| MacroMarketMonitor December 2009 |
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| Written by Matt Blackman | |
| Saturday, 19 December 2009 | |
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Macro Market Monitor December 2009 Here comes Santa Claus? Trading places – Gold and the dollar make the switch Carry trades in trouble? Baltic Dry Index showing weakness Global Stock Markets Challenged Want more? Daily commentaries here… Interesting Stories Here comes Santa Claus? This month’s newsletter will be shorter than usual as it is a time of the year that many traders take holidays and volumes are lower than usual. However, there is one annual event worth mentioning. It’s coming on Christmas and the much hoped for Santa Claus rally is due – one that has been good for an average 1.4% gain during the period of the last five days of the year and first two of the New Year since 1969 according to the Stock Trader’s Almanac. But if it fails to appear, watch out. History has not been kind to stocks in the years following a Santa Claus rally miss. In the last decade Santa failed to lift markets three times and two of the three following years were down. In the one year that was up, 2005, prices did not surpass their December 2004 month-end highs until well into July.
Figure 1 – Weekly chart of the S&P500 showing the peak in October 2007 and rally off the March 2009 low. A bearish wedge chart pattern is still in force that is much longer in duration than usual. Chart by GenesisFt.com Trading places – Gold and the dollar make the switch There are a number of headwinds facing stocks this time around. One is a reversal in the dollar and a strong dollar has not been good for stocks lately. As the next chart shows, there is a strong negative 50-week correlation between the SPX and the dollar – one that is nearly perfectly at negative 95%. When the dollar has gone up in the last year, 95 times out of a 100, stocks have come down as the next chart shows.
Figure 2 – Weekly chart of the US Dollar Index (top), the S&P500 Index (middle) and 50-week correlation between the two in red (bottom). Chart by GenesisFt.com The inverse 50-week correlation between the USD and gold has not been quite as strong at -73% but it is safe to say that gold strength has been bad for the dollar and dollar strength bad for stocks. But lately gold and stocks have been moving together. Now with gold more than $100 off its November highs as I write this (down more than 10%), it is another reason for concern about stocks. As we will see next, currencies and the carry trade are another reason to suspect that the worst for stocks may be just beginning.
Figure 3 – Weekly chart of gold showing the 80 percent rally followed by a 10 percent correction off the November high. Chart by GenesisFt.com
Figure 4 – Updated chart of the dollar priced in gold. Since peaking in early 2001, the dollar has lost 85% in real terms and there appears to be no end in sight. The recent dollar rally and gold correction has yet to really become visible on this chart and at present must be considered volatitily. Chart by GenesisFt.com Back in the good old days before the credit crisis when markets were flying high, the media buzzed about the carry trade and how it was helping propel stocks into the stratosphere. A carry trade occurs when an investor borrows in a low-yielding currency (in a nation where interest rates are low) and uses the proceeds to buy high- yielding investments in nations where interest rates are high. One of the most popular carry trades was selling the Japanese yen (JPY) and buying the New Zealand dollar (NZD). To benefit from this trade, the trader would go long the New Zealand dollar-Japanese yen currency cross (NZD-JPY). They are in effect buying the NZD and selling the yen (next chart).
Figure 5 – Weekly chart of the New Zealand dollar-USD (top), the S&P500 Index (middle) and the 50-week correlation between the two (bottom). Chart by GenesisFt.com This cross has proven to be a good leading indicator of stocks, the above chart shows the strong correlation between it and the SPX of 96%. As the chart shows, the trend was been broken five weeks ago to the downside and that is bearish for stocks. A similar break has occurred on a number of other carry trade currency crosses and pairs. Last month, we wrote about an important carry trade currency pair, the New Zealand dollar-US dollar (NZD-USD or kiwi). Although the kiwi had dropped, it was still officially in an uptrend. As we see from the trendline break, that is no longer the case.
