China's an Early-Warning System for Stocks: Strategist

Last week’s stock rally showed that investors are searching for positive signs, but further gains will be dependent on economic data and China according to Philippe Gijsels, the head of research at BNP Paribas Fortis Global Markets.

Photo by: Cory Doctorow

“Over the last couple of days equity found a number of positive elements that allowed them to rally from these oversold levels,” Gijsels told CNBC Monday.

First, there was some positive data from the International Council of Shopping Centres that showed the fastest pace of sales for four years, but Gijsels said this good news is likely to be temporary.

“Given stalling employment growth, still shaky real-estate markets in combination with high household leverage, there are legitimate doubts concerning the durability of the sales rebound," he said.

Second, there were bullish earnings projections fromState Street and JPMorgan Chase , who took a positive stance on their ability to absorb costs of upcoming regulation, fees and taxes by increasing margins. That allowed bank stocks to rally.

“Even though these figures do not necessarily paint a positive picture for the more Investment-banking-oriented financial companies, we expect the upcoming earnings season to be good,” Gijsels told CNBC.

“Unfortunately these figures will be giving us information about the past and it is the second half of this year and the start of 2011 that everybody is interested in," he said.

Look to China

China could be the key to predicting where the market goes, Gijsels said, adding that he is watching the stock market in Shanghai closely.

“Remember that the Chinese are a leading indicator and the Chinese stock market bottomed a couple of months ahead of the March 2009 low in equities in the Western world," he said. "The Chinese leading indicators and stock market also started topping out before the correction process in the West started a couple of months ago.”

“If this logic were to continue we should see the start to an uptrend in Chinese equities before we call this period of volatility over," he said. "For the moment this is not yet the case."

Gijsels said he is also cautious given all the technical warnings the market is giving investors.

“Death crosses are still developing (50-day moving average crossing the 200-day moving average to the downside)," he said. "This process is still ongoing and it will take more than a rally of couple of days to change that.”

Watch the Data

Another big question is the pace of any second-half slowdown for the global economy, Gijsels said.

“Our base scenario still calls for a serious slowdown but not a double dip," he said. "In this scenario equities are probably reasonably-to-attractively priced."

"I am not a big believer in price/earnings measures as they move in regimes," he added. "This means that the average can be 15 for 20 years and then 8 for the next 20. Unfortunately you don't know in what regime you are until after the facts, which makes comparisons difficult is not outright impossible."

“If the economy does not experience a double dip, there is probably a valuation case to be made for equities," Gijsels said. "However, the double dip is exactly what the market is worrying about.”

It will not become clear whether economies are heading into a double dip until the end of the third quarter at the earliest, he said.

“This means that we will be stuck with this highly volatile market for quite a number of months to come," Gijsels said. "Each time we get a set of figures that points in the direction of a double dip, markets will sell off. Each time we get some comforting figures we will see violent spikes.”