Roubini Says U.S. Economy on Verge of Another Recession

Aug. 31 (Bloomberg) — Nouriel Roubini, a professor at New York University’s Stern School of Business and co-founder of Roubini Global Economics LLC, talks about his latest forecast for the U.S. economy. Roubini, speaking on Bloomberg Television’s “InBusiness With Margaret Brennan,” also discusses the European debt crisis and economic challenges in China. (Source: Bloomberg)

Negative 2nd Quarter Triggers Recession Fears for Canada

Wednesday’s release by Statistics Canada revealed that for the three months ending in June, the Canadian economy contracted by 0.1 percent. With a recession typically defined as two or more consecutive quarter of negative growth, Canada is already half way back to a recession.

Like most of the industrialized world, Canada suffered through a recession triggered by economic events in late 2007 and 2008. For Canadians, the recession lasted from the final quarter of 2008 to the end of the second quarter of 2009. While growth as measured by Gross Domestic Product (GDP) during the recession declined by more than 3 percent, this was still better then most other G7 countries where losses were much more pronounced. Canada also was one of the first to emerge from recession returning to positive growth by the third quarter of 2009.

These realities helped the country garner a reputation as somewhat of a fiscal prodigy. Hoping to continue to build on this legacy, Finance Minister Jim Flaherty downplayed the GDP result noting that Canada’s economic and fiscal fundamentals remain “sound and sustainable”.

“The weakness in Q2 was largely due to external factors — the tsunami and earthquakes in Japan in the second quarter had a very strong effect on the auto sector, particularly auto imports,” he said. “And of course there was some slowness in U.S. growth, so that affected our exports. The domestic situation is much stronger.”

As much as Canadians may wish to believe it, the ability of Canadian monetary policy to manage the economy is often overpowered by a much stronger force – the huge market lurking below the 49th parallel. For most of its existence, Canada has been an exporting nation and remains so to this day. An abundance of resources combined with an educated and skilled workforce situated within sight of the world’s largest consumer market has served Canadians positively for well over a century.

However, there is a downside to this arrangement; today, about 75 percent of Canada’s exports find their way to the American market. When times are good and American consumers feel confident regarding their economic future, Canada enjoys a trade surplus that prior to the last recession, averaged more than $70 billion a year. In 2009 and 2010 the surplus declined sharply to $20 billion a year.

Should the U.S. economy tip back into recession and force consumers to cut back even further on their spending, this will certainly impact Canadian export sales. It may even push Canada’s economy to recession. Already the Bank of Canada has noted that Canadian growth is likely to ease in the final two quarters of the year and all talk of an interest rate hike appears to now be a thing of the past.

Scott Boyd,

Is Gold the New VIX?

By Jared Levy, Editor, Option Strategies Weekly,

Those of you who know me know that I love statistics and that I’m always looking for ANYTHING that gives me an “edge” or “early warning signal.”

I use statistics to predicted major movements in the market. Some signals are bullish, like this one I wrote about in Smart Investing Daily on June 7th.

Just recently I found an abnormality in the way that options were being priced and traded. Back on July 22nd, the signals I saw were pointing to move sharply lower in the Nasdaq and S&P 500. Sure enough, these indexes dropped 18% almost immediately.

I find these early warning signals in charts, trade volume, options, news stories, and in abnormal trading activity. I also find signals in correlations between securities. (This is one of my favorite signals.) But correlations can hard to spot.

Correlations in the Market

Believe it or not, just about every investor has come across a correlation in their analysis. For example, many investors look at something called beta. A stock’s beta tells us how volatile it is compared to the market. If a stock has a beta of 1 it should be moving at about the same rate as the index it belongs to.

For example, Google (GOOG:NASDAQ) has a beta of 1.13, which means that if the market is up 1%, Google is going to be up about 1.13% on average.

Stocks can have negative betas as well. The company China Green Agriculture Inc. (CGA:NYSE) has a beta of -5.52, which means if the market is up 1%, chances are this stock is going to be DOWN 5.52% on average.

Most stocks, commodities and metals have natural relationships with one another. When these correlations become “disconnected,” it can be a sign that something is wrong.

Major disconnections can be a warning to investors… and an opportunity if you know what to look for.

