same thing in China? And now we can say the same thing about Japan and Europe.

In the short term, I think the major risks lie not with China itself but with China’s energy and raw materials suppliers. Countries like Australia, Brazil, Chile, Angola, Saudi Arabia, and Russia are all going to lose as China continues shifting to services and away from infrastructure building and manufacturing. China is not going to turn off the spigot, but it will reduce the flow of materials into the country. Those commodity-exporting countries will, in turn, reduce their purchases of US, Canadian, and European goods and services.

We’ll all feel China’s pain to some degree. That, ironically, is the main reason I think China will get through this. By virtue of its sheer size, it has spread its impact over practically the whole globe. Just as we all shared in China’s growth, we will all share in its contraction.

Detroit, Toronto, NYC?

My September travel schedule looks surprisingly light. Right now there is nothing until the end of the month, when I will go to Detroit for a day and then on to Toronto for a few days. In Toronto I will be speaking at the annual CFA Forecast Dinner. I am told there will be some 1200 people there. For whatever reason, I have been making the circuit of Canadian CFA forecast dinners for the past few years. I have done British Columbia, Alberta, and Manitoba. Thankfully this one is not in January – Edmonton was cold; Winnipeg was colder. I find speaking for CFA groups somewhat intimidating, as the majority of the audience knows more about what you are talking about than you do. I will also be doing a completely different presentation the night before for my Canadian partners, Nicola Wealth Management. More info on all the events in a later letter.

I will probably have to be in New York for a few days sometime in the middle of this month. Then October looks to be busier, but not too much so. Which is fine by me, as I am really diving into the new book I’m writing on how the world will change over the next 20 years. I’ve been wanting to write this book for at least 10 years, and now seems the right time to do it.

I have to confess that I was not as diligent with my diet and in working out in August. There were just too many fabulous meals with friends and too much temptation, so when I got back last Sunday I put myself on the most serious diet and workout schedule I’ve ever attempted. Before this, my concept of diet was to cut back a little, as opposed to the more controlled calorie restriction that both my friend Pat Cox (who is the biotech expert at Mauldin Economics) and my doctor Mike Roizen, head of wellness at Cleveland Clinic, keep telling me to try. To my utter surprise, it is working better than I could have imagined.

I was surprised at how quickly I could get out of shape. The Beast has been putting me through my paces this last week. Yesterday, I finished my workout by walking the 17 flights of stairs to my apartment. I will admit I had to stop a few times to catch my breath. It brought to mind my experience in Zimbabwe some 23 years ago. I was with my friend Pat Mitchell, who lived in Johannesburg. I had done him a big favor, so to repay me he treated me to a long, first-class vacation in Botswana and Victoria Falls. The Chobe Lodge was fabulous. Amazing safaris. Highly recommended. The last day we white-watered the Zambezi below Victoria Falls, which is a class 5 rapids.

It was hot as Hades (it was summer there), and the rapids could get your adrenaline pumping. We came to the end of the run in a canyon, where we were informed that we had to walk to the top in order to get back to the hotel. It was some 400 vertical feet of switchbacks. Fortunately for me, Pat was seriously out of shape and had to stop every 30 or 40 feet to rest, so I didn’t have to reveal how out of shape I was. What was embarrassing, though, were the 60-year-old men who were running up and down porting the equipment back up. I swear I saw the same man four times, and he couldn’t have been much younger than I am now. The young guys weren’t intimidating, but I still recall that old man walking rapidly up that trail carrying a kayak. Today, I decided I needed to walk up to my apartment more often.

This is Labor Day weekend in the United States. My brother and his family and all but one of my kids, along with six of my grandkids, will show up Sunday night for a cookout by the pool. Six of my seven kids have harassed me into playing a game called Cards Against Humanity, which they swear is fun. Have a great week.

Your hoping the Fed raises rates analyst,


Nouriel Roubini dismisses China scare as false alarm, stuns with optimism

Economist describes alarmist reaction to the Shanghai stock market rout as 'excessive, unreasonable and irrational'

By Ambrose Evans-Pritchard, in Cernobbio, Italy

6:11PM BST 04 Sep 2015

Nouriel Roubini, chairman of Roubini Global Economics, poses for a photograph at the Ambrosetti Forum in Cernobbio, Ital

Nouriel Roubini at the Ambrosetti Forum in Cernobbio, Italy Photo: Bloomberg
 
Nouriel Roubini has cast aside his mantle as the lugubrious "Dr Doom" of the global economy, scathingly dismissing market panic over China as "manic depressive" behaviour by ill-informed investors.
 
