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By: Joel Kruger
Must We Part Ways? - I have been trading in and out of the S&P over the past few weeks, and for the most part with good success. On the whole, I caught a nice move from 1847 to 1818, and then sold again late Tuesday at 1839. My expectation was the market would put in a lower top ahead of a fresh downside extension back under the Monday low. But the market had other plans, and broke to yet another record high on Wednesday. At the time of this report, the S&P is consolidating just below the high and should it break higher again, I will part ways with the trade and revisit another time. At least I will be able to say that I was able to make money in 2014 with my bearish equity view. The funny thing about stocks is that there is no real value in playing the short side. Stocks are built to go higher. Currencies on the other hand are a different animal. Shorting one currency means you are buying another. So the dynamics are different. I had written about this idea several months back, and I have found it to be all too true as I have experienced this difference first hand. If you are selling equities it is because you don't like them. If you are selling a currency, it might be because you like something else and not purely because you don't like the currency you are selling. Moreover, with currencies, no matter how beaten down a specific currency gets, there is always demand for the currency on non speculative merits. So I guess my point here is that while the argument for a pullback in equities is highly compelling and completely justified, because stocks are not inherently designed to be sold, it becomes a lot harder to see the materialization of such a bearish reversal. The lack of a direct relative value play as you have with FX markets is a bit of a game changer. But I swear, I am a currency guy through and through and apologize if I have spent too much time focused on US equities. It's just that in this market environment, where everything is so closely tied together, it has become impossible to ignore the price action in this other asset class.
The Superfecta - Ok so back to currencies. I have gone ahead and re-established a long position in AUD/NZD today (see below). The latest slide in the cross rate has resulted in a drop to fresh multi-year lows, with the market now trading close to monumental support in the 1.0400-1.0500 area. The much softer than expected Aussie employment report has been the driver behind this latest slide, and as the market settles into this longer-term support zone, I am trying to start to look beyond the what was to focus on the what will be. The market has priced in a ton of Aussie bearishness over the past several months, and I was there at the very start of this when everyone thought I was crazy to sell AUD/USD above 1.0500. And while I still think Aussie is exposed against the buck, it seems like the divergence between Aussie and Kiwi has gotten a little out of hand. Perhaps we have now reached a point where the balance is so far out of whack that too much bearishness is being priced into Australia and not enough in New Zealand. Admittedly, at the moment, the picture looks rather bleak for Australia and much more encouraging for New Zealand. But these things always have a funny way of turning around. The technical picture is already warning of such an event and is screaming for a correction. It isn't too often that you see an FX superfecta, and today, AUD/NZD is showing highly oversold across all of the major time frames. The hourly, daily, weekly and monthly charts are all well overextended, and if you are a believer in the concept of mean reversion, we should soon see a reversal. Now what does soon mean? It means the market may still drop into the 1.0400's, but I suspect that at some point over the coming sessions, we will get that sharp reversal bounce. The fundamental catalyst could come from many different fronts. Perhaps it is a Kiwi specific event, or perhaps it is a sell-off in risk that weighs on higher yielding currencies. But the key takeaway is that something this oversold is highly compelling at a very minimum. I may be wrong and my timing might be off with this one, but happy to take another shot and find out. I would like to hold the trade for a while, but will need to see how the market responds over the coming sessions. At this point, only a break below 1.0400 would give reason for rethink. As far as the upside potential is concerned, I believe we could get a recovery back into the 1.1200-1.1600 area in the months ahead.
By: Joel Kruger
All Bark, No Bite - I was definitely a little surprised (but not shocked) to see the recovery in US equities on Tuesday. It is truly amazing just how well this market has been supported on any form of a dip. While Monday's setbacks were only marginal in the grand scheme, the bearish reversal formation from record highs, certainly generated a good deal of attention and concern that the bottom could finally fall out. But as has been the case again and again, the idea of any extended declines was quickly rejected, with the market rallying back quite sharply Tuesday. I have been trading the S&P in and out this year with success, and was able to catch most of the move from Monday. I exited into the Monday close and watched the Tuesday rally not thinking I would get another chance to sell at such an attractive level. But with the hourly chart trading overbought ahead of the Tuesday close, the opportunity to get back into the short could not be ignored. I am not sure how this newly established position will play out, but as highlighted the other day, I do not believe this market will be able to establish any meaningful and sustainable gains above 1850, without some form of a more significant correction. It seems the recovery was attributed by some to the better than expected retail sales data out of the US on Tuesday. Yet, I am not so sure I buy into this.
What's Changed? - While the solid economic data is a positive for the real economy, it should not necessarily be taken so easily as a net positive for financial markets. After all, a healthy retail sales print should only translate into the need for a less accommodative Fed. Less accommodation = less incentive to be buying stocks = increased chance of profit taking (if you believe Fed policy has been supporting the stock market). Over the years I have said that when I am fading a trend, I actually like seeing these sharp (scary) moves back in the direction of the trend, as it only makes the counter-trend play that much more compelling when the market stalls out again and reverses (in this case Tuesday's rally stalls and the market breaks back below Monday's low). So as we head into the meat of Wednesday trade, I see no less of a reason to be wanting to sell equities than there has been over the past several days. The fundamentals of Tuesday did nothing to change the picture, and if anything, as per above, there is arguably even more of a reason to be wanting to sell equities. I would say that if this reversal is going to play out, we would probably need to see a break back below Monday's low before the end of the week. As for currencies, USD/JPY is still very well tied to US equities, while the rest of FX is expected to on the whole continue to be well offered against the buck on any rallies. The whole shift in Fed monetary policy theme and anticipated narrowing of yield differentials in favor of the buck, should be what drives FX for much of 2014.
