Merryn's Blog

The killer wave that could send stocks 40% lower

A nasty wave has appeared in the charts of the S&P 500. Every time it has been seen in the in the last 80-odd years, it has been followed by average losses of 40%.

Bear market or bull market? I've got a chart that gives us a clue.

It's the one that legendary UK investor Ian Rushbrook liked to look at and charts the dividend yield of the FTSE All Share against the total real return from UK equities.

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It shows that very often when the yield is above 5%, stocks go up very dramatically. And when it is below 3% they take nasty tumbles. It's now 3.6%, which if you buy the idea, makes it hard to argue for a bull market.

But what might make it even harder is the 'killer wave' pointed to by Albert Edwards of Socit Gnrale (he credits the FT's Dominic Picarda with identifying it).The killer wave is a particular kind of technical formation also known as the Coppock indicator. It has appeared eight times in the S&P 500 in the last 83 years and has been followed by "substantial losses" each time. The average loss? 40%. Nasty.

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However, for those of a bearish (and not particularly chartist) bent, Edwards' latest note makes another point: that the rise in the US dollar recently is about to slam commodity prices and emerging market equity prices.

Why? Because of the currency pegs. The efforts on the part of China and the like to maintain the value of their currency to that of the dollar means that the strength or weakness of the dollar effectively dictates their monetary policy.

When the dollar is weak the monetary pump is at "full stretch." When it is strong, the monetary pump is "effectively switched off." So a rising dollar means much tighter monetary policy. That in turn could mean that "emerging markets and commodities are set to slide." Edwards, as you might have guessed, is coming down on the side of a bear market.

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