"China is not in free-fall," he told the Ambrosetti forum of world leaders on Lake Como.
Mr Roubini, a professor at New York University, described the alarmist reaction to the Shanghai stock market rout as "excessive, unreasonable and irrational".
 
The Shanghai bourse is largely closed to the rest of the world and is thinly owned by Chinese citizens, while the country's banking system is state-owned and therefore has the entire resources of the Communist regime to avert a financial meltdown.

While the equity collapse has been dramatic, the number of shares in private hands amounts to just 30pc of GDP, compared to 81pc on Wall Street in 1929 and 183pc in 2000.

Mr Roubini said global markets have swung with impetuous ferocity from complacency about Chinese uber-growth to "extreme pessimism", suddenly switching from talk of 7pc growth rates to 3pc or even zero, when in reality little has changed.


"None of this is happening. The slowdown in China is neither a hard landing or a soft landing, it's a bumpy landing. It could be better managed but growth is not likely to be worse than 6.5pc this year and 6pc next year," he said.

It is an unusual reversal of roles for the man known across the financial world as the prophet of the Lehman crash, almost invariably described by commentators as a perma-bear.

Mr Roubini, who also runs Roubini Global Economics, said the contractionay fiscal policies that have held back recovery across the developed world since 2008 are finally abating.

"Germany seems to have accepted the need for expansionary policies. The whole of fiscal policy in Europe is shifting," he said.

The pace of debt-deleveraging is slowing. Recovery in the US and the eurozone itself is gradually picking up.

Mr Roubini said Western markets have misunderstood the purpose behind China's move to shake up its exchange regime, mistakenly seeing it as the start of a steep devaluation that could send powerful deflationary shocks through the global economy.

This has not happened so far. The yuan has been strengthening over recent days as the central bank (PBOC) intervenes in the market to stabilize the rate, and premier Li Keqiang has vowed to keep the exchange broadly stable - in trade-weighted terms.

The yuan has lost just 2.2pc since the PBOC shock the world by ditching its dollar peg and switching to a managed float on August 11, setting off a minor earthquake and a full-blown correction on Wall Street and European stock markets.



Mr Roubini warned that the world economy remains fragile and said the European Central Bank was well-advised to open the door this week to yet more quantitative easing, if only as an insurance policy in case emerging markets spiral into crisis.

"The US Federal Reserve should wait and see if it is a temporary storm, and not a gathering storm. It may have to wait until May to raise rates, and the Bank of England may have to wait until the spring of next year," he said.

The expansion remains soggy on both sides of the Atlantic. The latest US jobs data show that non-farm payrolls rose by 173,000 in August, less than the 217,000 expected. The US manufacturing surveys are slipping, but are not yet flashing the sort of amber warning signals seen before the onset of the US recession in November 2007.

Lars Feld, a professor at Freiburg University and one of the official five "Wise Men" advising the German Chancellor, said the Fed has already waited too long to raise rates and risks repeating the errors of the last decade, when it incubated an asset bubble.

"The Fed is behind the curve. They should have increased rates in the first half of the year.

Under the Taylor Rule (a measure of slack in the economy) it should have acted at the end of the last year. I fear we're in the same situation as under Alan Greenspan when monetary policy was too expansionary," he told The Telegraph at the Ambrosetti forum.

Yet Mr Feld said fast-moving events in China are very hard to assess, and are potentially dangerous - a worry shared by most experts at the conclave of opinion leaders.

"The more they liberalize the economy, the more they are going to lose their grip, and we're going to be in for an unpredictable time. This is what I am scared of," he said.


The Art of Capital Flight

Kenneth Rogoff

Metropolitan Museum of New York


CAMBRIDGE – What impact will China’s slowdown have on the red-hot contemporary art market? That might not seem like an obvious question, until one considers that, for emerging-market investors, art has become a critical tool for facilitating capital flight and hiding wealth.

These investors have become a major factor in the art market’s spectacular price bubble of the last several years. So, with emerging market economies from Russia to Brazil mired in recession, will the bubble burst?
 
Just five months ago, Larry Fink, Chairman and CEO of BlackRock, the world’s largest asset manager, told an audience in Singapore that contemporary art has become one of the two most important stores of wealth internationally, along with apartments in major cities such as New York, London, and Vancouver. Forget gold as an inflation hedge; buy paintings.
 
