Free Money Trumps Fear Every Time
Here we go again. Just when the bears thought that this time would be different, the global central bankers decided that it was time to hop back up on their white horses. It never gets old, does it?
In an attempt to save the world from the evils of "market volatility," both the ECB and the BOJ have publicly declared war on falling stock prices. This is on top of China's "efforts" to stabilize both their currency and their stock markets.
And then with U.S. GDP coming in on the punk side (the growth rate was just 0.7% in Q4), investors realized that they can probably expect to start hearing dovish verbiage from FOMC members very soon. In short, many analysts believe that the Fed's plan to raise interest rates 3-4 times in 2016 could easily get pushed to the back burner.
So, while the market's focus for much of this year has been on oil (and to a lesser degree, China) Friday's action would seem to suggest that "the carry" trumps the fears related to crude's rude move and the spillover/contagion effects thereof.
Why Do We Care?
The questions investors probably have at this point are, (a) why did the game change on Friday and (b) why should we care about what Japanese or European Central Bankers are doing?
To be sure, stocks didn't follow oil on Friday. And stocks didn't give a hoot about the weak economic data seen here in the U.S. In fact, stocks didn't seem to care about any of the worries that wound up producing one of the weakest January's on record. No, on Friday, the battle cry appeared to be, "Buy 'em!"
It is safe to say that Friday's joyride to the upside was likely driven by short-covering and algo-induced buying. As such, we won't know for several days whether the +2.5% blast was for real. But after an emotional low that was followed by several days of waffling, the bulls contend that Friday was the first step toward a meaningful rebound.
But I digress. The question at hand is why the stock market seems to care so much about the central bankers. The answer can be summed up in 2 little words: the "carry trade."
The What Trade?
For those not familiar, the "carry trade" is a major source of revenue for big banks, sovereign funds, hedge funds - i.e. the biggest of the "big boys" in the global investing community. And at least part of the problem in January was the fact that carry trades of all kinds were going the wrong way.
In a basic carry trade, an investor borrows money in one place and then puts the cash to work somewhere else at a higher yield. For example, a year ago, investors could borrow in the U.S. repo market at 0.15% (15 basis points) and put the money in 2-year governments at 60 basis points (bps), netting a positive "carry" of 45 bps. And if the investor used 5-year treasuries, the carry would be a positive 135 bps. Not bad, eh?
This trade gets even more interesting for foreigners. Global investors can take the game up a notch by borrowing at low rates in a depreciating currency. So for the Chinese, they could borrow at near 0% in the U.S. and then invest the proceeds back home at higher yields. And since the yuan had been appreciating for years, they could count on paying the loan back with cheaper dollars. Bam - free money is a good thing!
However, these carry trades start to blow up when either (a) borrowing costs rise or (b) when the trend of the currency you are borrowing in reverses. So, with the Fed starting to raise rates and the Chinese yuan taking a dive on the surprise devaluation, this particular carry trade started to take on water in a big way.
Capital flows then become the issue as money began flowing out of China instead of in, which, of course, is not a desired result.
In addition, the reversal in the trend of a steadily increasing yuan also makes it more expensive for Chinese companies to repay any U.S.-based debts. Also, not a good thing for economic growth in China.
What this all means from a macro view is this: It is in China's best interest to keep their currency stable.
Back to the BOJ, ECB, and FOMC
But, let's get back to the action of the BOJ, the anticipated action of the ECB (remember, Super Mario has all but promised more QE at next month's meeting), and the idea that the Fed may not be able to raise rates anytime soon.
Cutting to the chase, negative interest rates in Japan, more new capital formation in Europe, and less pressure on U.S. interest rates means more opportunity for carry trades of all colors, shapes and sizes - as well as all kinds of currency games that can be played by global corporations.
So, the bottom line is the idea of more "free money" has trumped fear every time in this era of global bank intervention - aka the "QE Era" - that has been in place since 2009.
Turning to This Morning
Markets are back on the defensive in the early going with only Japan sporting a green screen overnight. The issues are largely the same with oil moving lower, this despite more commentary out of Saudi Arabia regarding the need for cooperation on supply reduction. In addition, the global economic outlook is in the news this morning as China's official PMI remained in the contraction zone for the sixth straight month while Europe's PMI declined from last month's reading. And as expected, the Fedspeak coming out of the US is becoming a bit more dovish as both the Dallas and San Francisco Fed Presidents said over the weekend that things are looking less robust. In response, European bourses are lower across the board at this time and futures here at home are pointing to a decline at the open on Wall Street.
