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Big Trouble in Asia

November 23, 2010
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The big headlines pushing the equity markets lower right now are coming out of Asia. Last week, we saw China take yet another step to put the brakes on inflation, as that country’s central bank raised bank reserve requirement ratios for the second time in just over two weeks.

Unlike here in the United States, where our central bank is trying desperately to create more inflation, China’s big problem is too much inflation. In October, China’s Consumer Price Index (CPI) rose 4.4%, the biggest monthly surge in more than two years. Much of that jump in the inflation rate was due to rising food and energy prices, and that’s not a good sign for the world’s second-largest economy.

If China continues to have inflation problems, it could throw a big wrench into the wider global economic recovery. It also could continue to put pressure on stocks in both China and the other emerging markets in Asia. If you look at the chart below of the iShares FTSE/Xinhua China 25 Index (FXI), you’ll see that the measure of China’s top 25 equities has come way off of its recent 52-week high.

We have more on how investors potentially can benefit from the drop in the Chinese stock market in today’s ETF Talk segment (see below). But for now, you need to be aware that stocks in China are currently under duress — both from a technical perspective, and from a fundamental, macroeconomic perspective.

As if China’s woes weren’t enough for the region to deal with, Asia now has to worry about renewed aggressive tensions between perennial enemies North Korea and South Korea.

Early Tuesday, news surfaced that North Korea had fired a flurry of artillery shells at a South Korean island, killing two soldiers and setting many homes on fire. The South Koreans reportedly returned fire, and the whole thing escalated into an international incident that caused traders to dump South Korean stocks.

The chart here of the iShares MSCI South Korea Index Fund (EWY) shows Tuesday’s plunge in the fund, which was down 5.4% midway through Tuesday’s trading.

As so often is the case with today’s global trading environment, tensions and worries in Asia also translate into declines in the U.S. stock market. That certainly was the case on Tuesday, as the S&P 500 slumped nearly 1.4% midway through the trading session.

The chart below of the S&P 500 clearly shows Tuesday’s drop, but it also shows how far the broad market measure has come back off of the 52-week high set right after the midterm election and the Fed’s latest quantitative-easing (QE2) announcement.

Now, keep in mind that this week’s trading is on relatively light volume, with many traders taking time off in front of the Thanksgiving holiday. Light volume tends to exacerbate the market’s price swings in both directions, so we have to be careful not to read too much into Tuesday’s selling.

My thinking here is that the current bull market is still intact, and that we’d have to see stocks break below the 1,173 mark before we likely would see any significant technical selling that could take stocks substantively lower. In the days and weeks ahead, I’ll be keeping close tabs on this market to see if, in fact, a turning of the proverbial tide has indeed hit the market’s shores.