A Future Race Between Energy and Technology For Market Leadership?

Bespoke Invest has another set of great charts shown below. They reveal of the fluid dynamics of the composite weightings of the S & P 500.

Since the latest rally, the mangled financial sector has made a significant move to regain some of its lost grounds.

Although what really caught our eyes is the seeming emergence of a new leadership seen in the technology sector.

From Bespoke, ``After representing nearly a quarter of the S&P 500 at its peak, the Financial sector's weighting in the index fell all the way to 8.88% on March 9th. Since then, however, the sector has regained some market share and now represents 11.78% of the index. This share gain of 32.66% is by far the biggest jump for any sector off the 3/9 lows. Consumer Discretionary increased its weighting by 11.34%, followed by Industrials (6.52%), Technology (3.24%), and Materials (0.32%) on the upside. The Energy sector has seen its representation in the S&P 500 fall the most during the rally with a decline of 12.27%. Telecom, Utilities, Consumer Staples, and Health Care are the other sectors with declines in market share. Technology still holds the title for the biggest sector at 18.15%, with Health Care in 2nd place and Consumer Staples and Energy in a race for 3rd." (bold highlight mine)

As presented in a table...

Bespoke also illustrates the historical trending of each sector of the S&P 500.

Adds Bespoke, ``Below is a historical look at S&P 500 weightings for each sector. The red line represents the average weighting for the sector since 1990. As shown, Financials moved sharply below average at the end of 2008, but have bounced slightly recently. Technology is just above its historical average, while Health Care and Energy are well above average but headed lower. Consumer Discretionary, Industrials, and Materials are below average but appear to be headed higher." (bold emphasis mine)


We have been looking at the energy and material sector as possible market leaders over the longer term since they've been depressed for quite sometime. (yes decades)

Nonetheless, technology has also been a downtrodden sector since the dot.com bust during the advent of the millienium. But given the rapid explosion of technological advances, it wouldn't be a surprise for this sector to have a shorter cycle relative to the others.

So a question popped into my mind, could the next bubble be a race between the energy and technology industry?

Stay tuned.

Global Economies and Markets: From Debt Deflation To Creative Destruction?

``Yet “revolutions” every generation, as was recommended by Thomas Jefferson, are not the solution. We know that “revolution” is not achievement and the new dawn. It results from senile decay, from the bankruptcy of ideas and institutions, from a failure of self-renewal. The only way in which an institution – whether a government, a university, a business, a labor union, an army – can maintain continuity is by building systematic, organized innovation into its very structure. Institutions, systems, policies, eventually outlive themselves, as do products, processes, and services. They do it when they accomplish their objectives, and they do it when they fail to accomplish their objectives. Innovation and entrepreneurship are thus needed in society as much as in the economy, in public service institutions as much as in business. The modern organization must be a destabilizer; it must be organized for innovation.-Peter Drucker, Modern Organization Must Be a Destabilizer

The mainstream has argued sternly about the “myth of decoupling”, when the term decoupling has been a palpable misnomer.

In the globalization heyday of yesteryears, which means the integration of finance, trade, investment and labor, “convergence” was obviously the natural outcome. Thus, global markets and economies had been mostly coordinated or harmonized as the bubble blossomed.

But when the US originated global credit bubble imploded, this globalization platform have effectually been reduced, as world trade is expected to decline by more than 2% (usatoday.com), and capital flows around the world is also expected to crater- world Foreign Direct Investment (FDI) is expected to slump by 21% (Dailystar.net) and capital flows to Emerging Economies is likewise expected to tumble to $165 billion from $466 billion according to the Institute of International Finance (Marketwatch.com).

In addition, ongoing debt deflation in major economies have been reversing capital flows, as major financial institutions vie to meet capital requirements hence repatriate capital from liquidated overseas investments.

And as we previously argued, the recent surge of the US dollar’s price against most of the world’s currencies has been a function of dollar shortage in the system, the BIS recently issued a report which essentially validates our view [see The US dollar's Vitality Stems From Debt Deflation Prompted US Dollar Shortage]

Worst, the rising protectionist sentiment seen in many diverse forms are being resurrected and may further add to negatively impact trade and financial flows [as discussed in Will Deglobalization Lead To Decoupling?].

Hence, the natural incipient impact from deglobalization was also a synchronous meltdown seen late last year.

Now a new trend seems to be evolving.

In contrast to the macroeconomic perspective, whose penchant is to view the world in terms of aggregates and who seem to believe that people behave like automatons and tend to think alike, we think that people respond differently to the circumstances, hence may lead to diverse reactions. In short, people act based on purposeful behavior or incentives.