What made Fink’s elevation of art to investment-grade status so surprising is that no one of his stature had been brave enough to say it before. I am certainly not celebrating the trend. I tend to agree with the philosopher Peter Singer that the obscene sums being spent on premier pieces of modern art are disquieting.
 
We can all agree that these sums are staggering. In May, Pablo Picasso’s “Women of Algiers” sold for $179 million at a Christie’s auction in New York, up from $32 million in 1997. Okay, it’s a Picasso. Yet it is not even the highest sale price paid this year. A Swiss collector reportedly paid close to $300 million in a private sale for Paul Gauguin’s 1892 “When Will You Marry?”
 
Picasso and Gauguin are deceased. The supply of their paintings is known and limited.

Nevertheless, the recent price frenzy extends to a significant number of living artists, led by the American Jeff Koons and the German Gerhard Richter, and extending well down the food chain.
 
For economists, the art bubble raises many fascinating questions, but an especially interesting one is exactly who would pay so much for high-end art. The answer is hard to know, because the art world is extremely opaque. Indeed, art is the last great unregulated investment opportunity.
 
Much has been written about the painting collections of hedge fund managers and private equity art funds (where one essentially buys shares in portfolios of art without actually ever taking possession of anything). In fact, emerging-market buyers, including Chinese, have become the swing buyers in many instances, often making purchases anonymously.
 
But doesn’t China have a regime of strict capital controls that limits citizens from taking more than $50,000 per year out of the country? Yes, but there are many ways of moving money in and out of China, including the time-honored method of “under and over invoicing.”
 
For example, to get money out of China, a Chinese seller might report a dollar value far below what she was actually paid by a cooperating Western importer, with the difference being deposited into an overseas bank account. It is extremely difficult to estimate capital flight, both because the data are insufficient and because it is tough to distinguish capital flight from normal diversification. As the late MIT economist Rüdiger Dornbusch liked to quip, identifying capital flight is akin to the old adage about blind men touching an elephant: It is difficult to describe, but you will recognize it when you see it.
 
Many estimates put capital flight from China at about $300 billion annually in recent years, with a marked increase in 2015 as the economy continues to weaken. The ever-vigilant Chinese authorities are cracking down on money laundering; but, given the huge incentives on the other side, this is like playing whack-a-mole.
 
Presumably, the anonymous Chinese buyers at recent Sotheby’s and Christie’s auctions had spirited their money out of the country before bidding, and the paintings are just an investment vehicle that is particularly easy to hold secretively. The art is not necessarily even displayed anywhere: It may well be spirited off to a temperature- and humidity-controlled storage vault in Switzerland or Luxembourg. Reportedly, some art sales today result in paintings merely being moved from one section of a storage vault to another, recalling how the New York Federal Reserve registers gold sales between national central banks.
 
Clearly, the incentives and motives of art investors who are engaged in capital flight, or who want to hide or launder their money, are quite different from those of ordinary investors. The Chinese hardly invented this game. It was not so long ago that Latin America was the big driver in the art market, owing to money escaping governance-challenged economies such as Argentina and Venezuela, as well as drug cartels that used paintings to launder their cash.
 
So how, then, will the emerging-market slowdown radiating from China affect contemporary art prices? In the short run, the answer is ambiguous, because more money is leaking out of the country even as the economy slows. In the long run, the outcome is pretty clear, especially if one throws in the coming Fed interest-rate hikes. With core buyers pulling back, and the opportunity cost rising, the end of the art bubble will not be a pretty picture.
 


Op-Ed Columnist         

A Silver Lining to Brazil’s Troubles

 
 
BRICS, of course, stands for Brazil, Russia, India, China and South Africa, a catchphrase that was meant to connect their rapidly growing economies. But that was then. Today, their economies are sluggish at best, and their prospects no longer seem so bright.
 
Everybody knows about China’s troubles: its falling stock market, its slowing economy and the amateurish attempts by the government to revive them, as if they should somehow snap to when the Communist Party gives an order.
 
Russia’s problems are also well known: In addition to the annexation of Crimea, and the ensuing Western sanctions, the Russian economy has slowed with the decline of the price of fossil fuels, its primary export. The South African economy is in such trouble that even its president, Jacob Zuma, described it as “sick.” Although India grew by 7 percent in the second quarter, that number was below expectations, and in any case, probably overstates the health of the economy, Shilan Shah of Capital Economics told BBC News.
 