Figure 6 – Weekly chart of the New Zealand dollar–USD (top), S&P500 Index (middle) and 50-week correlation between the two (bottom) showing that although the NZD-USD (top) broke its trendline support recently. Chart by GenesisFt.com A similar breakdown occurred in another popular carry trade currency pair, the Australian dollar – USD (AUS-USD or Aussie) (not shown). The Aussie has been accelerating its decline and since it also has demonstrated a high positive correlation with the SPX, it is further reason for concern about stocks. We see a similar breakdown in the Euro-USD (EUR-USD) below which has also shown a strong positive corelation with US stocks.
Figure 7 – Weekly chart of the Euro-USD (EUR-USD top) and Emerging Market ETF (EEM) showing a similar breakdown. Correlation between the two is in the lower sub-chart. Chart by GenesisFt.com We mentioned last month that “traders who are short the USD and US interest rates (and that includes those who are long commodity currencies like the Australian dollar and New Zealand dollar as well as commodities and emerging markets) can protect themselves with a USD long hedge like USD calls or call LEAPs for longer-term positions.” We hope they took some protective action as we could be in for a period of dollar strength simply based on the power of a snap-back or reversion-to-the-mean dollar rally. Transport demand is measured by the Baltic Dry Index that tracks shipping rates for dry goods transported by sea and since it is not traded on an exchange is less subject to speculation and manipulation. It is therefore a good indicator of real demand for goods and commodities used in manufacturing a wide variety of products around the world, as well as an economic bellwether. Although the BDI is up 500% from its lows in December 2008, it has shown signs of weakness since mid November.
Figure 8 – Daily Baltic Dry Index showing the peak of 4661 November 16, 2009. In the last few weeks, there have been some positive economic signs as the most recent ecomomic charts from the Cleveland Fed (see http://www.clevelandfed.org/research/data/updates/index.cfm ) show. The latest quarterly data from the Bureau of Economic Analysis (BEA) also shows a rebound in residential fixed investment; an increasingly important metric given the part housing played in the credit meltdown and will no doubt play in the economic recovery (see http://www.bea.gov/briefrm/resfi.htm ). But there are still a number of risks to consider and these technical and leading indicators give us reason for caution. It is simply too early to break open the champayne. Global Stock Markets Challenged US stocks are the only group struggling of late. International indexes, and especially the Chinese Shanghai Composite still has a way to go to get back to its 2008 highs as the next chart shows. The four major markets we are following and how they have moved since our last MMM. US stocks (SPX) have outperformed the other three indexes but much of that upside has been due to the falling dollar and more recently stocks around the world have struggled in the last month under pressure thanks to a rallying dollar and firming commodity prices.
Figure 9 – Weekly chart of the four major global indexes we’ve been tracking, the Shanghai Composite (SSE) in red, the S&P500 (SPX) in blue, the Indian Nifty Index (NFTY) in green and German DAX (GX) in magenta. The SSE and SPX peaked within a week of each other in October 2007 with the SSE leading the SPX, NFTY and GX lower from January through October 2008. Then the SSE bottomed well ahead of the other indexes. Chart courtesy of www.GenesisFT.com Daily Updates If you’re interested in more timely updates and articles, you can follow me on at http://www.twitter.com/matt__blackman (double underscore between first and last name). You don’t have to join twitter, simply click on that link to see what I’m tracking. If you have a question or comment, please email it to me at the following address: Investorinsightsmb [at] gmail.com (Please remove the spaces and substitute the @ symbol for [at] ) Best of the holiday season to you all and have a happy, healthy and prosperous New Year! China Faces Crash Scenario http://globaleconomicanalysis.blogspot.com/2009/12/china-faces-crash-scenario.html Empire at Risk by Niall Ferguson http://www.newsweek.com/id/224694 October another month of foreign Treasury selling Time labels Bernanke “Person of the Year” (A contrarian indicator?) http://www.reuters.com/article/idUSTRE5BF20920091216 Democrats approve debt ceiling limit http://finance.yahoo.com/news/House-passes-290-billion-cnnm-1509772721.html?x=0&.v=1 Does the steepest yield curve since 1980 spell trouble? http://www.bloomberg.com/apps/news?pid=20601110&sid=a5qWFADmQj4E Greek Debt Problems a Real Pain for Europe
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