The Ominous Rollercoaster

After just a brutal last week and a follow through massive sell-off Monday, everyone and their mother’s expected a respectable dead-cat bounce today. I personally expected to regain about half of Monday’s losses (still a bearish price movement). And the day began almost precisely as most expected, the Dow shot up 500 points and the market roared out of the gate. It petered out from there but still was solidly up the entire day. 

The final 30 minutes of trading was catastrophic and wild, breathtaking in the rapidity and persistence of the selling pressure. 

The Dow finished down more than 200 points. The previous 3 days of sharp declines haven’t been this steep since 2008. And today’s wild ride was also the largest reversal since the infamous days of utter panic during the peak of the global Financial Crisis in October 2008.

Today’s action was very ominous. You should be very, very careful. It’s too early to step in and buy this correction. 

I’m going to try to explain why I think he market behaved the way it did today, before all the pundits start with their silly ideas.

Overnight China crashed again over 7%. But following this continuous bleeding, the government lowered interest rates to stimulate the economy modestly. 

Markets initially reacted very positively as is usually the case. But the effect throughout the day, as I was watching the currency markets, I noticed the Chinese Yuan weaken considerably (nearly 1.5% which is a lot for China), an expected response to lower interest rates, especially in the context of recent Chinese government action to intentionally weaken the yuan. 

As the Dow and S&P failed to hold important technical levels, the sellers gained more confidence throughout the day, emboldened by the further weakening of Chinese currency. 

The weakening Chinese currency is at the heart of this selloff that started in earnest last week after the PBoC announcement. Further weakening is bad. It wjll continue to weaken over the coming months, likely going down about 10% vs the dollar. 

This, again, is very bad for markets and the global economy. This reflects the real weakness in the Chinese economy and the contagion effects I wrote about in my earlier blog today. All emerging market economy currencies will also weaken. This adds tremendous global risk as I’ve written about.

The stronger yuan also will slow western imports, especially technology companies. 

The markets are going to correct far below 10%, probably close to 20% before this is over in the near term. China will continue to sell off. Emerging markets will get crushed and are in serious trouble (large parts of Asia, South America, Europe and Africa).

This will only turn into a full on financial crisis if there is an unexpected major default(s) and markets begin to worry about a trend and the derivative exposures of fiancial companies. This is possible but I think too early; it’s more likely to take more time to develop into next year. 

But most people don’t seem to understand that a fundamental change has occurred in our economic world in the past month; they shouldn’t expect the bull market to just eventually return to previous levels – even months later. Forget about today’s or yesterday’s solid economic numbers; they are meaningless for markets. Focus on how this new paradigm effects the world and specific companies. Because it surely will. Markets look ahead, not at today or backwards. You should too if you want to be a successful investor.

As I’ve said, the bull market is dead. It died in early August (per my earlier blog). And for the record, I’m the only person that specifically called the day (ok week). It’s the first time I’ve emphatically and specifically stated the bull market died since the 2009 crisis days. It wasn’t some non-specific warning as I’ve given before.