Cliff Wachtel's  Instablog

Part 1 of Weekly Review/Preview: Prior Week Market Movers & Their Lessons For the Coming Week

The following is a weekly summary and strategy guide for traders and investors, covering prior week's market movers and their lessons for the coming week for traders of all major asset classes via both traditional instruments and binary options. See Part 2 for coming week market movers

Markets opened the week closing higher due to Fed Chairman Bernanke's downbeat assessment of the US economy. It was a case of bad news is good news, because that raised expectations for new stimulus, which is the only thing justifying current risk asset prices, many of which are at multi-year highs. An unexplained late surge Friday allowed most major indices to close the week with modest gains.

However for most of the week the big story was renewed fears of contagion from Spain, and to a lesser degree, Italy and Portugal.

No big surprise here, because everyone knew the lull in the EU crisis was temporary. The ECB's LTRO program addressed short term bank liquidity. It did nothing to address the root causes of the crises: debt loads that the GIIPS cannot hope to repay without a sudden and sustained spike in their growth. However the austerity measures imposed on them by the EU have these nations in a death spiral of declining or negative growth that makes default only a matter of time.

Here are the three reasons the EU crisis is likely to come roaring back shortly.

Most of the bad news focused on too-big-to-bail Spain. The latest bad news included:

• Monday: Italian PM Monti says Spain could reignite the EZ debt crisis. News that Spain's ruling party lost a weekend regional election doesn't help the dour mood, and Spanish stocks dive while other EU indexes rallied on hopes for more US stimulus.

• Tuesday: Spain reported a budget deficit of €20.7B for the year's first 2 months vs. €9.3B last year. This works out to 1.94% of GDP, or an annualized pace near 12% of GDP. The Bank of Spain announces Spain is again in recession after negative growth in Q1, further complicating government efforts to meet an EU mandated deficit target of 8.5% of GDP. Spanish stocks again are Europe's worst performers of the day -1.1%.

• Wednesday: A note from Citi Bank's Chief Economist Willem Buiter forecasting that Spain will need to seek troika aid this year ignites further market anxiety. Spain's Banca Civica, which had been considered one of the more stable regional banks, was taken over by Caixabank, which wrote down the bank's former book value of €2.8 bln to zero due to the large proportion of bad loans on its books. This confirmed the view that these troubled regional banks are hiding even worse problems. Spanish stocks are Europe's worst performers for the third straight day down 2%.

• Thursday: Yields on Spain's benchmark 10 year bonds rise 11 bps from the start of the month.The Wall Street Journal reports that the LTRO program, which was supposed to provide EU banks with 3 years of liquidity, "could evaporate in 3 months" because low share prices prevent Spanish banks from raising capital, which may force them to sell their recently purchased Spanish government bonds and reignite a wave of reselling. That would threaten a new spike in GIIPS borrowing costs that could force the ECB to buy up more shaky GIIPS bonds in order to stabilize their prices and prevent a contagion.

Meanwhile, as of Thursday Italian benchmark 10 year bond yields were back up to 5.25%, Italian stocks were diving over 3%, with trading suspended for one Italian bank

Cumberland Advisors' David Kotok reported from his trip to Portugal that the situation there is "unraveling," similar to what has happened earlier in Greece. Specifically he cites:

• Runs on Portuguese banks.
• The cost of insuring Portuguese sovereign debt soaring because investors fear that a CAC (collective action clause that is in essence forces bondholders to accept losses) can be imposed on them as it was on Greek bond holders.

As we've written in the past, the use of the CACs as a retroactive rule change is a game changer. The EU has officially bitten the hand that feeds it, namely the global credit market. If EU governments are now more likely to reduce previously agreed upon returns, bond buyers will need higher returns to accept that added risk. Recent ECB intervention has prevented yields from spiking thus far, but at some point that added risk will be reflected by significantly higher borrowing costs.

