Will U.S. Stocks Continue to Benefit From the Expanding Euro Crisis?

The euro has fallen to levels last seen in May 2009, trading as low as 133.01. A downgrade of Portugal's sovereign debt from AA to AA- by rating agency Fitch has created new weakness for the eurozone currency, as a solution to the Greek crisis still remains elusive.

The British pound, the Swiss Franc and Swedish Krona all traded down more than a percent at one point on the news. Money continues to flow out of Europe in general, not just the eurozone. This has been going on since early December. The U.S. dollar has been the beneficiary, as have U.S. stocks.

The stock rally since last March has actually had two distinct phases, although this may not be immediately obvious by looking at the charts. Both phases are connected to actions in currencies. The U.S. trade-weighted dollar sold off between March and December 2009 and U.S. stocks rallied strongly during this period.

This pattern has actually been common since the early 2000s. It makes sense because when a currency devalues, stock market caps in that currency need to rise assuming the real value of a company's assets remain unchanged. This drove the first phase of the rally. The driving force then shifted gears in December with capital fleeing Europe and looking for a home elsewhere. A lot of it wound up in dollar-based assets.

The U.S. stock market rally is not healthy, however. The recent rally has been on low volume. Trading volume in the Dow Jones actually peaked last March during the market low and has generally declined since then throughout the entire rally. It's gotten even worse lately.

Declining volume in a trend is a strong technical negative. The VIX, the volatility index for the S&P 500, has gotten as low as 16.17 - and this is very low (it reached the 90 level during the market sell off in 2008). It can go lower though and traded around 10 during the placid days of 2005 and 2006.

The current investment environment is not exactly placid however. The VIX is a contrary indicator and low values are a negative for future stock prices, although it can bottom months before the market falls apart. Moreover, it is not even clear that the VIX has hit bottom.

Precious metal investors should keep in mind that the price of gold and the euro tend to move together. This is also true of oil, but to a lesser extent. The euro has strong chart support in the 1.30 area and very strong support around 1.25, the low during the Credit Crisis.

The trend indicators on the daily chart indicate a new sell off has begun, so a fall to 1.30 is very likely. If that doesn't hold, a test of 1.25 will take place. If the 1.25 level breaks, investors should assume that another major crisis is unfolding in the global financial system and that it could be as bad as the one that occurred in the fall of 2008.

Is Shanghai Property The Next Dubai ?

Stories of rapidly inflating property prices, loose credit and off-plan speculation sound only too familiar to veterans of the Dubai real estate crash, and yet this is what we hear from Shanghai these days. How long before the Chinese property bubble bursts?

Of course, it is wrong to compare a wealthy, advanced economy like Dubai with an emerging market economy like China with very low salary levels. And yet this also highlights the severity of the problem in Chinese real estate right now.

Shanghai prices.

Shanghai property is presently 50 percent more expensive than in Dubai, and yet per capita income in Dubai is up alongside American levels, and higher for most property buyers who still mainly pay in cash and not debt.

Last year real estate investment in China more than doubled to $156 billion, and residential property prices shot up 68 per cent to $450 per square foot in Shanghai. Sounds very much like Dubai in 2008, before the crash in October of that year.

The Chinese authorities have responded belatedly with restrictions on new lending to property developers and buyers. Yet the risk of withdrawing liquidity from an investment bubble is only too clear. Bubbles burst when liquidity is withdrawn.

As in Dubai, China's real estate and construction sector has become an important motor of domestic economic growth, particularly after the 16 per cent slump in exports last year which comprises around two-fifths of GDP.

It has been driving purchases of everything from cars to home furnishings and building materials. Pull out the real estate boom and Chinese economic growth is going to undergo a huge correction.

Not different this time!

They said it could not happen in Dubai but it did. Is China really going to be any different? Is this not the business cycle at work and human folly magnified by official hubris?

All emerging markets are prone to especially dramatic business cycles. It is partly due to a lack of diversification. It is partly due to a lack of past experience to temper expansion plans. It is also due to corporate and government structures that allow uncontrolled expansion until it is too late.

Is the Shanghai property boom going to end like Dubai? Sure it is. Shanghai has had several violent real estate corrections in the past decade. They all bounced back but this time could be different as the Chinese export machine is severely compromised by a weak global economy.

Source : http://www.seekingalpha.com/