Part 1 of Weekly Review/Preview: Prior Week Market Movers & Their Lessons For the Coming Week
There were only two really market moving events last week, both on Wednesday. In keeping with the current dominance of government policy over the markets, both came from the two most influential central banks.
- The ECB’s LTRO operation to provide cheap liquidity to cash starved EU banks. In theory this should have been good for stocks because it adds liquidity that should boost stock prices. In fact stocks fell because the large number of banks participating (~800) suggested widespread liquidity trouble at smaller EU banks. Also, LTRO should have hurt the EUR, which it did, because like the US QE programs, it threatens to dilute the EUR’s value and promote inflation.
- Fed Chairman Bernanke’s semi-annual monetary policy report before the House Financial Services Committee, which reduced expectations for QE 3. As expected, that both hurt stocks (because it meant less cash available to boost stock prices) and boosted the USD vs. the EUR and other major currencies because it reduced the chances of another QE program boosting the supply of dollars and weakening their purchasing power.
The two events reinforced their similar effects on market sentiment, reversing the ‘risk-on’ trend prior to Wednesday. The rally in most risk assets stalled, and the USD index moved higher the rest of the week for its biggest weekly gain this year, and possibly forming a bottom in its downtrend from the start of 2012.
Lessons & Ramifications For Coming Weeks
Here’s why the odds favor a pullback in most risk assets, including the EUR, and rally for most safe-haven assets, including the USD.
Fundamental And Technical Factors Favoring A USD Rally
Fundamental: The ECB is in easing mode, increasing the supply of Euros, whereas the Fed is not easing further at this time given the recent improvements in jobs (with many, like SocGen, expecting this trend continue) and GDP. The LTRO and latest Greek bailout (if it in fact passes) have done nothing but defer for a few months both the liquidity problems in EU banking and contagion risks from a widely anticipated coming Greek default. Both are highly negative for the EUR, and thus positive for the USD regardless of the dollar’s own fundamental picture. Remember, because the EURUSD trade is about a third of all forex volume, about a third of the cash from EUR sales goes to buy dollars, and vice versa, so the two currencies move each other in opposite directions like children on a seesaw.
The potentially most bullish factor for stocks and other risk assets could be the cash released from the LTRO, but thus far liquidity has not found its way into risk assets but rather into ECB cash accounts and short term sovereign debt of 3 year maturities or less that are effectively subsidized by the LTRO program.
Technical: The S&P 500 monthly chart shows that this bellwether risk sentiment measure has now fully retraced its May-August pullback and now, at nearly 1370, (labeled B) is at highs not seen since June 2008.
S&P 500 MONTHLY CHART AUGUST 2007- PRESENT, COURTESY globalmarkets.anyoption.com 01 mar 04 0204
This suggests, barring some potent upside surprises, that the risk asset rally is due for some kind of pullback even before considering what happens if the ISDA rules Greece to be in default (see Part 2 of this post on the coming week’s likely market movers for details). The recent rally’s low volume also suggests some kind of pullback is coming.
Admittedly, the S&P 500 (and other risk assets) are in a multi-week uptrend, and the S&P’s monthly, weekly, and daily charts show the index remains within its Double Bollinger Band Buy zone. That means we the trend should be deemed alive and well from a purely technical perspective. However fundamentals ultimately drive technical performance, and the fundamental context for risk assets is not encouraging as long as so much uncertainty looms on Greece next week (see Part 2).
What To Do?
We’re avoiding new long positions in risk assets and the EUR. However we’re not taking new shorts in them, or long USD positions, until we have confirmation of a trend reversal on daily charts, our shortest preferred trading time frame.
The same message holds for longer term passive investors (who use support and resistance levels on weekly or monthly charts to determine entry and exit points) in dividend stocks used for income, especially currency-diversified income. For further details on building an income stream that’s diversified among the strongest dividend paying stocks in currencies with strongest long term trends, see my coming book, The Sensible Guide To Forex: Safer, Smarter Ways to Prosper from the Start (John Wiley & Sons, 2012) and see the Book Description for details. My profile page on seekingalpha.com and linkedIn.com (under Projects or Publications) has further details.
The Picture For Gold and Oil Is Less Clear In The Near Term
Gold: Gold is neither risk nor safe haven asset, but rather a currency hedge. In the short term it’s being pulled by conflicting forces – the threat of EU and EUR weakness from the LTRO and Greece on the one hand (bullish for gold), and the threat of USD strength on the other (bearish for gold). Low inflation is bearish for gold, but two possible near term scenarios would be very bullish for gold should they occur.
High fear/panic levels from spreading contagion. That would likely start with either a Greek default or failure of the ISDA to rule that such a default triggers CDS (default insurance) payments. Either could send the bond yields of other GIIPS nations spiking in response to the greater risk now associated with these bonds, as was the case in July when haircuts for Greek bondholders were first officially introduced.
Meanwhile, its 20 week EMA, which has served as reliable support for about 3 years, continues steadily higher, suggesting no threat to its long term uptrend.
Oil: Oil is not nearly the pure currency hedge that gold is, rather its price is driven by a combination of both demand for hard assets and oil’s specific supply/demand picture, which is being influenced by tensions with Iran, and periodically other geopolitical concerns from major oil producers.
Disclosure/disclaimer: No positions. The above is for informational purposes only. All trade decisions are solely the responsibility of the reader.