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Stock market summer slump looms

Markets have regained strength, yet Middle Eastern and Asian trade surpluses mean a summer slump is likely in store.

After last year’s turbulence, stock markets of the world have clawed their way back. They are now roughly where they were before the euro-crisis crashed them. As problems associated with Europe’s banks and the liquidity of EU member states have been addressed, markets have in turn rallied and normality or something resembling it has resumed.

Yet what has been fixed? Tiny Greece may have rebased parts of its debts, yet the rest of Europe is still in an awful economic mess. Trade and budget deficits have never been so huge. America, meanwhile, is ploughing on, printing money and careering towards new debt ceilings with abandon.

What exactly has changed? Aside from a little cosmetic application of freshly printed money?

If the euro crisis created last year’s slump, then what caused the one the year before? What is it that causes these summer falls that occur so regularly, falls that can be traced back long before the credit crisis kicked off?

“Sell in May and go away, come back on St Ledger Day [September 15th]” is an old stock market saying suggesting summer slumps are caused by the idle rich going on holiday, causing a large drag on the market. While this might have been true in the old days, especially in Europe, it seems unlikely that in today’s technological world, this seasonal feature can simply be caused by the middle and upper classes skiving off for the school holidays.

Americans are famous for taking few holidays yet surely the US still drives markets.

Yet it’s all there in the charts. Time and time again, a large market disjuncture kicks off during late spring or early summer.

Another old saying goes “trade what you see”. Optically, the same pattern can be viewed over and over.

So, is another slump or crash looming this summer?

The probabilities look high.

If holidays cause this correction, then the slump is inescapable yet perhaps that’s not what is going on.

I believe there are good chances these corrections are caused by hedging. The huge trade imbalances between the developed and developing world are not left to rot; they are hedged to be protected from global economic swings. It is my speculation that these hedges are put into place around early summer and that their scale is what causes the volatility and disruption.

In the modern era, much of the trading going on is highly technical. Banks hedging a currency for a client for example, will put on a series of complicated positions to keep the value of the client’s capital protected.

If you were a small oil state, your yearly trade surplus would be billions of dollars. So you would want your sovereign wealth fund to make sure that surplus did not get whittled away by the fall of, for example, the US dollar.

When you consider that perhaps trillions of dollars worth of trades must be made to protect the value of a trillion dollars of trade surplus, you can see why any seasonality in this hedging is going to dislocate the market.

Trade balances are not greatly different this year, compared to last. Only perhaps, a market shift from bonds can stand in the way of equities taking another beating from the effects a giant round of hedging has on liquidity.

It might seem strange that an industrial company can see its stock price fall by 20% because far away a nation is trying to protect the value of its trade surplus. Yet in the modern world all markets are chained together by the laws of correlation and arbitrage.

The global markets are a unified machine with all cogs interconnected.

So, this summer, we can reasonably expect a sudden fall in equity markets again along with a series of narratives trying to explain this sudden surprise.

Perhaps we will read of further Euro worries, or maybe the correction will be put down to sovereign debt downgrade concerns. Perhaps the media won’t bother to even mention the bumps in the road. In any event, if we get another summer slump, it’s more likely to be Middle Eastern and Asian delta hedging than the politics making front page news.

The US election has a very predictable market pattern attached to it, allowing a summer correction followed by an autumn rally that would help usher Obama into office again.

Of course, in these volatile times, traders need to expect the unexpected. Still, it really would be a surprise if we miss the summer slump, have no autumn rally and end up with Mitt Romney as the new US president.

That certainly would be a long odds outcome.

Only one thing could change the picture - the end of the bond ‘bubble’. When this happens, equities will go through the roof. It’s unlikely to happen this year, however it will happen. When it does, all established seasonal market patterns will go to the wall.

Clem Chambers, CEO of stocks and shares site ADVFN.com and author of ‘101 Ways to Pick Stock Market Winners’.

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Published March 24, 2012 at 9:05 am (Updated March 24, 2012 at 9:04 am)

Stock market summer slump looms

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