In terms of actual scheduled economic calendar events, the week is light. That will leave traders and pundits alike with time to continue speculating on variations and aspects of The Great Question - how much can we trust the current bull market in stocks and other risk assets to continue, and is there still time to get it without excessive risk of buying at them top? See here (section: The Most Compelling Reason To Be Bullish On Stocks & Other Risk Assets) for our take on whether it's still safe to open new long positions.
For all but the short term traders, all else is just commentary.
Drawing from lessons of the prior week, which we covered here, as well as other sources, we'll briefly review what high-potential market movers you should monitor this week. We conclude with a few recommendations, and our updated forecast for the second half of 2013. Like our weekly forecast, this focuses on the big market movers that affect most major global markets and asset classes, and so should be relevant to all.
Continued Speculation On Fed Tapering Plans: Is It Real? Will It Matter?
Each time we've had a major article or statement suggesting the that the Fed is leaning towards at least a gradual start to winding down its stimulus program, markets have moved because, right or wrong, it's widely believed that:
- QE has been the prime support for stock and other risk asset prices, including banking stocks, house prices, and related industries
- QE is USD dilutive, that is, more of it drags the USD lower, while hints of tightening send it higher. As we discuss at length in The Sensible Guide To Forex, US dollar movements have profound but often under-appreciated affects on global markets. Just a few simple examples include:
- The USD is involved over 80% of all currency transactions, and is the primary trading counterpart for every other major currency and currency pair. So its movements profoundly affect currency markets, which in turn profoundly affect prices for just about everything in international trade. Its movements send corporate planning departments scurrying.
- Much of the huge Japan stock rally is based on an assumption of an increasingly cheap Yen vs. the USD.
- Commodity prices are still based mostly in USD and so changes in its trend commodity prices and thus based economies.
This week could provide further clarification or obfuscation about the Fed's direction.
Here's a list of the voting members of the FOMC (Federal Open Market Committee of the Federal Reserve Board) in 2013: Note how many are speaking this week, and that in addition to that there are two notable Fed events.
Ben S. Bernanke, Board of Governors, Chairman - Voting member giving semi-annual testimony on the Fed's economic and policy outlook Wednesday, and FOMC meeting minutes also issued. If the Fed is going to make a clear statement about something, this is the likely day for it.
William C. Dudley, New York, Vice Chairman - Voting member, speaks Tuesday
James Bullard, St. Louis - Voting Member, speaking Tuesday
Elizabeth A. Duke, Board of Governors
Charles L. Evans, Chicago - Voting member speaking Monday
Esther L. George, Kansas City
Jerome H. Powell, Board of Governors
Sarah Bloom Raskin, Board of Governors
Jeremy C. Stein, Board of Governors
Eric S. Rosengren, Boston
Daniel K. Tarullo, Board of Governors
Janet L. Yellen, Board of Governors
In sum, 4 voting members of the FOMC plus Benanke's semi-annual testimony to Congress and Fed meeting minutes release. Whatever the Fed wants us to believe, it will be clear by the end of Wednesday, and it could intensify or quell speculation about the timing and extent of QE tapering. Given the US dollar's impact on almost every major global market, there is plenty of market moving potential here.
That said, until the US economy shows signs of a more robust recovery and/or looks like it's approaching at least one of the Fed's stated metrics for cutting back on QE, we expect at most a gradual tapering that does not materially change US monetary policy. Still, if markets believe the process as definitely begun, the anticipation factor alone could still boost the USD.
Would it pressure stocks? As we noted here, as long as upward momentum remains strong, markets have shrugged off bad news, or dipped briefly and bounced back as entrenched optimism brings in the buy-any-dip crowd.
Other Central Banks Also Active
Given the otherwise mostly quiet calendar, other major central bank activity this week has added market moving potential, at least for their regional markets and local currencies. These may be relevant on a more global scale to the extent that they make the Fed look relatively more or less hawkish. More hawkish brings a higher USD.
Worth watching (in addition to the above Fed activities):
- Tuesday: RBA (Australia) policy minutes
- BOJ (Japan) policy statement, BOE (NASDAQ:UK) monetary policy meeting minutes. Japanese stocks have come so far over the past months based on assumptions of a falling JPY) that some believe they are now overvalued. If so, and if the BOJ is in fact striving to stimulate spending via the wealth affect of rising stocks, then it will need to continue driving the JPY lower.
- Also SNB (Switzerland) Chairman Jordan speaks. Why does this matter? The CHF was the reigning safe haven currency until the SNB intervened to weaken it against the EUR. With Japan debasing the JPY, the USD rising as the Fed is now seen as relatively hawkish, will the Swiss consider backing off on intervention? Not likely, given the EUR's continued downtrend. The EU is Switzerland's prime export market and they seem determined to keep Swiss exports competitive by debasing the CHF.
So why does this matter? Of the three classic safe haven currencies, only the CHF has arguably the healthiest economy, making it a truly deserving safe haven. When the Swiss eventually decide to let the CHF find its true market rate, it's likely to rise and once again make Swiss assets, especially Swiss income producing assets, a worthy option for those smart enough to diversify their assets and passive income stream by currency exposure as well as sector and asset type. For investors based in EUR, USD, JPY, and other currencies at risk of debasement, CHF assets are something to seek when the price is right. A protracted rising USD would be a real opportunity for US investors to pick up some Swiss assets on sale.