VIX is the Ultimate Negative Correlation

The pros know that the VIX, which measures option prices in the S&P 500, is about as opposite to the overall market as one can get when it comes to correlations.

In fact, if you look at the graph below, you can see that the 60-day correlation is -0.882. This means that when the market is up 1%, the VIX has been down an average of 0.882% over the past 60 days.

Courtesy of AI Stock Charts

Courtesy of AI Stock Charts
View larger chart

It is “normal” and widely accepted that the VIX moves negative to the markets. It has been that way since the VIX was created.

So if the market was rising and the VIX was rising along with it, we would have a bunch of Wall Street pros scratching their heads. More accurately, they would probably be selling their stock positions. That’s because if stocks are rising and option values are rising along with it, it means one of two things:

a. Investors are buying massive amounts of option “insurance” because they don’t believe in the rally (in other words, buying put options).

b. The smart-money investors see big volatility to come, so they are buying calls and puts because they are unsure about direction.

Either way, it’s not a good time to be long stocks.

Funny Things are Happening in Gold

Just like the VIX, gold has a long-lasting relationship with the stock market. When the market is rising, gold is usually dropping, and vice-versa.

You see, gold is a safe haven. Every analyst I work with has written about it and knows the story. We have also been telling you to buy gold since early last year.

When investors are all warm and fuzzy inside, they sell gold and buy stocks. The historical correlation between the SPDR Gold Trust ETF (GLD:NYSE) and the SPDR S&P 500 ETF (SPY:NYSE) shows that they have a low to negative correlation of about -0.10 to -0.50. So if the market is falling, there is a good chance gold is on the way up.

But what if things start changing? What if the gold correlation breaks down?

For the six months leading up to the crash in October 2007, gold started moving almost in lockstep with the market. It jumped in correlation to 0.40, meaning that when markets climbed 1%, gold climbed 0.40%.

This was very unusual for gold… It’s like gold knew abut the crash before it happened!

6-month Gold Correlation
6-month Gold Correlation Until Oct 31, 2007

Another way to explain this correlation would be to compare it to the normal reaction people have to a burning building. Normally people will run as fast as they can AWAY from a burning building. This can be thought of as a “normal negative correlation.” If you were to notice people running into a burning building, wouldn’t you be puzzled?

In the stock market, noticing these disconnected correlations is not usually that easy.

Well, let’s take that a step further. Spotting the effect might be easy, but finding the cause takes skill.

Sometimes it takes complex mathematical calculations. But you can do a simple test yourself. Just look at a daily chart of the SPY compared to GLD and see if they are moving together or apart. If they start to move together, you need to be cautious in the short term.

If you’re loving this article, sign up for Smart Investing Daily to receive all of Jared Levy and Sara Nunnally’s investment commentary.

The Recent Downturn

I was running some tests, and sure enough, on June 24th — right before the first correction in the stock market — the GLD to SPY correlation shot back up to 0.36, which is historically high and close to where it was back in October of 2007. Remember, I am looking at how gold investors act when the market is moving higher.

If the two start to become highly correlated, it is a warning signal. Fear is brewing and it may be time to sell your long postions, at least partially.

This is the canary in the coal mine.

In Option Strategies Weekly, I use this along with other indicators to help me predict market direction.

45-day Gold Correlation Until June 24th
45-day Gold Correlation Until June 24th

The Future

For the past 30 days, investors have been getting pummeled in stocks and buying gold like there is no tomorrow. This means that the relationship has swung into deep negative-correlation territory (-0.57).

Your parents probably taught you that most things are okay in moderation. The markets think the same way. Right now the pendulum is swinging toward major fear, which means that gold and volaltility will remain high and market gains will be suppressed.

With the big runup in gold, expect it to be EXTRA senstive and remain negatively correlated to the markets.

If the market begins to climb again, be sure that gold is not climbing with it. That said, I would be a very cautious buyer of the market up until 1,260, but NOT if gold continues to rise with it!

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Technical Analysts, Prepare to be Offended

By Derek Simon, Guest Editor,

My closest friends — the e-mailers who address me as “kind sir” and beg me to help them transfer the estates of their late uncles into my checking account — understand that, in addition to Internet scams, I love numbers.

Big numbers, small numbers — it doesn’t matter. I like them in the rain, I like them on a train; I like them in a box, I like them… well, I think one gets the picture.

