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Markets Look Overbought To Start The Week

Perhaps not much was expected, but the G20 meeting of finance ministers set no new agenda with regards to a more coordinated stimulus, therefore creating the potential for a negative fundamental driver at the start of the week. Technical indicators on the equity and currency charts are also pointing to some downward momentum.

The U.K. and Japan were apparently on board for U.S. Treasury Secretary Geithner's call for injecting a fiscal stimulus amounting to at least 2% of an economy’s gross domestic product this year. However, French and German officials believe they have already spent enough and remained concerned about immersing themselves more deeply into debt.

There was concern that U.S. efforts to contain the banking crisis hadn't been more effective or more rapidly implemented. According to the statement released after the meeting, the "key priority" of the G20 will now be "to restore lending by tackling, where needed, problems in the financial system head on, through continued liquidity support, bank recapitalization and dealing with impaired assets, through a common framework."

It also said "G20 central banks will maintain expansionary policies as long as needed, using the full range of monetary policy instruments, including unconventional policy instruments, consistent with price stability," a clear sign that officials see no near-term end to the global economic crisis.

Officials released a three-page "framework for financial repair and recovery" aimed at restoring bank lending. Possible actions it listed included providing liquidity through government guarantees, injecting capital into banks, safeguarding deposits, and addressing impaired assets.

"Some countries have not fixed their banks, so I want them to fix their banks," Canada's Finance Minister Jim Flaherty said after the meeting.

"We are convinced it makes no sense to pump more and more money in our economy when we haven't restored the confidence on the financial markets," said German Finance Minister Peer Steinbrueck at a joint press conference with French Finance Minister Christine Lagarde.

Adding to the downward pressure are increased tensions between the U.S. and its biggest creditor, China.

At his annual press conference on Friday, Chinese premier Wen Jiabao expressed concern about the safety of China’s investment in the U.S., and urged the Obama administration to provide assurances that its investment would keep its value in the face of a global financial crisis.

“President Obama and his new government have adopted a series of measures to deal with the financial crisis. We have expectations as to the effects of these measures,” Mr. Wen said. “We have lent a huge amount of money to the U.S. Of course we are concerned about the safety of our assets. To be honest, I am definitely a little worried.”

The President responded by saying the U.S. is the world's “most dynamic economy.”

“Not just the Chinese government, but every investor can have absolute confidence in the soundness of investments in the U.S.,” Obama said at a press conference on Saturday.

It perhaps was no coincidence that Mr. Obama was meeting with Brazilian President Luiz Inacio Lula da Silva. Given the need to fund the estimated $1.5 trillion fiscal 2009 budget deficit, the President looks to be seeking an increased investment from Latin America's largest nation.

According to the latest IMF figures, Brazil has over $1.8 trillion in foreign currency reserves. Yet it holds just $127 billion of Treasury securities (as of December 2008), less than a fifth of China's $727.4 billion. Brazil is the sixth largest foreign holder of U.S. debt with about 4.1% of the total $3.1 trillion outstanding, but in the year to December it actually decreased its holdings by $2 billion while China increased theirs by nearly $250 billion (52.3%).

New data on this will be released on Monday.

We're seeing some bearish signs on the daily stock and currency charts which imply the dollar could strengthen at the beginning of the week. This is consistent with the overall view that strong trends are unlikely to be seen for the foreseeable future and that markets will continue to be subjected to rallies and sell-offs.

As shown below, the daily S&P chart is showing a double stochastic overbought condition, where price has become overbought at a lower level then where the last overbought area was seen. This implies that even though price has gone down, it still is considered to be too expensive. The S&P futures, DOW Industrials, NYSE Composite, DOW Transportation and Russell 2000 are showing the same indication.

This is correlating well with the AUD/USD (below) and NZD/USD charts. It's also seen in the chart for the euro, but isn't being seen on sterling. A double stochastic overbought is showing up clearly on the weekly USD/JPY chart, although the daily is looking a bit oversold.

There certainly is a risk to see the S&P hit 600 at some point over the next couple of months; with foward earnings estimates in some quarters hitting $50 (Goldman Sachs said $40 recently) a 12 P/E puts the S&P at that level. Remember also that single-digit P/E ratios are commonly seen in recessions and considering that the global economy is probably going through its worst period since the Great Depression, even 500 would seem to be entirely doable. Trailing 12-month earnings fell by 50% in the last recession and were just over $80 at the end of 2007.

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