Wednesday, January 20, 2010

Lessons From the Market Magician

The market is a magician: It calls attention to the right hand, while performing the tricks with the left. A big part of becoming a good trader and investor is learning to look for the left hand when the right one starts waving about.

The Massachusetts election was the right hand. Was it important politically? No doubt. Was it a game changer for markets? No way. We were in a multi-day trading range before the election and we're in that range after.

But the left hand may just have a trick up its sleeve.

Above we see the chart of a lagging stock index. As the S&P 500 Index has moved steadily to bull market highs in 2010, this index has failed to make new highs. Indeed, this index remains below its summer levels.

What's the index? It's the CSI 300 Index, a large-cap index of the shares most representative of the Shanghai and Shenzhen stock exchanges in China.

That index closed down over 3% today amidst continuing indications that China is tightening monetary policy and limiting bank lending. That has led to a flight into the yen and U.S. dollar, selling of commodities, and a drop in U.S. shares overnight despite the U.S. election results.

What the chart above is telling us is that the market is pricing in lower growth expectations for China, as central bank policy there is fighting inflation and the possible creation of asset bubbles. This shift means that a major driver of 2009 stock and commodity strength has not materialized thus far in 2010.

And it's a neat trick for those expecting a stock market rally on the election news. The reality of the Massachusetts election is that it is a vote against Big Spending. It's not just health care reform that is jeopardized; it's any big spending stimulus/bailout/social engineering effort.

And that, too, removes a prop for the bull market.