Category Archives: S&P 500/SPX

What Are Yields Yelling

The bond market flashed warning signals on Friday and we look at what it could mean for FX. Last week, the pound was the top performer while the Canadian dollar lagged badly on  5 consecutive days of declines. The Asia-Pacific calendar is light to start the week.

USD/CAD continued to move higher in early-week trading, hitting 1.0910 from 1.0888 at the open. Otherwise, action has been light as the week gets under way.

Last week ended with US non-farm payrolls casting doubt on the strength of the US economy heading into 2014 and the report sparked some sizeable moves across assets, including a slump in the US dollar. The moves that really stood out were in the bond market as yields tumbled.

Five-year yields fell 13 basis points to 1.62% and 30s fell 8 bps to 3.80%, below the yield when the Fed announced a taper on Dec 16. The magnitude of the declines in yields should not be taken lightly, it’s either a squeeze on of over-ambitious shorts or it’s signaling a flight to quality that could spill over and lead to declines in stocks and USD/JPY.

The market is complacent in the view that economic growth will pick up toward 3% in 2014, businesses will begin to invest and inflation will track higher. That’s a reasonable line of thinking but it hasn’t been confirmed by data and significant risks remain.

Weekend news was mostly inconsequential but there was positive news from Iran where negotiators struck a nuclear deal that lifts restrictions on oil exports. The move could weigh on oil prices, especially Brent.

Commitments of Traders

Speculative net futures trader positions as of the close on Tuesday. Net short denoted by – long by +.
EUR +14K vs +31K prior
JPY -129K vs -135K prior
GBP +18K vs +23K prior
AUD -57K vs -57K prior
CAD -61K vs -58K prior
CHF +5K vs +11K prior

The market has struggled to build any significant positions in euros because of the lack of consistent trend. The move toward neutral came after the break of the 55-dma but Friday’s rebound likely confused traders further.

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S&P 500 Chart Analysis and Comparisons

There is absolutely zero confirmation of today’s breakout in the S&P 500. Looking at charts of other stock markets and metals, this is almost assuredly a fake out but it could last another 40-50 points.

After trading between 1100 and 1225 since mid-August we broke out to the downside and then snapped back higher. Oftentimes when you get a false breakout in a range trade, it will breakout on the other side. A widening wedge, like the one illustrated by the orange lines is extraordinarily rare. I believe there is further room to run on the upside, but not much.

The number one reason it will ultimately fail: no other stock markets are confirming the US move.

First, we have the Shanghai composite. Not only has it declined, despite investments from China’s sovereign wealth fund and its pension in the past few weeks, the SSE touched the lowest April 2009 just yesterday. At the moment, the 2330 is extremely important. If it breaks (definitively) it’s a long way down before more support. To me, this probably the most important chart in the world in the week ahead.

Second, we have the French CAC. Similar to the S&P 500 chart but we are now 7-8% below the August highs.

Third is Canada, which has made some recent gains but is clearly trending lower.

Fourth is copper, which is nowhere near the August highs, or even October highs. Industrial metals like copper are the preeminent indicator of global growth. There has been talk of inventory manipulation in copper but it’s non-sense. LME aluminum hit a 13-month low yesterday. Lead and zinc are at the lowest since mid-2010.

So what’s happening?  Let’s take a look at the S&P 500 over the past four years.

I was unable to get a daily chart for this time scale so this is a three-day chart but notice the similarities in the two areas in orange that I have circled. Let’s take a closer look at the similarities to the all-time S&P500 peak and the current chart.

 

Notice the false breakout to the downside followed by a rebound to a fresh high, above the recent range. It’s the same rare pattern that we’re seeing now, and it also follows a breakdown from the peak.

 

I believe the S&P 500 will follow a similar pattern to the fall from the 2007 peak. How deep we fall will depend on the response from policymakers.

In the short-term, this is a negative for my EUR/USD trade. I’m tempted to raise my stop above 1.3936. Obviously the trade has gone against me despite the difficulties at the EU summit and I’m holding a 68 pip loss currently at 1.3843 but I’m more confident than ever about the overall direction of the risk trade. I may open a long USD/CAD trade to further reflect this.

