Globalization brings benefits. Free trade makes more products available to consumers and reduces costs.
However, globalization also increases business cycle correlations. If the United States enters a recession, for example, production of low-cost goods in other countries declines. Now, those countries suffer recessions at the same time as the U.S. Most will also recover at the same time.
Stock market trends reflect business cycles. A growing economy should produce a strong stock market, while economic contractions bring bear markets. Increased globalization led to an increased correlation in stock market movements. Now, there’s nowhere to hide in a bear market.
That makes a recent sell signal in major U.S. and global stock market indexes even more alarming.
Crash Season
At the end of last week, the seasonal trend turned bearish in almost all major market averages around the world.
The chart above shows the seasonal trend of the SPDR S&P 500 ETF (NYSE: SPY). The vertical line on the chart shows where we are now. The trend’s annual peak occurred last week, on July 21.
Seasonal trends are found with mathematical techniques like the Fourier Transform. These same tools have many applications beyond the stock market, like reducing background noise in cellphone calls. So, the math is well-understood and useful.
Seasonal trends are common in financial markets. As one example, a seasonal trend almost completely explains why so many stock market crashes happened in September and October.
Farmers harvest crops in the fall. In the late 1800s, they sold the harvest for cash at local granaries. Crops flowed to markets where grains were processed, usually by rail. Cash changed hands at each stop.
Before computers, banks in the Midwest needed physical cash to start this process. Banks back East sent cash to them, usually at high interest rates. Eastern banks then had little cash since cash was limited under the gold standard of the time.
This was a problem. Wall Street also needed access to cash to function. If Wall Street’s need for cash suddenly spiked while cash was making its way back from the Midwest, the risk of a market crash increased. This often happened.
Market crashes in the autumn of 1903 and 1907 led to calls for change. The Federal Reserve was created to solve this problem.
Markets Around the World
The Fed has solved many problems, but it didn’t completely remove seasonal trends from the stock market. These trends are still visible in markets around the world. And, at the end of July, they sync up in a bearish fashion.
The FTSE All-World Index is shown in the next chart. Charts of major Asian markets along with European and North American markets show a similar trend. Again, the blue line shows where we are now.
Seasonalities are just tendencies. They aren’t absolute rules markets follow precisely. But we know that global stock markets are weak on a seasonal basis for the next two weeks.
This might not be the ideal time to add money to index funds. Only targeted trades based on multiple indicators should be considered in this environment.
Regards,
Michael Carr, CMT
Editor, Peak Velocity Trader