The carnage in October of 2008 instigated by the institutional run or “electronic run” in the US banking system seems to have posed as a severe mental shock known as the Posttraumatic Stress Disorder (PTSD) to the world economic activities and the financial markets. In some accounts, such mental discord has been labeled as the “After Lehman” syndrome [see our latest post, Global Posttraumatic Stress Disorder (PTSD): The After Lehman Syndrome].

And as the world fell in into a transient suspended animation from such anxiety disorder, the consequent spillover to the real economy have been transmitted through a deep retrenchment of the credit driven demand and the subsequent sharp downside adjustments in the global supply chain, which reflected on the abrupt dismantling of the production structure built around the bubble global paradigm.

This means that the compression of the supply chain had been equally manifested in the mass closure of relative excess capacities, the efforts to reduce existing surplus inventories and the reduction of labor and or rationalization of wages. Likewise, expected valuations in on diverse asset markets during the bubble days are being intensely reappraised, as the once euphoria outlook seems to have transmogrified into a depression mentality.

In short, as explained in Fruits From Creative Destruction: An Asian and Emerging Market Decoupling?, the world’s financial markets and economies appear to be undergoing ‘creative destruction’, where the speculative excesses from the bubble structure is being undone by market forces, despite government’s exhaustive travails to futilely sustain them.

As Friedrich Hayek once wrote, ``The thing which is most needed to secure healthy conditions is the most speedy and complete adaptation possible of the structure of production. If the proportion as determined by the voluntary decisions of individuals is distorted by the creation of artificial demand resources [are] again led into a wrong direction and a definite and lasting adjustment is again postponed. The only way permanently to 'mobilise' all available resources is, therefore to leave it to time to effect a permanent cure by the slow process of adapting the structure of production.” (bold highlight mine)

Signs of Positive Impact From Creative Destruction?

However, considering the scale and depth of collapse, much of these precipitate changes may have been overdone. Yet, combined with the idiosyncrasies of the political, capital and production structure of each nation, signs of creative destruction may have started to reinforce signs of “divergence dynamics”- in a world where globalization trends have apparently been on a descent.

Proof? See figure 1.

Figure 1: Danske Bank Weekly: Last In, First Out

China appears to be leading the way out of the global economic morass, as industrial (manufacturing) activity, credit growth and car sales appear to be markedly recovering even as the US remains in doldrums.

According to Steen Bocian Chief Economist of Danske, ``China was one of the last countries to be dragged into the global financial crisis, and now looks set to be one of the first to come out the other side.”

And it's not only China but other East Asian countries as well.

And this development seems congruent to what we wrote in July of 2008 in Phisix: Learning From the Lessons of Financial History,

``This I think is what the global financial market has thus far priced in, aside from the ongoing delevaraging process that has fomented the forcible selling of most liquid asset classes by institutions caught in the web of illiquidity stasis.

``And if Asia is not a bubble then the likelihood is that the bear market arising from the present contagion conditions as mentioned above could be likewise be cyclical and temporary in nature. If our analysis is correct then we should see the rendition of the same patterns even amongst our neighbors.”

While much of Asia’s equity markets hasn’t been lifted by these developments yet, but instead dragged by dreary global sentiments, China’s Shanghai index remains as the world’s market leader up 5.29% for the week and up 20.4% over the year.

It should be a reminder that in every cyclical transition there will always be a change in market leadership and perhaps, China could be assuming such a role, if the recovery will be sustained.

Economic Restructuring Will Restore Global Growth

Nevertheless, it would be a misguided collectivist notion to think that China would even attempt to save the world. China will only act to protect its political, financial or economic self-interest. And any spillover will mostly be coincidental than intended, except perhaps for extraordinary circumstances which is exigent to their self-interest.

Take this report from Chinastakes.com, ``Chinalco’s $19.5 billion capital injection into Rio Tinto, so far the largest foreign investment of any Chinese enterprise, is believed to signal China’s holding’s transition into strategic resources. Officials and leaders of state-owned enterprises also suggest the government inject some of the reserve into state-owned enterprises to help them invest overseas or establish funds for overseas acquisition.”

Ironically, common sense tell us, where everyone wants to be saved, the world is simply too enormous and too complex to be saved with restricted resources.

And the harsh reality is that world will have to undergo an economic restructuring than continue to survive on a farcical political economic landscape dependent on sustained bubble blowing.

Otherwise what may seem like a temporary recovery may even lead to a malevolent nightmare, as Joseph Schumpeter in the The Economics of Recovery Program observed, ``"Depressions are not simply evils, which we might attempt to suppress but-perhaps undesirable-forms of something which has to be done, namely, adjustment to previous economic change. Most of what would be effective in remedying a depression would be equally effective in preventing this adjustment. This is especially true of inflation, which would, if pushed far enough, undoubtedly turn depression into the sham prosperity so familiar from European post war experience, but which, if it be carried to that point, would, in the end, lead to a collapse worse than the one called in to remedy.”