Thus, it should come as no surprise that technical analysis intrigues me almost as much as the notion that eating green eggs and ham would not, could not lead to a severe intestinal disorder.

Yet I often wonder if some technical analysts truly understand the purpose of the tools they use, or if, like Dr. Seuss, they simply dazzle us with made-up words and pictures.

Take, for instance, the Fibonacci sequence.

Fibonacci Sequence

Leonardo 'Fibonacci' Pisano

Named after the Italian mathematician (Leonardo Pisano, nicknamed “Fibonacci”) reputed to have discovered it, the Fibonacci sequence is a series of numbers, beginning with 0 and 1, in which each successive number is equal to the sum of the previous two.

Hence, the sequence is 0, 1, 1 (0+1), 2 (1+1), 3 (1+2) and so on, and so on.

Now, the real power of Pisano’s discovery, Fibonacci followers say, is not the sequence itself, but rather the quotient of the adjacent terms it contains. This quotient has been called PHI, the golden ratio, the golden mean and the divine proportion, among other names, and is roughly equivalent to 0.618 (or its inverse 1.618) as the sequence approaches infinity.

According to Fibonacci fanatics, this amazing ratio expresses perfection — the subconscious embodiment of beauty and contentment — and can be seen throughout the natural world.

For example, the family tree of a honeybee drone (a bee hatched from an unfertilized egg) closely correlates with Fibonacci’s magical sequence; each spiral of seeds on a sunflower has a diameter approximately 1.618 times greater than the one before it… and the list goes on.

So what does all this have to do with the stock market? Well, supposedly, these same key numerical relationships observed in nature can also be witnessed on Wall Street.

Some technical analysts even use multiples of the golden ratio to express levels of support and resistance (arcs, fans and retracements) and also periods in which major price moves are likely to occur (time zones).

Which brings us back to the writings of Dr. Seuss: Frankly, I think the Fibonacci sequence — at least as it applies to investing — is largely “gluppity glup” and “shloppity shlop.”

Despite what some believe or have read in a Dan Brown novel, there is no mysticism in numbers — they don’t explain anything, they only describe what is or what is not. As Albert Einstein once said, “Mathematics are well and good, but nature keeps dragging us around by the nose.”

In other words, fitting data to a theory, rather than the other way around, is like trying to summarize a book by reading the last page — there is no context, no understanding, no progression of ideas.

I learned this lesson the hard way.

If you’re loving this article, sign up for Smart Investing Daily to receive all of the regular editors, Jared Levy and Sara Nunnally’s, investment commentary.

Avoid Using Methods

Many moons ago, during the running of the dot-coms, I made my first major stock purchase on a technology issue that my research convinced me looked promising.

Trying to be the wise and prudent investor that I wasn’t at the time, however, I decided to limit my potential losses by putting a stop order on the stock, which I set at 10% below my purchase price (based on the teachings of a well-known financial author).

Of course, readers who remember those turbulent days know that the market was volatile and that technology issues, in particular, recorded more highs and lows than a barbershop quartet… bungee jumping… from a roller coaster.

Not surprisingly (in retrospect), the stop was triggered and I watched from the sidelines as my former holdings promptly doubled in value in a matter of months.

Following another, similar debacle a few weeks later, I made a vow to never again take a cookie-cutter approach to investing, which is precisely what I think certain technical “tools” like the Fibonacci sequence encourage.

These days, I try to let each stock tell me when to buy, when to sell and where to place my price targets and stop orders. Because, let’s face it, no investment is exactly alike, and one’s analysis should reflect that. Even within the same industry, there can be vast differences in a stock’s volatility and overall trading patterns.

Even when the stocks are very similar, there are variances that can make or break an investment. As an example, let’s take a peek at Apple (AAPL:NASDAQ) and Microsoft (MSFT:NASDAQ).

Apple Chart
View larger chart

Microsoft Chart
View larger chart

Notice that their 30-day charts look almost identical. Yet, based on my analytical techniques, I see slightly more upside in Apple (price target of $403, stop at $375) than I do in Microsoft (price target of $27, stop at $24) over the next month, although I wouldn’t invest in either at the current prices.