As noted above, Fed Chairman Bernanke's downbeat outlook on the US economy ironically lifted stock and other risk asset markets Monday because they raised hopes for more Fed stimulus. With the threat of EU contagion, plus lackluster data, growth, and earnings expectations for 2012-13, yet stocks at multi-year highs, apparently investors believe that more stimulus is the only thing keeping markets from falling hard. The current operation twist is due to end in June, so investors are eagerly awaiting signs of what will replace it.

The next day Fed Governor Bullard dampened these expectations, and that helped send markets lower.

Here's a quick listing of other events that were important but did not move markets. The most significant development from these mostly EU and EUR negative events was that they had no visible effect on markets, which for now have gone mysteriously numb to bad news from the EU and the ample evidence of more trouble to come. The EURUSD and major stock indexes closed higher Friday for the day and the week.

The much anticipated meeting yielded the minimum expected increase in the available emergency bailout funds to about €800 bln, less than the expected € 940 bln, and well less than the €1 trln minimum needed per the OECD. This minimal figure confirms the widespread belief that the EU's commitment to preventing contagion is not to be trusted, and is likely to come back to haunt it at some point.

Theoretically good news because at least in the short term Spain showed it's trying to be a fiscally responsible EU citizen. Its revised deficit target of 5.3% of GDP was higher than the 4.4% demanded by Brussels, but still better than what had been threatened earlier this month. The likely reason for the lack of market reaction is the minimal correlation between what Spain says and what it actually does, as well as a lack of details regarding coming corporate tax hikes.

Per a Wall Street Journal report last week, ahead of expected elections the combined strength of fringe parties ranging from Communists to neo-Nazis in recent polls is ~50% vs. 35-40% for the establishment parties, New Democracy and Pasok, which took 75% of the vote in the prior election. This threatened political splintering raises risks that Greece won't be able to stick to the austerity needed to stay in the EZ.

Per a CNBC report, earnings projections suggest a dismal earnings season, coming after a mediocre Q4 2011 season. Alcoa's announcement on April 10th marks the traditional start of earnings season.

The key features of last week, their ramifications and lessons, include:

Global stock indices, oil, and other risk assets remain near multiyear higher despite threats of EU contagion, likely slowing growth in virtually all major developed world economies, and lackluster predictions about earnings season. That leaves them vulnerable to pullback. That implies a bias going forward to safe haven assets. What currencies should they be denominated in? Frankly it's not clear to me.

1. USD: the only one whose central bank isn't actively intervening to keep it down, or at less actively intervening than the BoJ or SNB for the JPY and CHF. Threat of additional stimulus, growing deficits is stronger because we're in an election year.

2. CHF: the only safe haven currency backed by an economy that doesn't have excessive debt/GDP and so in theory a better store of value. Downsides include a central bank keeping it low for now, and it's tied heavily to the troubled EU, which is Switzerland's prime export market.

3. JPY: Worst debt/GDP in developed world by far at around 200% (Greece has ~ 160 % debt/GDP). Japan has gotten away with this and can borrow cheaply because of its very positive current account that makes it a safe bet to repay its bonds even without money printing. Strong domestic demand for Japanese government bonds has also helped keep borrowing costs low for Japan. Both of these conditions are weakening, as exports slow and its aging population of savers (the oldest in the developed world with 25% over age 65) is buying fewer bonds and selling more to fund retirements. Future of the JPY is arguably the bleakest of the three safe havens.

Given the above EU troubles, a dovish Fed in an election year, and slowing global growth while much of Europe slides into recession, and most major central banks pursuing inflationary policies, (though inflation risk remains low while growth is low) it's hard to be excited about any of the traditional safe haven or other major currencies. Assets denominated in the currencies of more fiscally sound nations like Canada, Sweden, Norway and Singapore are an option, but scouting them out requires some extra work, and with stock markets as high as they are, and bond yields so low, where does one turn?

I'm curious to hear your input, dear readers.