Today's Pre-Game Indicators
Here are the Pre-Market indicators we review each morning before the opening bell...
Major Foreign Markets:
Hong Kong: -0.44%
Crude Oil Futures: -$1.39 to $32.23
Gold: +$7.40 at $1123.80
Dollar: lower against the yen, euro and pound
10-Year Bond Yield: Currently trading at 1.933%
Stock Indices in U.S. (relative to fair value):
S&P 500: -17.44
Dow Jones Industrial Average: -139
NASDAQ Composite: -33.47
Thought For The Day:
When in doubt, just take the next small step...
Here's wishing you green screens and all the best for a great day,
David D. Moenning
Founder and Chief Investment Strategist
Heritage Capital Research
Current Market Drivers
We strive to identify the driving forces behind the market action on a daily basis. The thinking is that if we can both identify and understand why stocks are doing what they are doing on a short-term basis; we are not likely to be surprised/blind-sided by a big move. Listed below are what we believe to be the driving forces of the current market (Listed in order of importance).
1. The State of the Oil Crisis
2. The State of Global Central Bank Policy
3. The State of China's Renminbi
4. The State of the Earnings Season
The State of the Trend
We believe it is important to analyze the market using multiple time-frames. We define short-term as 3 days to 3 weeks, intermediate-term as 3 weeks to 6 months, and long-term as 6 months or more. Below are our current ratings of the three primary trends:
Short-Term Trend: Moderately Positive
(Chart below is S&P 500 daily over past 1 month)
Intermediate-Term Trend: Negative
(Chart below is S&P 500 daily over past 6 months)
Long-Term Trend: Neutral
(Chart below is S&P 500 daily over past 2 years)
Key Technical Areas:
Traders as well as computerized algorithms are generally keenly aware of the important technical levels on the charts from a short-term basis. Below are the levels we deem important to watch today:
- Key Near-Term Support Zone(s) for S&P 500: 1905
- Key Near-Term Resistance Zone(s): 1950-1980
The State of the Tape
Momentum indicators are designed to tell us about the technical health of a trend - I.E. if there is any "oomph" behind the move. Below are a handful of our favorite indicators relating to the market's "mo"...
- Trend and Breadth Confirmation Indicator (Short-Term): Neutral
- Price Thrust Indicator: Negative
- Volume Thrust Indicator(NASDAQ): Negative
- Breadth Thrust Indicator (NASDAQ): Neutral
- Short-Term Volume Relationship: Neutral
- Technical Health of 100+ Industry Groups: Negative
The Early Warning Indicators
Markets travel in cycles. Thus we must constantly be on the lookout for changes in the direction of the trend. Looking at market sentiment and the overbought/sold conditions can provide "early warning signs" that a trend change may be near.
- S&P 500 Overbought/Oversold Conditions:
- Short-Term: Neutral
- Intermediate-Term: Oversold
- Market Sentiment: Our primary sentiment model is Positive
The State of the Market Environment
One of the keys to long-term success in the stock market is stay in tune with the market's "big picture" environment in terms of risk versus reward.
- Weekly Market Environment Model Reading: Negative
Trend and Breadth Confirmation Indicator (Short-Term) Explained: History shows the most reliable market moves tend to occur when the breadth indices are in gear with the major market averages. When the breadth measures diverge, investors should take note that a trend reversal may be at hand. This indicator incorporates an All-Cap Dollar Weighted Equity Series and A/D Line. From 1998, when the A/D line is above its 5-day smoothing and the All-Cap Equal Weighted Equity Series is above its 25-day smoothing, the equity index has gained at a rate of +32.5% per year. When one of the indicators is above its smoothing, the equity index has gained at a rate of +13.3% per year. And when both are below, the equity index has lost +23.6% per year.
Price Thrust Indicator Explained: This indicator measures the 3-day rate of change of the Value Line Composite relative to the standard deviation of the 30-day average. When the Value Line's 3-day rate of change have moved above 0.5 standard deviation of the 30-day average ROC, a "thrust" occurs and since 2000, the Value Line Composite has gained ground at a rate of +20.6% per year. When the indicator is below 0.5 standard deviation of the 30-day, the Value Line has lost ground at a rate of -10.0% per year. And when neutral, the Value Line has gained at a rate of +5.9% per year.