The point is, there are no shortcuts to making money on Wall Street — no cute formulas, no mystical number sequences, no set rules (though history can provide some pretty decent guidelines).

In the words of Peter Lynch, investing “is not like pure science where you go, ‘Aha’ and you’ve got the answer. By the time you’ve got ‘Aha,’ Chrysler’s already quadrupled or Boeing’s quadrupled. You have to take a little bit of risk.”

This means avoiding miracle market methods… especially those not thoroughly proven to bolster one’s bottom line.

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Russian Economy Ministry Downsizes Growth Forecast


The Russian Economy Ministry recently announced that it has decided to decrease its growth outlook for the Russian domestic economy. Citing diminishing oil prices, weakened exports, and a global economic slowdown, Deputy Minister of Economic Development Andre Klepach now says that GDP growth is expected to come in near 4.1%, down from the 4.2% expected earlier this year.

Economists also view the value of the Russian ruble (RUS) to be in decline, with some estimates predicting a 25% loss of value against the US dollar (USD) over the next three years. The Economy Ministry highlighted that its growth forecast for the RUS was also cut, expecting it to reach roughly 28.6 against the greenback as opposed to the 28.4 previously anticipated. A deficit in Russia’s current account is also expected to arise in 2013, standing contrary to the surplus of 2011 and predicted surplus of 2012.

Klepach did offer some conciliatory tones in stating that his ministry does not believe a double-dip global recession is impending, or even likely. But the general slow-down in growth among emerging economies like China and India, as well as those of Eastern Europe, does gouge many previous forecasts. Making Russia’s economic outlook reflect this reality was only logical and should not alter investor portfolios in any major way.

Read more forex trading news on our forex blog.

US Employment Data Spurs Risk Aversion


News out of Automatic Data Processing, Inc. (ADP) today appears to have shifted a large number of investors back towards safe-haven assets. While private sector job growth has been on the rise for the past 14 months, the data is expressing an ominous trend that is approaching contraction. Stoking the flames this week was also a report which cited a 47% increase from this time last year in impending job cuts.

Ahead of Friday’s Non-Farm Payroll (NFP) release, this employment data may spook investors away from riskier assets, which have been seen rising this week. Employment is an important sector of the economy and any signal that it is approaching contraction – if not already there – will only heighten tensions that the economy is approaching a double-dip recession.

Read more forex trading news on our forex blog.

Canadian GDP Returns to Growth


Updated from the previous month’s downturn in GDP data, the Canadian economy appears to have reentered expansion this month. Canada’s release of GDP data is unique, however, in that it is published on a month-by-month basis instead of quarterly like other countries. A quarterly release is issued, but it is merely a summary of the monthly reports.

Last month, the figure came in with a dismal reading showing a contraction taking place of roughly 0.3%. This month, though, the figure is back up to an expansionary reading of 0.2%. The Canadian dollar (CAD) doesn’t appear heavily affected by the news thus far, but should see some volatility as the North American trading sessions get further underway.

Read more forex trading news on our forex blog.

Maisonneuve Recommends Commodity Stocks on China Demand

Aug. 31 (Bloomberg) — Virginie Maisonneuve, head of global equities at Schroder Investment Management Ltd., discusses investment strategy, volatility and the global economy. Maisonneuve speaks with Maryam Nemazee on Bloomberg Television’s “The Pulse.” (Source: Bloomberg)

Erixon Says Greece Loan Can Progress Without Collateral

Aug. 31 (Bloomberg) — Fredrik Erixon, director of the European Centre for International Political Economy, discusses Finland’s demand for collateral on new Greek loans. He spoke yesterday from Stockholm with Andrea Catherwood on Bloomberg Television’s “Last Word.” (Source: Bloomberg)

Economist Shirakawa Says Japan May Enter Recession Again

Aug. 31 (Bloomberg) — Hiromichi Shirakawa, chief Japan economist at Credit Suisse in Tokyo, talks about the outlook for the nation’s economy. Japan’s industrial production rose 0.6 percent in July from a month earlier, the Trade Ministry said in Tokyo today. The median estimate of 28 economists surveyed by Bloomberg News was for a 1.4 percent gain. Shirakawa, who also discusses the change in the nation’s political leadership, speaks from Tokyo with Susan Li on Bloomberg Television’s “First Up.” (Source: Bloomberg)