“God help us if earnings [in the U.S.] are anything short of fantastic.”
-Keith McCullough, June 17, 2010
Conclusion: Despite the remaining bullish sentiment, China still matters to the U.S. growth story. Moreover, signals from China and Dr. Copper are telling us that U.S. 2H10 growth will more than likely surprise bulls to the downside.
With the Shanghai Composite down 22% YTD, Chinese loan demand and loan growth slowing sequentially in 1H10, and Chinese property prices starting to show signs of deflating, it’s been clear for quite some time that the Chinese Ox is still boxed in. Furthermore, Dr. Copper – a leading indicator for global growth – is in a bearish formation and continues to break down quantitatively.
What does this all suggest? Simply put, growth internationally is setting up to slow and the most leading of all indicators (marked-to-market prices) are telling us just that. U.S. bond yields have been creeping down, which has historically been a leading indicator for slowing growth. The yield on the 10Y Treasury is now at 3.22% - down 79bps from the YTD high on April 5. Factor in a slowdown from the European demand side of the equation as a result of austerity measures and rising illiquidity, and it’s not hard to see why we think growth will slow both globally and domestically in 2H10.
Bullish sentiment in the U.S. has hinged largely on a hopeful domestic growth outlook in 2H10, which is a large divergence from the Chinese growth story that pulled up equity markets globally since the March 2009 bottom in the S&P 500. Again, using market prices a leading indicator for growth, the S&P sectors most levered to the U.S. growth story (Industrials - XLI, Energy - XLE, and Basic Materials – XLB; each broken from an intermediate-term TREND perspective) are telling us that the U.S. is not yet ready to take off the training wheels. In fact, a very high positive correlation still exists between each of those sectors and Chinese equities and copper (see charts below). As noted before, both China and Dr. Copper are still in very bearish setups from a quantitative perspective and weakening international and Chinese fundamentals strongly support that. Despite that, a divergence has emerged between bullish domestic sentiment and marked-to-market leading indicators globally.
When it’s all said and done, we expect this bifurcation to create more downside risk in the U.S. equity market. As Shakespeare once penned, all crashes occur against expectations; and expectations domestically are still far too high in our option. Bulls are too bullish. Bears aren’t bearish enough. With U.S. sovereign debt and deficit issues approaching the limelight, a disastrous setup for housing domestically, and rising joblessness each not fully on everyone’s radar, U.S. growth is likely to crash against current expectations.