And then, sigh, there’s Brazil. Inflation? It is closing in on 10 percent. Its currency? The real’s value has dropped nearly in half against the American dollar. Recession? It’s arrived. The consensus view is that the Brazilian economy will shrink by some 2 percent in 2015. Meanwhile, “between 100,000 and 120,000 people are losing their jobs every month,” says Lúcia Guimãraes, a well-known Brazilian journalist.
 
Compounding the economic problems, many a result simply of poor economic stewardship, a huge corruption scandal has swept up both Brazilian politicians and a number of prominent businesspeople. The scandal centers on the country’s biggest company, Petrobras, whose success had been an object of real pride during the go-go years.
 
Although the details are complicated, as its core the scandal is “an old-fashioned kickback scheme,” as The Times’s David Segal put it in a fine story last month — a kickback scheme that has been estimated at a staggering $2 billion.
 
Politicians and members of the business elite alike have been arrested. The country’s president, Dilma Rousseff, who was the chairwoman of Petrobras while much of the scheme was taking place, hasn’t been accused of anything, but her approval rating is in the single digits. People have taken to the streets to call for her impeachment, though there are really no grounds yet to impeach her.
 
Political corruption has long been a fact of life in Brazil, but rarely has it been on such vivid, and nauseating, display.
 
The double whammy of scandal and recession has created a mood that combines outrage, anguish and resignation. But there is something else, too. “People feel betrayed,” says Guimãraes. Rousseff’s party, the Partido dos Trabalhadores (PT) — or Workers’ Party — came to office in 2003 promising, idealistically, to create social programs that would help the poor join the middle class. Between 2003 and 2011, according to one estimate, some 40 million people have climbed from abject poverty to the lowest rung on the middle class.
“The worst thing,” a Brazilian friend of mine wrote in an email recently, “is this feeling of disappointment with the … PT, which brought so much hope to the middle class. I’d call this feeling a kind of political depression.”
 
And yet, as I look over the BRICS, I think there is more hope for Brazil than some of its fellow members. Admittedly, I am a lover of Brazil, and want to see it succeed, and so was pleased when, as I made phone calls and emails for this column, a surprising silver lining emerged.
 
It is this: For all the pain Brazilians are going through right now, its democracy and its judicial institutions are working.
 
“What I see, more than I’ve ever seen before, is that the country is weathering this storm,” says Cliff Korman, an American musician who has lived and taught in Brazil for decades. It has a free press, which has stayed relentlessly focused on the Petrobras scandal. It has prosecutors who are actually putting politicians and businessmen in prison, and bringing cases against companies. The judiciary is not backing down.
 
“Corruption is such a part of public life,” says Riordan Roett, the director of Latin American Studies at Johns Hopkins School of Advanced International Studies. “But now people are being held accountable. There is a sense that things could actually change.”
 
And unlike a half-century ago, when a military dictatorship overthrew a president whose left-wing programs it didn’t like — and held power for the next 21 years — there is no hint that such a thing could happen today. No matter how the economy goes, Brazilians are going to be able to choose their own leaders, and in so doing chart their own course.
 
“It is the beginning of a new Brazil,” Roett says optimistically. It couldn’t happen to a nicer country.


Weekly Market Update: The Bull Market Is At Its Most Critical Juncture Since It Began


Summary
  • Seasonality is now an issue, as September hasn't been kind to investors over time.
  • The US equity market has disconnected from the US economy, and at the moment is trading with the Chinese economy on sheer emotion.
  • Given the present technical picture, the bulls will need to 'pull a rabbit out of the hat' to avoid more downside pain.
  • In my view, what ails the markets does not appear to be earnings fear driven.    
"I don't want a lot of good investments, I want a few outstanding ones."
Philip A.Fisher

That is a message that many investors may want to pay special attention to now, as I believe this bull market is at a critical juncture with some difficult tests ahead.

We're now more than eight months into the year and people are already starting to talk about how certain investment styles are not working for them anymore. In the financial world, people jump to the conclusion that six or seven months is considered statistically significant because everyone assumes that the short-term trends trump all. I am not as surprised with this mentality, given the recent market action.

