Strategic lessons for investors in stock indexes, forex and other global markets, both technical and fundamental outlooks, lessons about what's really moving markets now and what we need to watch in the future.
We look at the technical picture first for a number of reasons, including:
Chart Don't Lie: Dramatic headlines and dominant news themes don't necessarily move markets. Price action is critical for understanding what events and developments are and are not actually driving markets. There's nothing like flat or trendless price action to tell you to discount seemingly dramatic headlines - or to get you thinking about why a given risk is not being priced in
Support, resistance, and momentum indicators also move markets, especially in the absence of surprises from top tier news and economic reports.
Overall Risk Appetite Medium Term Per Weekly Charts Of Leading Global Stock Indexes
Weekly Charts Of Large Cap Global Indexes February 10, 2013 To Present With 10 Week/200 Day EMA In Red: LEFT COLUMN TOP TO BOTTOM: S&P 500, DJ 30, FTSE 100, MIDDLE: CAC 40, DJ EUR 50, DAX 30, RIGHT: HANG SENG, MSCI TAIWAN, NIKKEI 225
Key For S&P 500, DJ EUR 50, Nikkei 225 Weekly Chart: 10 Week EMA Dark Blue, 20 WEEK EMA Yellow, 50 WEEK EMA Red, 100 WEEK EMA Light Blue, 200 WEEK EMA Violet, DOUBLE BOLLINGER BANDS: Normal 2 Standard Deviations Green, 1 Standard Deviation Orange.
- Leading US and European Indexes mostly higher, all maintaining their slow but steady uptrends as continued low rates and supportive central bank policies outweigh the bearish pull of mixed economic data
- Momentum indicators put the odds in favor of further upside
- Indexes continue to close in their double Bollinger® band buy zone
- Moving averages from 10-200 weeks continue trending higher.
- Asian index trends continue to be too diverse for easy generalizations.
Lessons For The Coming Week
Low Yields, Market Calm, Momentum Explain Current Rally, Not Data
Economic data remains mixed, but apparently good enough to keep markets trending higher. US durable goods and weekly new jobless claims beat expectations.
Source: St. Louis Federal Reserve
On the other hand, preliminary GDP and pending home sales missed.
The poor GDP figure was widely dismissed as the result of temporary factors like weather and unsustainably low inventories, both of which suggest a coming rebound in these that will boost Q2 GDP and put the US back into positive territory for 2014. They also noted that consumer spending had held up well despite the bad weather.
One report that typified Wall Street's reaction concluded that:
…final demand - GDP less the inventory component - grew at a 0.6% clip instead of the 0.7% initially estimated. That's not great, for sure, but enough to be basically where we expected to be.
Most European data was weak and below even their modest expectations, but European indexes were up too.
The key point is that stocks are not rallying based on the rather mixed economic data, but rather on low yields supporting demand and a lack of fear factors to chase investors away.
Why Rates Are Falling
We offered our explanation in our special report last week here. We continue to monitor the story but see no consensus, partly due to lack of data, which leaves lots of conjecture but less hard evidence. Marc Chandler offered one of the better collections of hypotheses in the absence of hard data. These included:
- Europeans shifting from European bonds into Treasuries
- A general shortage of lowest risk sovereign bonds that's driving German and other relatively top rated sovereign bond rates lower
Markets Behavior Continues To Suggest Fed Will Be More Dovish
The market is pricing in only ~ 50bp of tightening by the end of 2015. With the taper ending later this year, U.S. yields should be trading at much higher levels.
In addition to reasons we presented last week in our special report, 2014's Biggest New Investment Theme: Lower US Rates For A Much Longer Time, there is plenty of other evidence suggesting that markets are lowering expectations for the pace and extent of Fed tightening.
Note the recent price action in currencies, equities and treasuries
- Stocks: US and most other leading Western stock indexes continue to advance or hold steady, yet any hint of tightening in recent years has sent them lower,
- Bonds: For reasons covered in the above mentioned special report, US treasury debt yields have been falling since the start of 2014, and that trend has accelerated in recent weeks. Marc Chandler offered additional reasons for falling yields in a recent post. These include possible purchases by European banks (as part of their drive to improve capital ratios ahead of coming ECB stress tests) and investors shifting out of European bonds and into US treasuries as the ECB moves into easing mode.
- Currencies: The USD has yet to begin its long anticipated rally versus the EUR, despite the long anticipated rate advantage that was supposed to come from ECB easing and Fed tightening, as well as the continued outperformance of the US economy relative to that of Europe. What little advances it has made in recent weeks versus the EUR have come solely from EUR weakness resulting from growing expectations of ECB easing. The USD has also failed to advance much against other major currencies, even on days when the US economy posts strong top tier data, as we saw last Monday when we had solid durable goods, consumer confidence, and housing reports. Markets realize none of these are likely to change fed policy.
Slow growth and low inflation (and leaks that the former Fed Chairman Bernanke sees more of the same ahead) reinforce the above evidence that has markets believing that the central bank won't be raising interest rates anytime soon.
Indeed, if growth and inflation data don't improve, the central bank could even halt the tightening process. Rather than continuing to cut its treasury and mortgage bond holdings, it could reinvest proceeds from maturing Treasuries and mortgage bonds into new ones to keep rates low and thus provide continued support for the recovery.