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Focus on Rumours and Financials

Rumours like the ones we saw today about trouble at SocGen are just the beginning. The three L’s of the rumour-monger are about to take front stage: liquidation, losses, litigation.

The 17% drop in the S&P 500 since the beginning of July is going to generate fund liquidations. Every holding in a funds will get rag-dolled when overall losses in the fund are in excess of 20%. The rumours of withdrawals and liquidations will cause many magnitudes more damage than the withdrawals themselves.

Losses are coming in an economy that is underperforming expectations. As Warren Buffett said: “It’s only when the tide goes out that you learn who is swimming naked.” Financials are especially vulnerable because talk and rumours of losses ALWAYS precede the real thing and cause far more damage.

Litigation is a special ‘L’ in the list because the declines now are coming on the heels of the financial crisis. We are now precisely in the window of time (3-4 years after the event) when lawsuits will peak. Talk of $40-50 billion in lawsuits hitting Bank of America related to mortgage fraud have hit. The desperation in the economy and markets is going to spark others.

We are major believers in following central banks for guidance and with what we heard from the Fed and the RBA in the past 10 days, we think the message is clear. The US is on the precipice of another recession. Now it’s time to sort out who will survive.

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Stocks Have Bottomed But AUD Hasn’t

The S&P 500 will continue to rebound after the post-FOMC rally but forex market risk trades like AUD/USD will underperform as the market adjusts to the zero-growth reality in the United States.

The FOMC decision set off a wild round of trading. In less than two hours, the S&P 500 traded in a 117 point range. Eventually stocks closed at the daily highs and pulled risk trades along for the ride.

Here are some highlights of the FOMC decision:

  • The Fed committed to keeping rates low until “at least through mid-2013”
  • Three FOMC members dissented to ‘mid-2013’ saying they preferred to keep the vague commitment to low rates “for an extended period.”
  • The Fed said growth so far this year “has been considerably slower” than expected. They noted a deterioration in the labor market. There is no longer any mention of “the recovery”. They also noted that temporary factors like the tragedy in Japan account for only some of the recent weakness.
  • Previously, the Fed said it expected the recovery “to pick up” in the coming quarters. It now expects “a somewhat slower” place of recovery. They compounded the downgrade by saying that downside risks have increased.
  • The outlook for inflation was downgraded.
  • The Committee discussed the range of policy tools available to promote a stronger economic recovery… and “is prepared to employ these tools”

The final point was key because it helps explain the rebound in risk assets. It sounds like the Fed has several ideas on how to boost the economy, if need be. The thinking is that after Jackson Hall something will be implemented. This was the course of action with QE2.

To us, a larger factor was the relative value of stocks compared to bonds. After the FOMC, ten-year Treasury yields touched a record low of 2.03%. Dividends on 22 of the 30 stocks in the Dow yield more than 10 years and the average yield is 3.26%. The market tried to bully the Fed into QE3. The Fed didn’t bite (yet at least) so the market took a second look at where it could stash its money and decided risk assets were still a good bet.

That’s the takeaway for the immediate term, but what about the next 4-6 months?

We believe the market is in the process of pricing in a long period of near-zero growth in the US — something akin to the Lost Decade in Japan.

The US government is tapped out and spending cuts will continue no matter the economic state. This will be a headwind to growth, cutting about 0.5% per year from GDP.

The Fed is tapped out as well. There is nothing the Fed can do to lending rates that will stimulate growth. Borrowing rates are next-to-nil and we they don’t have a mandate or the power to get the economy moving.

This scenario may sound negative for stocks but it’s not as bad as it sounds. 1) Companies with solid (A+) ratings can borrow at extremely low  rates. 2) The worldwide economy is growing, booming in some places. Multinationals are making a larger and larger portion of their revenues abroad.

In the forex market, this doesn’t translate into the ‘risk trade’. Slower US growth will hurt commodities more than corporate profits so commodity currencies will underperform. CAD is especially vulnerable because a) rate hikes are priced in. b) Canada is highly integrated with the US. c) raw commodity exports are a large part of the Canadian economy. d) Canadian house prices are overvalued.