Virtually every major central bank is trying to inflate away its debt problems via historically low rates and continued stimulus programs that threaten the value of their currencies and anything denominated in them, including your assets. We all need currency diversification just as we need asset and sector diversification. However traditional currency trading doesn't work for most investors. The best help I can offer you is THE SENSIBLE GUIDE TO FOREX, SAFER, SMARTER WAYS to SURVIVE and PROSPER from the Start. It's the first book to show how both prudent active traders and long term investors with limited time and risk tolerance can tap forex markets to hedge currency risk and improve returns. See my profile page or the above link for details.

Call this naked promotion, but I feel like the guy selling lifeboat reservations on the Titanic.

DISCLOSURE /DISCLAIMER: THE ABOVE IS FOR INFORMATIONAL PURPOSES ONLY, RESPONSIBILITY FOR ALL TRADING DECISIONS LIES SOLELY WITH THE READER. IF WE REALLY KNEW WHAT WOULD HAPPEN, WE WOULDN'T BE TELLING YOU FOR FREE, NOW WOULD WE?

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Part 2: Coming Week Market Movers

The following is Part 2 of our weekly review and preview strategy guide for traders and investors of all major asset classes via both traditional instruments and binary options, covering coming week's market movers and trade ramifications.

See Part 1 for prior week market movers

Early in the week we may see some delayed reaction to the meager boost to the EU firewall weigh on markets, particularly in regard to the EUR and EU stock indexes.

Beyond that, assuming the concerns on the EU remain mysteriously subdued, a typical packed start of month economic calendar should provide most of the market moving events.

This week, we will get significant updates on Chinese, EU, UK, Aussie, and U.S. economic performance. With recent US data disappointing, we'll see whether the US recovery has really lost momentum.

• PMI figures for China, the EU, UK, US, and Canada. China's are expected to show further declines. That may explain why markets ignored signs of improvement from Australia last week
• Minutes from the most recent FOMC meeting.
• Aussie trade and retail data
• Rate statements from the RBA, ECB, and BoE. The first two offer the most potential for insights into future policy
• Friday brings the US monthly non-farm payrolls report and is the most important update on the state of the US recovery. Given the uptick and revisions in jobless claims, there is a very good chance job growth slowed in March. Note that US and some EU markets will be closed for Good Friday, so reaction to the jobs reports may be delayed until Monday.

Consult any good economic calendar like that of forexfactory.com for detail about each event.

Also, keep an eye out for more early reports about Q1 earnings season. Last week CNBC reported that projections for earning growth were looking very grim. Expect reports forecasting earnings season to appear more frequently. They will be important next week, and could begin influencing markets this week too.

Given the strength of the week's calendar, volatility in the coming week should increase and could well take us beyond recent trading ranges in major stock indexes and major currency pairs, particularly the EURUSD.

The most bullish news we had last week came Monday when Fed Chairman Bernanke's comments raised hopes for new US stimulus, and so sent markets higher because apparently that's the only reason risk assets might justify higher prices - government easy money policy rather than actual improved growth prospects.

Central bank policy remains arguably the single biggest short term market driver in most major economies and for most major currencies.

The problem is, virtually every major central bank "policy" involves trying to inflate away its debt problems via historically low rates and continued stimulus programs that threaten the value of their currencies and anything denominated in them, including your assets. We all need currency diversification just as we need asset and sector diversification. However traditional currency trading doesn't work for most investors. The best help I can offer you is THE SENSIBLE GUIDE TO FOREX, SAFER, SMARTER WAYS to SURVIVE and PROSPER from the Start. It's the first book to show how both prudent active traders and long term investors with limited time and risk tolerance can tap forex markets to hedge currency risk and improve returns. See my profile page or the above link for details. Is this naked promotion on my part? No more so than it would be for the guy selling lifeboat reservations on the Titanic.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Part 1 of Weekly Review/Preview: Prior Week Market Movers & Their Lessons For the Coming Week

The following is a weekly summary and strategy guide for traders and investors, covering prior week's market movers and their lessons for the coming week for traders of all major asset classes via both traditional instruments and binary options.

The biggest market moving event this past week was the absence of spiking GIIPS bond rates in reaction to the prior week's Greek default. That calm allowed risk assets to break higher after being tightly capped for the past 4 weeks, as shown in the S&P 500's weekly chart below (ellipsis B).

