By David Moenning
Here we go again. Just when the bears thought that this time would be different, the global central bankers decided that it was time to hop back up on their white horses. It never gets old, does it?
In an attempt to save the world from the evils of "market volatility," both the ECB and the BOJ have publicly declared war on falling stock prices. This is on top of China's "efforts" to stabilize both their currency and their stock markets.
And then with U.S. GDP coming in on the punk side (the growth rate was just 0.7% in Q4), investors realized that they can probably expect to start hearing dovish verbiage from FOMC members very soon. In short, many analysts believe that the Fed's plan to raise interest rates 3-4 times in 2016 could easily get pushed to the back burner.
So, while the market's focus for much of this year has been on oil (and to a lesser degree, China) Friday's action would seem to suggest that "the carry" trumps the fears related to crude's rude move and the spillover/contagion effects thereof.
Why Do We Care?
The questions investors probably have at this point are, (A) why did the game change on Friday and (B) why should we care about what Japanese or European Central Bankers are doing?
To be sure, stocks didn't follow oil on Friday. And stocks didn't give a hoot about the weak economic data seen here in the U.S. In fact, stocks didn't seem to care about any of the worries that wound up producing one of the weakest January's on record. No, on Friday, the battle cry appeared to be, "Buy 'em!"
It is safe to say that Friday's joyride to the upside was likely driven by short-covering and algo-induced buying. As such, we won't know for several days whether the +2.5% blast was for real. But after an emotional low that was followed by several days of waffling, the bulls contend that Friday was the first step toward a meaningful rebound.
But I digress. The question at hand is why the stock market seems to care so much about the central bankers. The answer can be summed up in 2 little words: the "carry trade."
The What Trade?
For those not familiar, the "carry trade" is a major source of revenue for big banks, sovereign funds, hedge funds - i.e. the biggest of the "big boys" in the global investing community. And at least part of the problem in January was the fact that carry trades of all kinds were going the wrong way.
In a basic carry trade, an investor borrows money in one place and then puts the cash to work somewhere else at a higher yield. For example, a year ago, investors could borrow in the U.S. repo market at 0.15% (15 basis points) and put the money in 2-year governments at 60 basis points (bps), netting a positive "carry" of 45 bps. And if the investor used 5-year treasuries, the carry would be a positive 135 bps. Not bad, eh?
This trade gets even more interesting for foreigners. Global investors can take the game up a notch by borrowing at low rates in a depreciating currency. So for the Chinese, they could borrow at near 0% in the U.S. and then invest the proceeds back home at higher yields. And since the yuan had been appreciating for years, they could count on paying the loan back with cheaper dollars. Bam - free money is a good thing!
However, these carry trades start to blow up when either borrowing costs rise or when the trend of the currency you are borrowing in reverses. So, with the Fed starting to raise rates and the Chinese yuan taking a dive on the surprise devaluation, this particular carry trade started to take on water in a big way.
Capital flows then become the issue as money began flowing out of China instead of in, which, of course, is not a desired result.
In addition, the reversal in the trend of a steadily increasing yuan also makes it more expensive for Chinese companies to repay any U.S.-based debts. Also, not a good thing for economic growth in China.
What this all means from a macro view is this: It is in China's best interest to keep their currency stable.
Back to the BOJ, ECB, and FOMC
But, let's get back to the action of the BOJ, the anticipated action of the ECB (remember, Super Mario has all but promised more QE at next month's meeting), and the idea that the Fed may not be able to raise rates anytime soon.
Cutting to the chase, negative interest rates in Japan, more new capital formation in Europe, and less pressure on U.S. interest rates means more opportunity for carry trades of all colors, shapes and sizes - as well as all kinds of currency games that can be played by global corporations.
So, the bottom line is the idea of more "free money" has trumped fear every time in this era of global bank intervention - aka the "QE Era" - that has been in place since 2009.
Turning to This Morning
Markets are back on the defensive in the early going with only Japan sporting a green screen overnight. The issues are largely the same with oil moving lower, this despite more commentary out of Saudi Arabia regarding the need for cooperation on supply reduction. In addition, the global economic outlook is in the news this morning as China's official PMI remained in the contraction zone for the sixth straight month while Europe's PMI declined from last month's reading. And as expected, the Fedspeak coming out of the US is becoming a bit more dovish as both the Dallas and San Francisco Fed Presidents said over the weekend that things are looking less robust. In response, European bourses are lower across the board at this time and futures here at home are pointing to a decline at the open on Wall Street.
Today's Pre-Game Indicators
Here are the Pre-Market indicators we review each morning before the opening bell...
Major Foreign Markets:
Hong Kong: -0.44%
Crude Oil Futures: -$1.39 to $32.23
Gold: +$7.40 at $1123.80
Dollar: lower against the yen, euro and pound
10-Year Bond Yield: Currently trading at 1.933%
Stock Indices in U.S. (relative to fair value):
S&P 500: -17.44
Dow Jones Industrial Average: -139
NASDAQ Composite: -33.47
Thought For The Day:
When in doubt, just take the next small step...
Current Market Drivers
We strive to identify the driving forces behind the market action on a daily basis. The thinking is that if we can both identify and understand why stocks are doing what they are doing on a short-term basis; we are not likely to be surprised/blind-sided by a big move. Listed below are what we believe to be the driving forces of the current market (Listed in order of importance).
1. The State of the Oil Crisis
2. The State of Global Central Bank Policy
3. The State of China's Renminbi
4. The State of the Earnings Season
The State of the Trend
We believe it is important to analyze the market using multiple time-frames. We define short-term as 3 days to 3 weeks, intermediate-term as 3 weeks to 6 months, and long-term as 6 months or more. Below are our current ratings of the three primary trends:
Short-Term Trend: Moderately Positive
(Chart below is S&P 500 daily over past 1 month)
Intermediate-Term Trend: Negative
(Chart below is S&P 500 daily over past 6 months)
Long-Term Trend: Neutral
(Chart below is S&P 500 daily over past 2 years)
Key Technical Areas:
Traders as well as computerized algorithms are generally keenly aware of the important technical levels on the charts from a short-term basis. Below are the levels we deem important to watch today:
- Key Near-Term Support Zone(s) for S&P 500: 1905
- Key Near-Term Resistance Zone(s): 1950-1980
The State of the Tape
Momentum indicators are designed to tell us about the technical health of a trend - I.E. if there is any "oomph" behind the move. Below are a handful of our favorite indicators relating to the market's "mo"...
- Trend and Breadth Confirmation Indicator (Short-Term): Neutral
- Price Thrust Indicator: Negative
- Volume Thrust Indicator(NASDAQ): Negative
- Breadth Thrust Indicator (NASDAQ): Neutral
- Short-Term Volume Relationship: Neutral
- Technical Health of 100+ Industry Groups: Negative
The Early Warning Indicators
Markets travel in cycles. Thus we must constantly be on the lookout for changes in the direction of the trend. Looking at market sentiment and the overbought/sold conditions can provide "early warning signs" that a trend change may be near.
- S&P 500 Overbought/Oversold Conditions:
- Short-Term: Neutral
- Intermediate-Term: Oversold
- Market Sentiment: Our primary sentiment model is Positive
The State of the Market Environment
One of the keys to long-term success in the stock market is stay in tune with the market's "big picture" environment in terms of risk versus reward.
- Weekly Market Environment Model Reading: Negative