Is USD Rally Durable?
There are a few other factors behind the USD rally and all its ramifications for other markets. See here for a quick look at the most important of them, and their likely durability.
One key point is that US dollar based investors should use periods of dollar strength to diversify their exposure into assets linked to harder currencies, especially income producing assets. See here for what has happened to those who neglected to do so over the past decades (hint: the past 30 years have not been kind to those based solely in USD).
Watch The Ongoing Debate on Risk To Japan
As we discussed here in the section on Japan: Land Of The Rising Yields & Implications, the risks of Japan's current policy are well known, but there is much serious debate about how real or imminent they are. Japan is the third biggest economy in the world, so perceptions about Japanese stability are as essential to market stability as they are for the US or EU.
Ongoing Upward Momentum For Stocks And Related Risk Assets
As we noted here (in the section: Is It Still Safe To Enter This Rally? The Most Compelling Reason), now that so many major global indexes have broken past 5-10 year resistance and continue hitting historical highs despite a comparably weak global growth and earnings prospects, market momentum appears to have taken on a life of its own, as long as there is no material reduction in stimulus.
When an uptrend is this old and this strong, there is an equally strong reluctance to open new long positions in risk assets (or shorts for safe havens) due to the fear of buying too late. We discuss an extremely useful indicator for resolving that fear, especially when markets are at historical highs and there is no established resistance or support to use for reference. For background on that, see 4 Rules For Using The Most Useful Technical Indicator, Double Bollinger Bands. It isn't often that I claim a single 15 minute read will make you a materially better investor or trader. This article will do that. If you're not familiar with double Bollinger bands, read this one.
So what do we make of the coming week's likely market movers?
Valuations? In The Eye of The Beholder
Last week brought a number pundits saying no, and that their measures of stock valuation did not show them to be overprice. As we covered here:
David Tepper emphasized that the risk equity premium suggests stocks are cheap when measured against government bond yields (which are at historical lows due mostly to QE).
Josh Brown pointed out that this market is not making the valuation errors made in 1999 (dot-com bust ignoring valuations of tech companies) or 2007 (mistaking sub-prime and contagion risks).
However, comparing stock returns to historically low bond yields is not particularly reassuring unless you believe these yields will stay low. So pay attention to the Fed utterances next week, especially those from Bernanke, for clarification on when and how the Fed plans to taper off QE, if at all.
Nor is the assertion that we aren't making past stupid mistakes any assurance that we aren't making other, ahem, omissions in our thinking. Consider just two points:
- Global economic and earnings growth is tepid at best, and even the US recovery is still quite weak overall. See here for a good summary.
- The EU crisis remained quiet and likely will continue to until after Germany's elections in September. Meanwhile the region remains overall mired in recession or worse, and nothing has been fixed to restore competiveness or even prevent a repeat crisis. So far they've just bought time on a combination of sheer bravado and PR, and more lending to those who can't repay, funded with printed money. The EU risks are still there and if they return, the debt bill will be bigger than ever.
- We have plenty of black swan event risk, mostly from my neighborhood here in the Mideast. Our neighbors were willing to go to war to prevent any kind of state, and to wipe it out even before there were any 'occupied territories.' Still, at least there was usually some badass who was at least in control of his side of the border. Except for Jordan, that's no longer the case.
Does this seem like a logical foundation for new highs?
Momentum: Has Taken On A Life Of Its Own
Have we seen the return of Irrational Exuberance?
Whether you believe the new highs are from central bank manipulation (heck even Tepper's equity risk premium argument suggests it - how did those bond rates get so low) or from something else, still the trends are strong, and we never fight them, no matter how compelling our theories.
The ongoing extremely strong technical trend has brought a seemingly self-perpetuating uptrend. Market make minimal down moves on bad news, and jump on good news days. Dips are quickly bought with a matter of days. It's been an exceptionally long time since we've had any kind of even normal bull market correction (end of 2012 due to debt ceiling uncertainty).
Most popular measures of fear are at long term lows. Extreme sentiment tends to be mean reverting, meaning excessive complacency often indicates we're about to get whacked. However such sentiment indicators are notoriously hard to time, so just beware that corrections happen.
At minimum, place some stop losses under every reasonably liquid position you have. However, if you own relatively illiquid assets, you'll need to weigh benefits versus risks.
Here's what I mean. Let's say you own a lovely Canadian stock or US based MLP with a high yield, some risk to its revenue stream, and relatively low daily trading volume. Unless you place your stops at considerable distance (and risk absorbing a bigger loss before they're hit) you run the risk of losing you stock due to a random large sell order or less than pure-hearted market maker. The stock price is relatively easy to move.
What About The Second Half of 2013?
As we approach the second half of 2013 our forecast remains unchanged in essence from the one we put out in January. The durability of the current rally depends on its prime supporting pillars remaining in place:
- Stimulus continues much as is. That means piles of yield seeking cash have no place to go but risk assets.
- No outbreaks of contagion from the EU: That keeps the cash from fleeing into low yield safe havens.
Watch the Fed, watch Europe, watch Japanese bond yields. Be ready for a correction, at least a normal 10-15%, possibly something more.
Disclosure/disclaimer: No positions. The above is for informational purposes only. All trade decisions are solely the responsibility of the reader.