S&P 500 WEEKLY CHART MARCH 2011 - MARCH 2012

Courtesy of metaquotes software corp. and the sensibleguidetoforex.com

02 MAR 18 0050

Given that the ECB's LTRO operations to keep EU banks liquid have done nothing to address the more fundamental solvency problems of the GIIPS and their banks, we believe that this first default of the EU crisis will not be the last, neither for Greece nor the rest of the GIIPS. Bond markets will eventually remember this and send GIIPS sovereign and bank borrowing costs higher to compensate for this risk. That spike in bond yields will signal the next phase of the EU crisis. It's unclear when that will happen, but given the recent struggles of just Portugal and Spain, along with the EU's inability to fund a firewall large enough to discourage speculative attacks on GIIPS bonds, it's only a question of if, not when.

Back in July 2011, the mere threat of haircuts sparked a new phase of the EU crisis. So why then, did credit markets decide to forget that the EU had just allowed the hand that fed it to be bitten? Certainly part of the reason is that the news was already priced in, but that was also the case last July, though perhaps to a lesser extent. We suspect part of the explanation involves:

• sheer fatigue about the Greek issue
• a desire to test recent resistance like the 1360 level on the S&P 500

However these reasons are pure speculation on my part?

Ideas, oh esteemed readers? I'm open to your input and I'm sure the rest of the readers would be interested.

With EU worries on hold, once markets absorbed China's poor trade deficit report Monday, risk assets spent the rest of the week moving higher, with the bellwether S&P index finally breaking past resistance of the past month at 1360 to reach 4 year highs. The driver behind the move was a batch of overall positive data that is likely to have only short term influence, but was good enough to make the rally happen. The main risk appetite drivers were:

1. Tuesday: better than expected German ZEW survey, US core retail sales (which confirmed that the up-trend in US jobs was real and helping US spending and thus US GDP), and positive US bank stress tests results.

2. Wednesday: The positive momentum and Italian bond auction allowed markets to suffer minimal losses despite downbeat remarks from the Chinese Premier Wen Jiabao on home prices and news of the 4 US banks that failed the stress tests.

3. Thursday & Friday: Firm readings on US jobs and manufacturing Thursday allowed for modest gains and most major indices closing up 2% for the week.

Here are the big take-away lessons from last week.

As long calm prevails on the EU, barring any nasty surprises like a war with Iran, markets will be moving on week to week data. This week's calendar is a typical light mid-month affair, unlikely to spark major moves either way. However with both major stock indices and other risk assets at multi-year highs and little fundamental fuel for further moves higher, we could see markets succumb to some profit taking.

The USD index has been trending higher for the past 3 weeks, as part of a larger uptrend that began in August 2011. Its continued rally in recent weeks, along with other risk assets, has been a key story recently, because the USD is a safe haven asset that generally moves in the opposite direction of risk assets like stocks and oil.

The primary forces behind this rally have been:

1. Fear from both forecasts of slowing global growth for 2012 and particularly from risk of a disorderly Greek default that could spark a wave of sovereign and bank insolvencies, and crash global financial markets. We see clear evidence of that fear from the weekly S&P 500 chart, which shows the rally that began in September 2011 capped around 1360 for the 4 weeks prior to last week, as shown in the chart above(labeled B).

2. Because the fear centered on the EU, the resulting EUR weakness meant USD strength. That's because the EURUSD comprises about a third of all forex trade, so for every 3 EUR bought a USD is sold & vice versa, so the two currencies push each other in opposite directions like children on seesaw.

3. In the past months, both the Swiss (since September 2011) and Japanese (since February 2011) central banks have been intervening in forex markets to weaken their currencies in order to support their exporters. That caused the USD to become, by default, the preferred safe haven currency.

