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  • Markets Are Following A Two Factor Equation 0 comments
    Jun 13, 2013 11:40 AM | about stocks: XLU

    Since June 2012, every stock market dip has been a buying opportunity. At that time, the major stock indexes in the United States surged higher on the back of the easy money policy called QE-3 implemented by the Federal Reserve. This is a program where the central bank buys $85 billion dollars a month worth of mortgage backed securities (MBS) and U.S. Treasuries. This action by the Federal Reserve has certainly been the leading catalyst for rising stock, and housing prices. Now the talk of the town is that the Federal Reserve will need to taper or cut its current easy money program.

    Now the Japanese central bank called the Bank of Japan (BOJ) has implemented a similar easy money program just like the Federal Reserve. The Japanese economy is one third the size of the U.S. economy so everyone can see how aggressive a stance the Japanese have taken to try and inflate its stock market. The Japanese have been fighting deflation for over 20 years now, but is this devaluing of the currency the correct method to stimulate the Japanese economy? That question is open for debate, but it is safe to say that the Japanese are simply following the blueprint initiated by the Federal Reserve in the United States.

    What is now moving the U.S. stock markets? There are two factors moving the stock markets in the United States, it is the weak Japanese Yen, and the interest rates on the 10, and 30-year Treasuries. Since March 2009 the interest rates in the United States have steadily declined. In July 2012 the yield on the 10-year U.S. Treasury yield fell to a low of 1.39 percent. On June 11, 2013 the 10-year U.S. Treasury yield surged to a high of 2.269 percent. Can the stock market handle higher interest rates? After all, rates on the 10-year bond yield have now jumped by 88 basis points since last July. This jump in yields has recently hurt many of the leading utility stocks, housing stocks, dividend paying equities, and mortgage REITS. So everything interest rate sensitive has been adversely affected by the recent move higher in bond yields. Should bond yields retreat or pullback in the near term then we are likely to see a bounce in many of these beaten down interest rate sensitive equities. Traders can easily see the recent decline in equities such as the Utilities Select Sector SPDR (NYSEARCA:XLU), iShares Dow Jones US Home Construction (NYSEARCA:ITB), and the iShares Dow Jones US Real Estate (NYSEARCA:IYR). This recent fall is due to the rising interest rate environment.

    The next market moving factor is the Japanese Yen. When the Japanese Yen declines against the U.S. Dollar it lifts the stock markets higher. The opposite is true when it rallies higher against the U.S. Dollar, this will cause the stock market to decline. The reason for this is because so many financial institutions are selling the Japanese Yen short and buying the Nikkei 225 Index. After all, the Japanese government has vowed that they will do whatever is necessary to achieve a 2.0 percent inflation target, so who could blame the financial institutions for doing this. The financial institutions are just trying to capitalize on the same central bank intervention that lifted the S&P 500 Index to new all time highs. Recently, the Japanese Nikkei 225 Index has been crashing lower from its 2013 highs, but it is still significantly higher from its lows in October 2012.

    The bottom line, if the bond yields pullback and the Japanese Yen starts to decline again the U.S. Dollar the world markets will likely rally and trade higher. The opposite is true if bond yields in the United States move higher and the Japanese Yen rallies higher against the U.S. Dollar, these stock markets will fall. It's a two factor equation that is moving the global stock markets at this time.

    Nicholas Santiago

    (click to enlarge)

    Stocks: XLU
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