Tail Wagging the Dog

By Jani Ziedins | End of Day Analysis

Sep 30
S&P500 daily

S&P500 daily

End of Day Update:

The S&P500 rebounded sharply, rocketing past 1,900 on the last day of the third quarter. Volume was above average, but suspiciously light given the size of today’s move and the traditional end of quarter repositioning.

It would be great if there was a solid reason behind these gains that we could build a sustainable rally on. Unfortunately this was another example of the U.S. markets taking their cues from overseas traders. Strong gains in Asia and Europe early Wednesday morning lead to our gap higher at the open. While there are plenty of reasons to believe in the U.S. economy, linking our stocks to overseas economies is not healthy. Few believe China and Germany are done falling into their respective holes and if we continue pricing US equities based on how foreign markets trade, today’s rebound will be undone in a matter of days.

The most important thing we need to see is our markets decouple from the rest of the world. Normalcy will return when we start trading on traditional metrics like earnings, revenues, employment, and GDP. There is a good chance this will happen over coming weeks as US employment and third quarter earnings season diverts our attention from how the DAX or Shanghai traded overnight. The first sign the correlation is breaking down will be the end of these wild one and two percent gap openings. Next will be more days where our trade bears little resemblance to the moves in Asia and Europe. No one payed much attention to foreign markets a couple of months ago and it is only time before traders stop looking at their terminals in the middle of the night before deciding to buy or sell US equities.

Without a doubt overseas weakness is a headwind, but a 10%+ correction has done a good job pricing it in. Europe and Asia have been slowing for a while and if they posed a serous threat to our economy, it would have shown up in our numbers already. Resilient third quarter earnings will prove that fears of overseas economies dragging us down are unfounded. When that happens, it will kick off our year-end rally as international traders move their money to the most attractive economy on an ugly block. In the meantime, expect elevated volatility as long as our markets remain linked to overseas trade.

Jani

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About the Author

Jani Ziedins (pronounced Ya-nee) is a full-time investor and writer who has successfully traded stocks and options for more than a decade. He earned a B.S. in Mechanical Engineering from the Colorado School of Mines and an MBA and M.S. Marketing from the University of Colorado Denver. His prior professional experience includes manufacturing engineering at Fortune 500 companies, structural engineering, small business consultant, collegiate instructor, and managing investment real estate. He is now fortunate enough to trade full-time from home, affording him the luxury of spending extra time with his wife and two young children.

Jim Pinkerton October 1, 2015

You fail to recognize that there is a positive correlation between our markets and the DAX that has existed for years. You’re right about the Chinese market-there is no correlation with our markets.

    Jani Ziedins October 1, 2015

    Thanks for the comment.

    Correlation vs causation, ie who wags who? The U.S. consumes a huge percentage of German output. On the other hand, Germany consumes a small fraction of U.S. output. Without a doubt Germany suffers through a U.S. recession because of how much they depend on us. But the opposite is not true. A German recession is largely a non-issue for the U.S. economy. This one direction linkage means German markets often follow ours, but right now we are following theirs. This doesn’t make sense and won’t continue for much longer.

      Jim Pinkerton October 1, 2015

      This looks like an awful lot of correlation to me-causation isn’t a factor.
      http://stockcharts.com/h-perf/ui

        Jani Ziedins October 1, 2015

        Not to get too nerdy here, but when things act in a similar way, it is due to one of three reasons; coincidence, correlation, or causation.

        No doubt the relationship between U.S. and German markets is more than a coincidence, making it a valid correlation. The question then becomes what causes both to act similarly? Is one driven by the other? Or are they both being moved by a third, unnamed force? I propose U.S. consumption is a significant driver of the German economy. But you appear to be claiming that the U.S. and German economies move in tandem because of a greater third force. It won’t be long before we know the answer to this when the U.S. markets recover while Germany stays weak, or if both continue to stumble due to German economic weakness.

Jim Pinkerton October 1, 2015

http://stockcharts.com/h-perf/ui

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