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The July – August 2011 market crash. Technical analysis and long term issues!

According to Jacques Ninet, head of research at UFG-LFP, it is obvious that the monetary European Union (an imperfect Trojan horse towards federalism) only gets half the job done when it comes to forging economic union…

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Technical analysis and long term issues

1 Technical analysis

1.1 Observations

The market crash (30% drop between the 18th of February and 9th of August) can be analysed as a brutal exit through the lower boundary of a range (Eurostoxx) or a wedge (Stoxx) whose periods (18 and 14 months respectively) were exceptional (with the exception of the Japanese market since the 1990 crash).

The July – August crash has been among the most violent ever recorded. Since the creation of European indices only September 2002 (Enron) has been more brutal. In the United States, however, the recent drop has not matched that of October 1987 or that of October 2008 (Lehman).

1.2 Perspectives

Can we predict what will come next? By taking the peak reached in February 2011 as a starting point, there are three phases of drop / rebound before the crash that took place at the end of July. With this in mind, two scenarios can be considered:

- The initial movements going into reverse motion leading to a series of significant rebound / drop over relatively long periods (2 – 4 months) but without a large overall downward dynamic.
- An end to the movement similar to what was observed at the end of 2008 and the beginning of 2009. This would translate by a strong rebound followed by a drop of similar proportion (32% drop seen on the Eurostoxx between the 6th of January and the 9th of March 2009). If that scenario happens, the indices would get pushed back to their lowest points seen during 2002 – 2003 or 2008 – 2009

1.3 Explaination

Beyond the seasonal aspect and the impact of automatic trading (via algorithms), which may have contributed to abnormal market moves, the fragility of financial markets can unquestionably be linked to the public debt crisis and uncertainties on economic growth.

Markets can be considered as places where opinions are confronted regarding the future value of debt securities. Those opinions are shaped through the way in which the world is represented. This depends on a number of beliefs and verified facts which, depending on their proportion, will determine the potential price instability [1]. When these beliefs are dominant because the facts happen to be too contradictory and / or the scenarios are too indecisive, versatility risk rises dangerously. In the current case, the belief was about the match between the exceptional austerity measures taken to deal with indebtedness and economic growth sustainability. The latter would be favoured exclusively through budgetary stimulus after the recession resulting from credit crisis. The brutality of the choc can be explained through the sudden realization of the paradoxical if not schizophrenic characteristic regarding this double requirement imposed by the markets even when none of the major disequilibriums has been solved. The fact that the US rating’s downgrade took place at the same time as an economic slowdown during the second quarter has shown how unrealistic those expectations despite all the promises made by the authorities and “official” economists.

No serious economist not to say any sensible man could have believed that the austerity package, meant to bring public finances back in order, would be have gone through without recessionary consequences. This would have only been possible if interest rate stability and profit increases proved that they were worthy of the unrealistic virtues applied to them which is simply absurd. Because they can no longer produce what they consume, western middle classes have resorted to debt (US, UK, Spain) or have been rescued by public subsidies (Southern Europe). The insolvency of private debtors and the support provided to the banks have been gathered within the public sphere. Forcing those middle classes to shoulder the burden of the austerity measures would amount to bringing them back to square one or facing a double sanction which is even worse. Overall, what can be described as “market dictatorship” is plainly suicidal over the long term just like any regime based on the egotism of a small minority. By a vote of defiance, markets get their revenge for their own excess.

There is at first glance no chance to exit this configuration as long as the politicians will not have grasped the real problems and consequently adapted their response. Measures such as the “Golden Rule” are merely incantations which leave people sceptical on the ability of our leaders to carry out an adequate analysis.

2 Long term issues.

2.1 The contribution provided by the Kondratiev cycles (Extract from a commentary published in Economie appliquée [2] at the end of 2010 and which is still relevant).
Even it does not precisely include the split between classical and heterodoxical thought, the opposition between two Kondratiev cycle readings shows the need for financiers to ask deeper questions.
By establishing some links, two schools of thought can be established:

- On one side, there are those supporting the idea that the cycle is based mainly on innovation phases and generates its own reversal as a result of excessive investments and a drop in profitability. This mainly happens when an innovation cluster comes to maturity. The cycle then goes back upward when a new innovation cluster comes around

- On the other side are those who consider accumulative social structures to be more important. Through this analysis, Kondratiev movements are not considered as cycles but vibes since a restart depends on the establishment of a new social structure that has the ability of generating a new long term expansion phase. This new social structure cannot however be considered as a given.