The proliferation of a wide variety of ETFs and mutual funds make it easier than ever for investors to allocate to just about any type of strategy or risk factor they choose. One also has to wonder just how much the ETF landscape has skewed some of the data that market analysts and investors track. Not to mention how much their mere existence impacted the 1,000 DJIA point drop on August 24th.

The problem with looking at just the latest performance figures is that there's no context involved. This type of thinking is how investors make mistakes.

Nothing makes sense when you look at just the most recent performance in the stock market or its various components, risk factors or strategies. You always have to keep an eye on what's happened in prior years or longer-term cycles to see how mean reversion and short-term momentum can come into play.

We all can fall into the trap of making quick judgments about the markets based on short-term moves or indicators. That brings "doubts" that creep in when anything we invest in is underperforming or losing money. The conclusion that follows then, is how certain investment styles or strategies, don't work anymore.

Case in point, after being the best-performing sector in 2014, Utilities have underperformed so far this year and dividend strategies have come into question. Markets are pricing in rising rates ahead of the first Fed rate hike, and these sectors have felt some of that adjustment.

Empirical Research reports that since 1952, the Utilities and Healthcare sectors outperformed the market 50% of the time in the first six months after the first rate hike. Consumer Staples and Telecom 55-60% of the time, and Energy 70% of the time. In fact, outside of Technology, the five sectors that had the best track record after initial rate hikes were ones favored by many income strategists. It may be time to give these underperformers a look, especially energy, given those statistics.

Jumping in and out of the different risk factors or a variety of strategies is a difficult game to play. I don't know of anyone who can do it consistently. If you find an asset class or strategy you're comfortable investing in over the long haul, you have to get used to the fact that they're not going to work every single year. The energy sector sure fits that description lately, doesn't it? At the end of the day, it is sometimes better to sit back, observe, and do nothing, rather than chase your tail.

One strategy that I truly believe cannot be ignored or abandoned is Dividend Growth Investing.

In my opinion, it is a must for all investors, no matter age, station in life, etc. Now with a caution flag raised for the entire market, this strategy should be drawing investors' attention.

History reveals that since 1928, the S&P 500 has gained 7.53% a year and has been positive 66% of the time. If you include dividends, the results improve to 11.53% a year and up 72% of the time. That is a serious improvement as it infers that when an investor includes dividends, the annual return increases by 53%.

With the power of compounding interest, the results are striking when you take that extra few percent over a period of time.

A $100 investment in 1990 without including any dividends, grows to $582. When dividends are added and compounded, that $100 grows to $972. That is 67% more for doing nothing, but assembling a portion or all of your portfolio using dividend growth stocks.

(click to enlarge)
Source Professor Damodaran - NYU

Don't lose sight of the fact that if we do in fact see more market weakness amidst a volatile backdrop, the income stream from this strategy will bolster your bottom line.

Unless you are a rabid bear, no one is going to be sorry to see August come to a close. For anyone long equities, it was pretty much the worst and most volatile month you have seen in a long time.

Good riddance to August, welcome to September. So, should we be relieved? That depends.

September has historically been the worst month of the year for the Dow. Over the last ten years, the S&P 500 has actually been up in the month of September seven times. What gives the month a bad reputation, however, is that when the S&P 500 does decline, the losses are steep.

August ended with a loss of over 6% for the month and as we enter September, I was wondering how this month plays out when August finishes poorly. The news for the bulls is not too good, as Septembers following down Augusts have been even worse than the "average" September.

I should note that the "average" September is the only month of the year where the Dow has averaged declines over the last 100, 50 and 20 years.

I can add that investors that want to look past this fact can take solace that the market has tended to bounce back when looking at the final four months of the year, which includes the down Septembers.

More on the ramifications of what this month may bring to the equity market later.

ECONOMY

Ed Yardeni discusses an issue which I have repeatedly stated in my missives. The issue of creating a "headline" to "scare" investors.

The U.S. economic scare of the week is all of the talk about how the recent GDI (Gross Domestic Income) number is not tracking with the recent GDP number that was just revised upward. Thus suggesting that a recession is looming.

(click to enlarge)

As Mr. Yardeni points out, the comparisons need to be investigated before one jumps to a conclusion, and after reading his missive, there is nothing "scary" about the divergence at all.

While all eyes are focused on China, the data here in the U.S. continues to show some positives.

No surprises with the latest Chicago PMI report as it came in as expected. While the Dallas Fed report disappointed, here is a review by the folks from Bespoke Investment Group.