Volume Thrust Indicator Explained: This indicator uses NASDAQ volume data to indicate bullish and bearish conditions for the NASDAQ Composite Index. The indicator plots the ratio of the 10-day total of NASDAQ daily advancing volume (i.e., the total volume traded in stocks which rose in price each day) to the 10-day total of daily declining volume (volume traded in stocks which fell each day). This ratio indicates when advancing stocks are attracting the majority of the volume (readings above 1.0) and when declining stocks are seeing the heaviest trading (readings below 1.0). This indicator thus supports the case that a rising market supported by heavier volume in the advancing issues tends to be the most bullish condition, while a declining market with downside volume dominating confirms bearish conditions. When in a positive mode, the NASDAQ Composite has gained at a rate of +38.3% per year, When neutral, the NASDAQ has gained at a rate of +13.3% per year. And when negative, the NASDAQ has lost at a rate of -8.5% per year.
Breadth Thrust Indicator Explained: This indicator uses the number of NASDAQ-listed stocks advancing and declining to indicate bullish or bearish breadth conditions for the NASDAQ Composite. The indicator plots the ratio of the 10-day total of the number of stocks rising on the NASDAQ each day to the 10-day total of the number of stocks declining each day. Using 10-day totals smooths the random daily fluctuations and gives indications on an intermediate-term basis. As expected, the NASDAQ Composite performs much better when the 10-day A/D ratio is high (strong breadth) and worse when the indicator is in its lower mode (weak breadth). The most bullish conditions for the NASDAQ when the 10-day A/D indicator is not only high, but has recently posted an extreme high reading and thus indicated a thrust of upside momentum. Bearish conditions are confirmed when the indicator is low and has recently signaled a downside breadth thrust. In positive mode, the NASDAQ has gained at a rate of +22.1% per year since 1981. In a neutral mode, the NASDAQ has gained at a rate of +14.5% per year. And when in a negative mode, the NASDAQ has lost at a rate of -6.4% per year.
Bull/Bear Volume Relationship Explained: This indicator plots both "supply" and "demand" volume lines. When the Demand Volume line is above the Supply Volume line, the indicator is bullish. From 1981, the stock market has gained at an average annual rate of +11.7% per year when in a bullish mode. When the Demand Volume line is below the Supply Volume line, the indicator is bearish. When the indicator has been bearish, the market has lost ground at a rate of -6.1% per year.
Technical Health of 100 Industry Groups Explained: Designed to provide a reading on the technical health of the overall market, this indicator takes the technical temperature of more than 100 industry sectors each week. Looking back to early 1980, when the model is rated as "positive," the S&P has averaged returns in excess of 23% per year. When the model carries a "neutral" reading, the S&P has returned over 11% per year. But when the model is rated "negative," stocks fall by more than -13% a year on average.
Weekly State of the Market Model Reading Explained:Different market environments require different investing strategies. To help us identify the current environment, we look to our longer-term State of the Market Model. This model is designed to tell us when risk factors are high, low, or uncertain. In short, this longer-term oriented, weekly model tells us whether the odds favor the bulls, bears, or neither team.
The opinions and forecasts expressed herein are those of Mr. David Moenning and may not actually come to pass. Mr. Moenning's opinions and viewpoints regarding the future of the markets should not be construed as recommendations. The analysis and information in this report is for informational purposes only. No part of the material presented in this report is intended as an investment recommendation or investment advice. Neither the information nor any opinion expressed constitutes a solicitation to purchase or sell securities or any investment program.
Any investment decisions must in all cases be made by the reader or by his or her investment adviser. Do NOT ever purchase any security without doing sufficient research. There is no guarantee that the investment objectives outlined will actually come to pass. All opinions expressed herein are subject to change without notice. Neither the editor, employees, nor any of their affiliates shall have any liability for any loss sustained by anyone who has relied on the information provided.
The analysis provided is based on both technical and fundamental research and is provided "as is" without warranty of any kind, either expressed or implied. Although the information contained is derived from sources which are believed to be reliable, they cannot be guaranteed.
David D. Moenning is an investment adviser representative of Sowell Management Services, a registered investment advisor. For a complete description of investment risks, fees and services, review the firm brochure (ADV Part 2) which is available by contacting Sowell. Sowell is not registered as a broker-dealer.
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Investments in equities carry an inherent element of risk including the potential for significant loss of principal. Past performance is not an indication of future results.
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