Dominos Beginning to Fall

I wrote two series of cautionary articles, one in the past few days, and the other in September 2015. Several of the earlier articles referenced China, which is again in focus due to the 7% plunge on Monday. China's manipulated market appeared to stabilize for a brief period after almost-continuous Government intervention, but their problems never went away. Here is the latest update.

China

Chao Deng reports on the latest market developments on Monday:

"Analysts cited a number of reasons for the selling, including China’s disappointing manufacturing data, reported earlier Monday, and the coming removal of a ban on major shareholders from selling stakes, put in place during the summer stock crash.

The Shanghai Composite Index SHCOMP, -6.86%  fell 6.9%, its biggest decline on record for the first trading day of the year, before trading was halted. The smaller Shenzhen Composite 399106, -8.22%  fell 8.2%."

Mark Magnier provided additional detail on the troubles of China's manufacturing sector, the pillars of its economy:

"A private measure of China's manufacturing sector slipped in December as factories continue to battle overcapacity and weak demand.

Caixin Media Co. said Monday its China manufacturing purchasing managers' was at 48.2 last month, down from 48.6 in November. This is the 10th straight month of a below-50 reading for the index. A reading below 50 indicates a contraction in manufacturing activity."

Bear Market Signal

Turning to the U.S. market, Victor ReKlaitis reports that the median stock in the Russell 3000 index is now in a bear market. This is another example of the weakness in market breadth that is well-hidden by the cap-weighted, broad market equity indices.

"The new year brings a “possibility that the ‘stealth bear market’ we have been in for 6-9 months is revealed as a true bear market,” says Jonathan Krinsky at MKM Partners in a note.

MKM’s chief market technician warns the median stock in the Russell 3000 RUA, -1.89%  , which represents 98% of the U.S. stock market, is “now down over 20% from its 52-week high.” So his shop’s “base case for 2016 is that the weakness seen at the stock level finally makes its way to the cap-weighted index level,” meaning main benchmarks like the S&P 500 SPX, -2.24%  and Nasdaq COMP, -2.76%."

Conclusion

There are many warning signs in the global economy and the global equity markets. China's problems have not gone away; they were only temporarily hidden from view. China's manufacturing sector has now shrunk for the 10th consecutive month, which is consistent with a recession, not an economy that is growing at the latest fantasy figure of almost 7%.

The latest Trader Edge recession model analysis is not currently forecasting a U.S. recession, but the risk has increased. Given that the U.S. equity market remains significantly overvalued and year-over-year earnings are declining, a recession is not a prerequisite for a market correction.

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Brian Johnson

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About Brian Johnson

I have been an investment professional for over 30 years. I worked as a fixed income portfolio manager, personally managing over $13 billion in assets for institutional clients. I was also the President of a financial consulting and software development firm, developing artificial intelligence based forecasting and risk management systems for institutional investment managers. I am now a full-time proprietary trader in options, futures, stocks, and ETFs using both algorithmic and discretionary trading strategies. In addition to my professional investment experience, I designed and taught courses in financial derivatives for both MBA and undergraduate business programs on a part-time basis for a number of years.
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