U.S. Auto Sales remain at a strong level, as Fiat Chrysler (NYSE:FCAU), Ford (NYSE:F) and GM (NYSE:GM) post better-than-expected August sales. F should be on your shopping list if you are looking for a stock with a 4.3% yield that is fundamentally sound.
"In the Tuesday release from Ford, the company announced total sales of 71,330 F-series trucks in the month of August. That represents the strongest month of truck sales since 2006."
The August non-manufacturing ISM report came in at 51.1, lower than economist predictions. However it is still showing expansion.
"Economic activity in the manufacturing sector expanded in August for the 32nd consecutive month, and the overall economy grew for the 75th consecutive month, say the nation's supply executives in the latest Manufacturing ISM® Report On Business®."
US Construction Spending Reaches Highest Level in 7 Years
"The Commerce Department said Tuesday that construction spending rose 0.7 percent to a seasonally adjusted annual rate of $1.08 trillion, the highest level since May 2008. The report also revised up the June increase in construction spending to 0.7 percent from 0.1 percent previously."
The Institute of Supply Management's (ISM) non-manufacturing/service sector index for August released this past Thursday showed the activity slightly slowed but continues to hover near decade highs. The index printed at 59.00, bettering the estimate of 58.2, but lower than the previous month's figure of 60.3. The sub indices highlight a slight slowdown in employment, but still promising.

If you need another indicator to restore your confidence in the U.S. economy, take a look at the ATA trucking index. It rebounded smartly during July and is almost back to its record high during January of this year. Intermodal railcar loadings rose to a record high in mid-August.

(click to enlarge)

In my view the August Jobs report continues to show strength in the employment picture. With the prior two months adjusted upward, job growth in the past 3 months has averaged 220,000.

The unemployment rate is now at 5.1%.

Friday's market action suggested that investors are now like "deer in the headlights", as they envision a 0.25% rate increase in September. The negative market reaction to this report can only be described as irrational.

Bottom line, the US economy has plenty of bright spots, and many of the recent reports are not tracking to the recent market action.

GLOBAL ECONOMY

China kept the global markets on edge after they reported their PMI report on Tuesday, with this headline "China Factory Gauge Slips to Three-Year Low in August "
"Chinese manufacturers saw the quickest deterioration in operating conditions for over six years in August, according to latest business survey data. Total new orders and new export business both declined at sharper rates than in July, and contributed to the most marked contraction of output since November 2011."
Of course, no one seemed to read the next sentence, "Weakness could be temporary, but it's clear economic engines not running at full speed."

Neither did they read this headline which came out the same morning

"German manufacturing PMI hits 16-month high."
"Germany Manufacturing Purchasing Managers' Index rose to 53.3 in August from July's 51.8. The actual figure surpassed the estimate of 53.2.
Nobody was impressed with this report either, also released later that day:

"Euro-Area Joblessness Declines to Lowest Level Since Early 2012."
"Unemployment in the euro area unexpectedly declined to its lowest level in more than 3 years, signaling the region's recovery is gaining pace even as dark clouds from China draw on the horizon."
Investors are obsessed with "everything" China.

EARNINGS

Of the 495 companies that have reported earnings to date for Q2 2015,
  • 74% have reported earnings above the mean estimate
  • 51% have reported sales above the mean estimate.
  • The 12-month forward P/E ratio is 15.2. This P/E ratio is based on Friday's closing price (1940.51) and forward 12-month EPS estimate ($127.76).
  • The comps for the Energy sector and the US dollar start to get easier as we move into year-end 2015.
  • Ex-Energy, the blended revenue growth rate for the S&P 500 would jump to 1.5% from -3.4%.
The risk of an earnings recession remains quite low. In my view, what ails the markets does not appear to be "earnings fear" driven.

SENTIMENT

It seems like a broken record, but "bulls" are now at the lowest levels since the March 2009 lows.
AAII sentiment 9-4-15.jpg
Source: Seeitmarket.com- courtesy of Ryan Detrick

The market surely stopped going down in March 2009, might the same logic apply here?

CRUDE OIL

A huge intraday turnaround in WTI during this past Monday capped a three day rally of 25%.

That price action helped solidify my thoughts that what I was witnessing was simply not a throwback rally from the lows of $37 bbl. Apparently the oil market had come to grips that global demand wasn't going to fall off a cliff.