By: Joel Kruger
Timing Is Everything - Although it was only one day of US equity weakness, it is hard to ignore the fact that something bigger could be going on. For much of the second half of 2013, I exhausted the idea that US equities were exposed on the expectation the Fed was going to start to move away from emergency super extended policy and towards a path of tightening (initially via Taperville). But like all things in markets, timing is the hard part and in this case, it is no different. Despite warning signs there would need to be some form of rotation out of equities back in the Fall, the market either chose to ignore these signs, or felt like this was the last hurrah and wanted to push as hard as it could before the party came to a screeching halt. So this was the story in those final months of 2o13, resulting in a rally to fresh record highs right into the closing hours of the year. But now at last, it seems like the party is over and market participants are digesting the reality that free money incentives to buy equities will no longer be there in the same way. Technically, US equities have been tracking in overbought territory on the longer-term chart for several months now, and the idea of a 10-20% correction would be completely healthy. I would not even go as far as to say I am so bearish stocks, despite my outlook over the past several months. I simply believe that price action has gotten out of control, with the stock market having leaned far too hard and far too long on the Fed.
You Know Something's Wrong When.. - There has been a very clear departure from the underlying market drivers, and we need to see the focus shift back towards the real fundamentals. Once we get a nice pullback, you may even see me recommending a buy into the dip. At the end of the day you know something is wrong when you get a pullback like we saw Monday, which was only a little more than 1%, and everyone is panicking that something needs to be done to support this crisis. The truth is, how confident can we really be in a market that inspires such uneasiness with only the smallest of pullbacks? Not much in my view. This is precisely why there needs to be a more pronounced period of weakness before we can comfortably start talking about compelling buy opportunities. Technically, a double top was triggered in the S&P on Monday, and this now opens the door for a measured move extension back into the 1790 area over the coming sessions. From there, the previous monthly low around 1760 will come back into focus, with a break of this level to set up a more serious monthly reversal. While anything is possible of course, and the market could still decide to race to another fresh record high, it is becoming increasingly apparent that the risks for any sustained strength above 1850 should be quite limited, until we at least first see the anticipated correction play out. The Fed was there to fuel equity market gains for 5 years, and at a minimum, even the smallest of monetary policy adjustments (as we are now seeing), should have some sort of weighing influence.
And What About FX? - So what does this all mean for currencies? Well, the currency market has already done a good job of starting to price in the shift in Fed policy and favorable impact this will have on yield differentials. The US Dollar has enjoyed substantial gains against many of the major currencies in recent months as a result. I believe this trend will continue going forward, and the recommendation is to look to be buying the USD across the board into dips. However, there are some currencies that I think are still highly exposed, that have yet to really respond to the changing environment. For me, it is the New Zealand Dollar and Israeli Shekel that really stand out. I know there are others as well, but these two currencies have managed to retain a relative bid tone, despite some very striking weakness in normally well correlated currencies. Yet while the respective local economies have performed well, my contention is these currencies have perhaps relied a little too heavily on the domestic picture, and have ignored the impact of external fundamentals. As such, I will be looking for this outperformance to transform into some underperformance in 2014, as these currencies start to play a game of catchup (catchdown more appropriate). I would also recommend keeping a close eye on the Yen over the coming days. USD/JPY has started to carve out a nice little top, which ultimately should end up being a lower high within the context of a broader, intense uptrend. The market is now looking for the next meaningful higher low, and I really like the idea of buying USD/JPY on a dip into the 99.00-100.00 area (should we get there) over the coming days.
By: Joel Kruger
Bernanke's Foresight - Hope everyone had a nice weekend. So quite a reaction from markets in response to Friday's monthly US employment data. In the end, it seems like it will still take a few more sessions before market participants truly figure out with this all means. I will say that Bernanke's super qualitative amended and updated remarks at the previous meeting with respect to higher rates are making a lot more sense in light of Friday's data. Bernanke had said that rates wouldn't be moving up until "well after" unemployment dipped below 6.5%. It seems like the Fed Chair (until the end of the month) had a good sense that we could be dipping below 6.5% a lot sooner than markets had anticipated. So with unemployment now potentially a print or two away from 6.5% (latest 6.7%), doves will find some comfort in Bernanke's comment. Still, the facts are the facts and with unemployment at 6.7%, we are that much closer to higher rates, no matter how far off it might be. Of course, the danger in linking policy directly to the unemployment rate, is that it can be somewhat misleading.
The Goldman Piece - Take Friday's overall data results for example. While unemployment dipped that much closer to the rate rise threshold, the NFP print was far worse than expected and sent an entirely different message. But generally speaking, the Fed is now in a tough spot where the bias needs to start slanting towards a tightening. The two markets that I think got it right on Friday (and into Monday) were USD/JPY and EUR/CHF. Both of these markets are still tied to risk sentiment, and both of these markets have been reacting to the latest print with a deep concern. I think this is rather revealing and should once again be sending a message to equity market participants that stocks are vulnerable at current levels by record highs. This past Friday after the close, Goldman Sachs (David Kosten) was out with a bit of a surprising piece, after outlining its view that US equities were "lofty." I certainly don't think you could argue for higher equities on the merits of Friday's discouraging employment report, with the only supporting variable coming from the expectation that this will keep the Fed in freeze mode even longer. But I don't believe this is the case. I believe the Fed is already moving towards reversal whether it likes it or not, and I also believe that any market bullishness on the back of this historic, ultra accommodative Fed policy, has already been well priced in. At this point, there really doesn't seem to be too much room for additional upside before some form of a major correction takes hold.