The first thing to break down will be the carry trade. This has already begun and will continue as AUD/USD falls to 90-cents. The Canadian dollar will be the next to decline. Traders will increasingly look to emerging market currencies.

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The Debt Ceiling and QE3

Our base case is for a bounce in stocks and USD after a debt ceiling deal is reached. We see a 90% probability of a deal before markets open on Monday and we will continue to trade in that direction.

Our trades were working for us until late in the session Thursday when sentiment worsened after S&P sovereign-rating chief John Chambers re-emphasized the importance of $4 trillion in savings. Both parties are currently proposing less than $3 trillion in savings so it looks more likely that S&P will have courage to cut.

Republicans postponed a vote on Boehner’s debt ceiling plan minutes before it was scheduled, likely because they did not have the votes in their own caucus to pass it. In any case, the legislation had no chance of getting by the Senate or the White House, so the delay could be helpful for negotiations. A vote is expected later in the evening but it is unlikely to move markets.

VP Biden is said to be in talks with Senate Republican leader Mitch McConnell on a deal. McConnell earlier said THE ONLY REAL STICKING POINT between the two sides is a Republican insistence on a two-stage ceiling increase process. We see this as a good sign for our USD/JPY and USD/CHF longs. There are also reports that a short-term debt limit extension may be possible if no agreement can be reached.

The QE3 debate will re-ignite after the debt ceiling and downgrade drama passes. The Fed’s Lacker (voter in 2012) called the US recovery decidedly mediocre but said the factors that have held growth back are beyond the Fed’s control – a signal that he will not support further QE. He said the US doesn’t face a significant risk of growth below 2.75% in the next two years.

Separately, the Fed’s Williams (voter in 2012) said the Fed may need to increase stimulus but that there is a “high hurdle” before he will consider it.

A broad slate of economic data from Japan will be released at 2330 GMT including CPI, employment and household spending. Industrial production will follow 20 minutes later. All the data is for June. It’s difficult to strategize around these numbers because of potential skews from the disaster but overall we expect a straightforward reaction with JPY strength on upbeat growth numbers.

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Bernanke Frustrated With Recovery, No Hints of Action

The US dollar fell and stocks declined for the fifth consecutive day after Fed Chairman Bernanke lamented the recovery and retained a dovish tone. The euro was strong on speculation Trichet will stress inflation risks on Thursday. We look at the warning signals in the bond market and the chance of a double dip.

Sentiment about the US economy continues to deteriorate and it is dragging down the dollar and stocks. The S&P 500 was higher with 1.5 hours remaining in the session but fell and then fell further after Bernanke delivered his remarks. Dollar bulls were hoping the Fed Chair to would dismiss economic weakness as transitory or that inflation was accelerating but Bernanke was cautious and said US growth so far this year is “somewhat slower than expected” and that inflation was a concern but doesn’t see much evidence it is becoming broad-based. Stock market participants were hoping Bernanke would leave the dollar open for QE3 but he gave no hints at further stimulus.

In a separate speech, Atlanta Fed President Lockhart (voter) said there is a high bar for QE3 even though he is “troubled” by the slowing recovery. In order for the Fed to buy more bonds (beyond re-investments) he said there will need to be a dramatic GDP reversal, more unemployment or the risk of deflation.

EUR/USD rose to the highest since May 5 as it pushes up against 1.47. Strong EZ economic data and speculation Trichet will signal rate hikes on Thursday were behind the move higher. The pound also had a strong day while AUD lagged on the dovish RBA.

The bond market continues to flash concerning signals. A three-year auction was very strong and 10-year yields fell back below 3% despite supply later this week. Two year yields fell to just 0.41%. The bond market is flashing signs of more than just a dovish Fed; there is a demand for safety. Indications are also that Treasury dealers are positioned for bond yields to rise. This trade has gone badly against them, which tells us: 1) They will have to unwind the trade 2) Something they didn’t anticipate is happening in the economy (Weakness? Disinflation?)

This is one of the five or so times that the US has looked like it could tip back into recession since the crisis ended. It has proven resilient but this time neither the Fed, nor the Federal government is in a position to provide support. Remember that the bond market moved far before the crisis and that the USD weakened for some time before it became clear that the problems far exceeded US borders.

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