Unfortunately, that scenario seemed to be tossed out of the window. The very next day, the entire global demand picture was reversed as WTI gave back 7% in the single session. However the critical $42-$43 level that I highlighted last week has held.

By one measure, the volatility in crude oil over the last two weeks is at levels that exceed what we saw when prices first crashed late last year and have not been seen since the Financial Crisis.

Here are some thoughts to ponder in order to maintain a rational perspective of the situation.

Everyone knows that WTI is down from the 3 digit highs and that is ALL anyone is talking about. Fact is, crude oil is trading right about where it has traded in the last 100 years.

I can't speak for what others who view the following chart will say, but I am hard pressed to find where global demand is subsiding.

(click to enlarge)

Sooner or later, the supply side of this equation will come in balance as well. So unless you have a very short time frame for your energy positions, those facts need to be given some serious thought.

Investors tend to extrapolate all news and in some cases 'fact' as negative. Especially when they are experiencing losses. Studies have shown that losses are processed in the same part of the brain that responds to mortal danger. If that is true, then market participants have experienced their share of mortal danger with their energy sector positions.

If we stop to take a look, we need to realize that the crude oil market is trading about where it "averages". An investor now has to decide, given their personal risk tolerance, if they feel the tables are now slanted to a positive risk/reward scenario. If one has a time horizon of 18 to 24 months or longer, I believe that it is now slanted to the reward side of the ledger.

That suggests the beaten down names like (NYSE:CVX), (NYSE:OXY), (NYSE:COP), (NYSE:XOM) and the like should work well for long-term oriented investors. The operative words being "long term".

For additional ideas, here is the link to the Energy names I thought would be good candidates for research in July.

THE TECHNICAL PICTURE

One market factor investors must deal with today is the increased influence of algorithmic trading and indexing. As a result, in order for programs to trade the market, these programs must evaluate certain technical market patterns and trading these patterns can be a self-fulfilling prophecy.

No doubt they contributed to some of the wild rides the market has been on recently. The difficulty for fundamental investors is that fundamentally strong companies will not perform, and will be tossed aside in the short run if the "technicals" are not bullish. This is where opportunities are presented.

All eyes were on the "Death Cross" that was recorded on the DJ 30. Many chart watchers believe a death cross, when the 50-day MA crosses below the 200-day MA, indicates that a shorter-term decline has developed into a longer-term downtrend. Now it is time for everyone to focus on the same situation that has taken place with the S&P 500 and the Russell 2000.

So what are the implications for the S&P 500 going forward? This event has only happened 10 times in the index's history.

History reveals that while performance over the next week has been positive more than it has been negative, the S&P has run into trouble in the month following the Death Cross. The index's average one-month return has been a negative 1.38% with positive returns just 20% of the time.

That's extremely negative, and it suggests that investors should be prepared for more volatility in the near term. Over the next three and six months, however, the index has been up significantly, and much more than the average return for all three and six-month periods throughout history. Over the next six months following these crosses, the S&P has been up nine of ten times for an average change of +8.23%

Declines are certainly not without precedent, but 90% of the time the market has managed to shake it off and bounce back nicely. There are likely to be more sharp moves lower in the near term, so be prepared for them.

S&P 9-4-15.png

Moving averages are lagging indicators by the nature of their construction. In other words, the patterns traced out in the moving averages follow the price of an index or stock. When the death cross is triggered then, it is likely most of the price decline in the index or stock has already occurred.

Again, the exception is around recessionary economic periods. In my view, the US economy continues its slow growth pace and does not dip into recession.

This week's choppy action confirmed the entire rally from last week's S&P 1867 low was "corrective", as was the rally from Tuesday's 1903 low. Being classified as "corrective" rallies implies that the downtrend is still underway.

If I had to take a stab at support for this downtrend, it appears to be in the low to mid 1800's on the S&P. Before then, 1901 and 1867 can come into the picture.

SHORT-TERM OUTLOOK

There is one thing and one thing only that should be paramount on investors' minds as the market enters a very weak seasonal period. Will the August lows that were just posted hold?

In an attempt to remain objective, I presented my findings last week on two key technical issues that, in my view, cannot be ignored. Very simply, a significant breach of these lows will make it difficult if not impossible for the market to reverse the "caution" flags I outlined last week. The Dow Theory Sell signal, and the warning flash on the 20 Month MA for the S&P.