4. Good US jobs and spending data raised expectations for more USD supportive policy from the Fed. Specifically, the data both reduced the chances of further dollar-devaluing stimulus programs, and raised interest rate increase hopes and thus also USD demand. Meanwhile, other central banks, especially the ECB, were moving in a more dovish direction that undermined their currencies.

However the USD rally stalled late last week. Here's why (paraphrased from Kathy Lien of fx360.com):

1) The USD Technically Overbought: The US dollar had strong rally over the past month, particularly against the JPY, became overbought in the near term, and thus ripe for a normal correction. However, we believe the longer term up trend for the USD index remains intact.

2) Treasury Yields Fail To Advance: Secondly, the dollar had been rising along with 10 year U.S. Treasury yields (reflecting rate increase hopes), so lack of further gains kept the USD back.

3) Risk Assets Continue Rallying But Without New USD Positive Data: With the S&P 500 at its highest level in 4 years demand for safe-haven currencies like the USD has weakened. The USD has been able to rise with risk assets as the data behind the rally was also good for the dollar, like upbeat jobs and consumer spending. Without more such data, risk asset rallies will continue without the USD.

4) The USD was hurt hit by S&P's confirmation that the U.S. rating outlook remains negative, and that it's unlikely that any economic improvement would return the AAA rating anytime soon.

Looking at a weekly chart of the USD index, it's clear that it's up trend remains intact barring a decisive break below 78, which would mean a break below the dual support of both:

• The uptrend line ( solid red)
• The 38.2 Fibonacci Retracement Level

USD INDEX WEEKLY CHART 22 MAY 2011 - 11 MARCH 2012

Courtesy of metaquotes software corp. and thesensibleguidetoforex.com

03 MAR 18 0110

Going forward, we believe the USD is still more likely to end 2012 higher than its current level, because the above mentioned forces behind the up-trend remain intact. Specifically:

• The EU crisis is likely to continue to undermine the EUR and risk appetite
• The Swiss and Japanese central banks remain committed to weakening their currencies
• Expectations for the US economy (slowly improving) contrast favorably with those of the EU and China (both slowing down).

In the course of my work I read a lot of great articles and books, but I rarely find one that makes me want to jump up shout to everyone that they've got to read this.

I found one this week, though. You've got to see this: Central Bank Regime Change: Who Cares About 2% Inflation Targets Anymore? A Chart. The key point that everyone must be aware of: the central banks behind most major currencies are "busily pressing real rates into negative territory to "erode the debt burden through stealth inflation … in the U.K., the eurozone, and the U.S., central banks are keeping bond yields low enough to stop their governments from going bust - and that's not going to change for the foreseeable future." (hat tip to seekingalpha.com's market currents section for bringing this to my attention)

That means their driving down the value of their currencies and anything denominated in them - like your portfolio.

While most investors understand the need to diversify into different asset classes and sectors, most of us ignore the basic principle of diversification when it comes to currency exposure, and have almost all of our assets denominated in a single currency, be it the USD, EUR, GBP, JPY, whatever.

Failure to diversify into the strongest currencies is just as reckless and foolish as any other failure to diversify.

While this problem is obvious, the possible solutions are not. I've spent years seeking them, ever since the Great Financial Crisis broke in 2007 and I suspected the central banks would pursue the silent tax of inflation. Here's the result of that research: THE SENSIBLE GUIDE TO FOREX, SAFER, SMARTER WAYS to SURVIVE and PROSPER from the Start (John Wiley & Sons, 2012). It's the first book to show how conservative, busy mainstream investors, those with limited time and risk tolerance, can tap forex markets to hedge currency risk and improve returns, regardless of whether they're active traders or long term investors with no interest in trading at all.

I apologize if this sounds like naked promotion, but the need for this kind of book is very real and utterly unfilled. I couldn't find any book or resource that pulled together such a wide range of solutions for different kinds of investors with different needs and risk tolerances, all in one neat package.

Like my articles, this too arose out of my own search for clarity & solutions that I wasn't finding elsewhere.

Just click the above link for a more detailed description of the book, and judge for yourself. As we approach the fall publication date, you'll be able to look inside the book for further details.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.