EU Parliamentary Elections: No Short Term Impact But Longer Term Warning
While many in the media used terms like "political earthquake" or "seismic elections" to describe the gains by anti-EU parties, it's unlikely there will be any near term effects on EU policy or the EURUSD, and may well be little in the way of longer term effects. Financial markets' certainly showed no discernable concern.
The big concern is that now needed further steps towards integration and centralized EU control over national banks and budgets (demanded by Germany and other funding nations as the price for their participation in funding risk sharing plans).
· The old guard itself has remained ambivalent about yielding meaningful sovereignty. The recent underpowered and underfunded EU banking pact is only the most recent example.
· Centrist parties (of both right and left wing orientation) are still dominant, as talks on choosing a new EC President and Commission should reveal as they begin this week.
· The anti-EU parties are a disparate group of national parties with no unified agenda.
· Although we've long held that EU voters and most of their leaders are not ready to commit to becoming the US of Europe, even the nationalist voters showed no clear opposition to some version of the EU.
· The ambivalent 43% voter turnout is hardly a clear call for change, and indeed suggests that the nationalist parties benefited more from the protest vote than anything else, particularly in France. A majority of Ukip voters in the UK appear to favor remaining in the EU.
Longer term, the elections were an obvious warning that the EU needs to produce tangible economic benefits and show it can cope with financial crises and recoveries at least as well as traditional currency unions that have fully functioning federal governments and reasonably unified regulation over their economies.
Time To Start Watching Japanese Inflation Figures?
Although Japan's taper exit from its own stimulus program remains far in the future, its expectations management team has apparently begun to prepare markets for that very eventuality.
Last week a Reuters report citing current and formal BoJ officials saying that "internal, informal discussions" were underway about how and when to start its own taper is likely the unofficially sanctioned beginning of that process. The BoJ is not known for its transparency or for rogue leaks, and it's understandable that it would want to begin the process gradually with these kinds of trial balloons.
The timing of such a move is both risky and extremely sensitive for Japan.
· There is no clear plan B to end 20 years of deflation and stagnant growth if Abenomics fails, and Japan has already been accused of blowing its last recovery with premature tightening.
· Also it no doubt wants to avoid the confusion that could lead to a repeat of the Fed's "taper tantrum."
Not surprisingly then, the article is careful to note that these same anonymous sources say there are no plans to taper any time soon.
BOJ Governor Haruhiko Kuroda has promised to maintain the flow of cheap cash until his 2% inflation target is locked in.
Yet in April, BoJ BOJ Governor Haruhiko Kuroda surprised markets by saying the BOJ's massive easing has boosted demand enough to essentially eliminate any slack in Japan's economy.
Then at a late May news conference, Kuroda went further, emphasizing that demand has been revived and the next step was for his "third arrow," economic reforms. These include the removal of supply bottlenecks by bringing more women into the workforce and making it easier to start new businesses.
After 13 months of Abenomics' pumping out $589-687 billion per year with inflation now over 1% and signs that the economy has survived last month's sales tax increase, Japanese central bankers know they need to plan a taper in order to avoid risk of inflation going beyond 2%.
Death By Inflation Risk
Japan has ample reason to worry about keeping its stimulus going for too long. Inflation much over 2% could be as bad or worse for Japan, which carries the highest debt/GDP of any developed nation (heck, its higher than that of many EM nations). Even with some of the lowest borrowing costs in the world, (yields on 10 year JGBs are only 0.6% versus about 2.5% for the US) Japan's debt service expense already consumes ~25% of its budget. A mere rise to 1.2% yield would suggest debt service costs consuming about 50% of Japan's budget. Yes, Japan can print, and it has, but at the risk of losing confidence of credit markets and eventual hyperinflation if it can't figure a way out when its 2% inflation target approaches.
Since the start of its huge asset-buying scheme in April 2013, the BOJ has bought about 70% of newly issued government debt, including nearly all new 10-year benchmark bonds sold by the government.
No one believes that's sustainable.
So watch Japanese inflation figures. As CPI breaches 1.5%, look for more signs and signals about a coming taper.
A taper could spark a selloff in Japanese and other Asian stocks and send the JPY soaring on anticipated higher benchmark rates, thus hurting Japan's export driven recovery.
Given the Fed's difficulties in tightening, we're unlikely to see Japan tighten as quickly as it would like, but we can expect some real volatility for stocks and the Yen.
China Also Having Stimulus Withdrawal Troubles
As we wrote about here last week, the Fed's planned tightening may be slowing. Apparently so has China's. After trying to cut its debt bubble, China reverted a mini-stimulus to ease its slowdown. Last week, Bloomberg reported that this program has ballooned into a larger stimulus.
See here for details.
Likely Market Movers For The Coming Week
See here for our preview of the likely market movers for the coming week and beyond, including a review of what could be the most market moving event of the year thus far.
To be added to Cliff's email distribution list, just click here, and leave your name, email address, and request to be on the mailing list for alerts of future posts. For information on a free intro to currencies video course based on my award winning book, see here.
Disclosure/disclaimer: No positions. The above is for informational purposes only. All trade decisions are solely the responsibility of the reader.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.