Has The Deleveraging Process Culminated? Where’s The Next Bubble?

``Many shall be restored that now are fallen and many shall fall that now are in honor.”- Horace, leading Roman lyric poet in Ars Poetica

Global markets rallied furiously over the week, setting stage for what perma bears call as the sucker’s rally. For all we know, they could be right. But I wouldn’t bet on them. Not especially when central banks start to use the first of its available nuclear option of monetizing government debt. Not when government central banks start running the printing presses 24/7 and begin a Zimbabwe type of operation.

We also don’t know to what extent of the forcible liquidations of the deleveraging process is into, what we do know is that governments are today starting to unveil their long kept ‘secret’ final endgame weapons. We appear to be at the all important crossroads. Will it be a deflationary depression outcome? Will it be a recovery? Or will hyperinflation emerge?

What we also know is that forcible liquidations from the ongoing debt deflation process have been responsible for the “recoupling” saga we are seeing today.

Figure 4 stockcharts.com: Gold leads Rally

In figure 4, compared to the previous failed rallies (2 blue vertical lines), gold, oil and commodities haven’t joined the bullish rebellion in global equities as shown by the US S & P 500 (spx), Dow Jones World (djw), and Emerging Market Index (EEM).

This time we see gold leading a broad market rally. The Philippine Phisix too has obliterated its 10.73% one week loss by surging 11.65% this week. And even our Peso has joined the uprising by breaking down the psychological 49 barrier.

In short, this week’s rally does look like a broad market rally. And broad market rallies usually have sustaining power.

The Philippine Stock Exchange’s market internal tells us that even during the other week’s meltdown, the scale of foreign selling appears to have diminished. It had been the local retail investor jumping ship. This week’s rally came with even less foreign selling even if we omit the special block sales of Philex Mining last Friday.

My ‘fallacy of composition’ analysis makes me suspect that perhaps the issue of deleveraging has ebbed, simply because as the US markets cratered to form a NEW low, just about a week ago, key Asian stocks as the Nikkei 225 ($nikk), Shanghai composite ($ssec) and our Phisix have held ground see figure 5.

Figure 5: Stockcharts.com: Asian stocks Show Signs of Resilience

To consider, even as streams of bad economic news keeps pouring in, as Japan has reportedly entered an official ‘technical’ recession or two successive quarters of negative growth, its main benchmark the Nikkei appear to be holding ground.

It’s been said that once a bear market has stopped being weighed by more streams of bad news or despite this they even begin to rise; this mean that markets may have digested all negative info and may have signaled that a bottom has finally been established. As we quoted Jim Rogers on a video interview, ``When people say it is over and when we you see more bad news and stocks stop going down. But when they go up on bad news, that’s when we are gonna hit bottom. We are not gonna scream I don't know."

Although it could be too premature to decipher recent events as a bottom, we’d like to see more improvement in the technical picture and even more participation from major benchmarks of the region (djp2) aside from sustained rise from the market leader-gold.

Furthermore, if indeed the deleveraging process is beginning to fade, then the next phase should be markets factoring in the repercussions from the recent credit crunch to the real economy. But considering the steep fall during the October-November carnage, it is our impression that most of these had already been factored in.

Moreover, the downturn in the real economy should reflect divergences because not all of the Asian region’s economy will experience recessions see figure 6.

Figure 6 IMF: Emerging Asia Quarterly Growth Forecast

As you can see from the IMF’s regional outlook, except for Industrial Asia (Japan, Australia and New Zealand) which is the only class expected to flirt with an economic recession 2009, the rest of Asia’s economic growth engine is expected to only moderate with the Newly Industrialized Economies (Hong Kong Korea Singapore Taiwan) experiencing the most volatility (steep fall but equally sharp recovery). Most of the Asia is expected to strongly recover during the second half of 2009.

Now if the IMF projection is accurate and if stock markets are truly discounting economic growth to the streams of future cash flows of companies, then we should begin to see today’s rally as sustainable, reflective of these projections and at the bottom phase of the market cycle.

This also means sans further deleveraging prompted liquidations, we could expect some stark divergences in market performances. Unless, of course the headwinds from the collective efforts to inflate impacts every asset class simultaneously, which we think is quite unlikely. But as we earlier said, the bubble structure in the US isn’t going to revive and that any new bubble will come from elsewhere, for example the US dot.com boom bust cycle shifted to the housing industry in 2003 as an offshoot to the inflationary policies applied against a deflating tech industry led market and economic bust.

Boom-bust market cycles always involve a change of leadership. And considering that gold has been the frontrunner during the recent bounce, we suspect that precious metals, energy, commodities, emerging markets and Asia as the next bubbles to blow.