The current period can be analysed in two radically opposed ways:
- Either the new information technologies have created the conditions for a new cycle restart after the downtrend that stretched from the end of the 1960s till the beginning of the 1980s (or 19990s depending on the authors) which means that we are merely going through a phase of financial instability within a longer term expansion phase.

- On the contrary, the neo liberal structure set up since the Reagan-Thatcher era is not an accumulative social structure which favours long term development. This is mainly shown by wage deflation and a chronic lack of solvent consumption. Under this perspective, the downtrend that started during the 1970s has not ended yet.

It is not easy to determine which theory is right considering how differently the markets behaved during the upward phases of 1995 – 2000, 2003 – 2007 and the downward phases of 2000 – 2002, 2007 – 2009. Besides, the rise of the emerging markets has created a world with two different paces of economic growth. An average figure of this growth does not make any sense. A possible agreement could come in proposing that the excesses of finance, which resulted from the inequity in productivity gains and the need to support household demand through virtual asset increases, have weakened the foundations of the new economy expansion phase…at least for the west.

This debate is not solely theoretical. It is on the contrary of a first degree importance from an operational point of view since its conclusion designs the long term perspective within which every forecast must be included. Whether or not we provide a major importance to the revenue issue, the recent can be considered (or not) as a real crisis exit.

2.2 The contribution of the world-economy concept (F.Braudel, I Wallerstein)

The fall of communism, the opening of China to world trade and the rise of emerging markets have marked the transition between two long term phases. On one side is the American hegemony in a western dominated world economy and on the other side is an integrated world economy (the global village) which is multipolar and within which China acts as the centre (It has not yet achieved this status though).

The major characteristic of this transition compared to the previous ones is that it is not include any armed conflict. The consequences resulting from the use of the nuclear weapon are dangerously binary. While peripheral conflicts wear out the former “master of the world”, there is a total economic war going on with, as a consequence of relative peace, a complete autonomy of multinational firms from the states. The fact that these firms integrate themselves at the heart of the relations between China and the rest of the world regardless of the consequences faced by people can be considered as the major characteristic of globalisation.

What balance will emerge from this transition? What will be the new economic and political system? Establishing a forecast seems merely impossible. The only certainty that we have is that this process will necessarily be long (It will likely take decades). Moreover, the people can become major actors of the process once again and natural resource allocation as well as intelligence control will play a major role.

2.3 The European question.

It has been obvious for a long time that the monetary European Union (an imperfect Trojan horse towards federalism) only gets half the job done when it comes to forging economic union. This incomplete structure has devastating effects. Right now, the dreams of the founding fathers have been shattered with the return of strong national interests. Just like the world usually works, Europe and the Eurozone typically remain non cooperative zones where every member tries to benefit in its own interest by trying to push their exploitation to the extreme. On that specific matter, economists have believed that they would be able to reinvent the rules by ignoring the fundamental relationships that link productivity, external balance, foreign exchange rates and interest rates. Curiously, while capitalism is openly transnational, political forces of nation states are the ones hesitating to embrace federalism. This is probably due to the fact that flattering national interests remains the best election leverage even when it is economically absurd.

2.4 Global assessment: The “magic square” of prosperity

Excluding the specific problems linked to the environment, sustainable growth depends on the four pillars described below.

These four pillars are associated to different measures and actions meant to face shortcomings.

When one of those pillars is excluded form a state or an economic zone, the latter’s global growth is endangered.

When applied to the member states of the Eurozone, this analysis board calls for the set up of deep reforms which go far beyond what is considered nowadays.


The broad indices: “Global Picture”

S&P 500

Stoxx 600

Even if they have gone back to their 2000 peaks in 2007 (which has never been the case for Japan), a decade has been lost for the broad European and American indices. In order to try to know whether the crash seen during the summer of 2011 is a serious indication of lengthy hard times to come, the in-depth analysis carried out in this paper highlights the major challenges faced by the economies concerned and the inadequate measures taken up till now. In spite of the huge innovative technological potential (created and upcoming), the return of sustainable growth and financial stability requires a readjustment of social equilibrium conditions (internal) and international cooperation (external). These conditions are far from being met.

Jacques Ninet , August 2011

Article also available in : English EN | français FR


[1] Rating agencies only issue opinions. Central banks have refused to do this job because they do not produce opinions but they act. The problem of agencies is their oligopolistic structure which eliminates the diversity of opinion and give to the views they share a large self-fulfilling capacity

[2] Réflexions sur la prospective en usage dans l’industrie financière. J Ninet. Economie Appliquée tome LXIII, 2010 N°4 p197-206)

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