The worst scenario for the bulls is that a retest brings about new significant lows below 1867.

That would force the issue and I will begin to acknowledge the Dow Theory "sell signal" of August 24, 2015. For the moment I am setting that sell signal aside, just as I did when the May 2010 "Flash Crash" Dow Theory sell signal (the last time the Dow fell 1000 points intraday), was flashed.

Moreover, market participants should be aware that retests usually come close to, or actually make a marginally lower low, than the capitulation low.

For the record, the lows that are on my radar are S&P 1867, Dow 30 15871 and the Dow Transports, 7466.

Along with the Dow sell signal, another technical indicator flashed red when the S&P fell below the 20 Month MA. That data point was detailed in last week's update.

Both of the signals I mention "can" be reversed. At the time of this writing, the S&P can reverse the 20 month MA violation by retaking the average which now sits at 1998. In addition, that MA is still in an uptrend and that is a positive.

Here is the strategy I have employed recently. Use the advice contained in Mr. Fischer's quote.

Look to concentrate positions staying with the "Outstanding Ones". Serial underperformers, if not already sold, should be eliminated. But as I have mentioned many times, it's always best to have a plan that tends to save you from yourself in volatile markets.

This next stage will likely be difficult to navigate. On a short time frame, with an elevated VIX regularly, trends broken, and manic intraday volatility, there's no reason to pile in at these levels, except on high-conviction, long-term holdings.

I don't diminish the headlines and MORE IMPORTANTLY the market reactions to those headlines. However, the head scratcher to all of this is that the economic data here in the US does not indicate a bear market coming and other data points seem to confirm that.

"The US equity market has disconnected from the US economy and at the moment is trading with the Chinese economy, on sheer emotion." - From Bespoke Investment Group.

Here is evidence as to what I am referring to.
"The refusal of stocks to rally on excellent data that was recently reported, is striking. Despite the huge auto sales figure reported, Ford (F, -1.08%), GM (-2.72%), Fiat-Chrysler (ADR FCAU, -3.40%), Toyota (TM, -3.41%), AutoZone (AZO, -0.23%), etc. all got hit despite their direct exposure to the market. If this isn't good evidence that the current slide in U.S. stocks has a life of its own completely divorced from the US consumer economy, I don't know what is."

INDIVIDUAL STOCKS

The only stocks that I have on my radar screen are what I would call my long term "High Conviction" list:

AAPL, GILD, CELG, DIS, OXY

SUMMARY AND CONCLUSION

While worries that a slowing China may pull down the rest of the world is on the minds of investors, the key variable going forward will be the US economy's ability to support global growth and earnings. In that vein, it's difficult to see how a slowdown in Chinese growth would have any significant impact on the ongoing US expansion given that exports to China make up less than 1% of US GDP.

We have entered a new phase of the current economic expansion and bull market. After three years of explosive asset price gains, with a very real pause in 2011, stocks are breaking trend lines for the first time in years. You can assign whatever narrative you want to it. China, cross-asset stress brought about by oil, concern over global growth or the Fed. There are pieces of truth in all of those, but the reality is "fear" and "irrationality" are in focus as investors are now shunning equities.

Focusing on one data point, one headline, is a great way to allow yourself to get wrapped up into accumulating a junk heap of unwarranted conclusions.

The newly formed "Death Cross", combined with weak seasonal backdrop, suggests that September could be very interesting. These issues, added to an already weak technical picture, add more fuel to the bearish fire that has started. The bulls will need to pull a rabbit out the hat to avoid the negatives that seemed to have stacked up against them.

If the equity market can muddle through September without more technical damage there may be a silver lining waiting for market participants as "history" then dictates that the October through December time frame may in fact be very positive. Therein lies the "best case" scenario for the bulls.

Of course, if the market's internal strength deteriorates further on the second wave down, it could be indicative of something more serious. But right now, I haven't seen any sign of that, so panic would be premature.

US bear markets have been caused by sharp contractions in liquidity that sparked a severe economic slowdown or recession and by technical factors such as too much optimism in two instances, 1962 and 1987.

Neither of these bear-market preconditions is present now. US economic data is improving and the individual retail investor was pulling money out of the market before the recent market turmoil. Since 1987, there has never been a bear market without a recession.

Yet the technical picture being presented may be forecasting just that. A real conundrum for investors to ponder. Anyone not remaining vigilant now may be asking for trouble.