Friday, August 28, 2009

Traders' Daily Global Markets Review/Preview for August 28, 2009: Part 2


(Continued From Part 1)

JPY: USDJPY has been heavy for the past few days and is sitting around 93.50 at the time of writing. Concerns about loose US monetary and fiscal policies and the possible return of risk aversion have supported the yen in recent months. The next tests for the yen are the upcoming elections and possible corporate repatriation. We maintain our USDJPY forecast of 95 in 1m and 3m. The S&P 500 and 10y yield relationship has changed recently, as investors have seemingly sought the safety of Treasuries even as equities continued to grind higher. The safe-haven dollar and yen have benefited during pullbacks from risk assets and with confusing signals from bonds and equities and risk assets looking fatigued recently, we might see investor caution, or rather uncertainty, lead to another bout of risk aversion.

In addition to reduced risk-seeking, the yen could gain support from corporate repatriation. Recent press reports suggest Japanese companies are looking to take advantage of an impending tax exemption on dividends from overseas units in order to repatriate overseas profits. As Japanese electorate heads to the polls this Sunday, the latest economic data suggests that political change in the world’s second largest economy is ever more likely. Pre-election polling indicates that opposition Democratic Party of Japan (DPJ) may for the first time in more than fifty years score an overwhelming victory over the ruling Liberal Democratic Party (LDP). The LDP has ruled Japan for all but 10 months since 1955.

SUNDAY ELECTION: Friday morning's economic news which showed that both unemployment and deflation reached record highs should only seal the deal in the voter’s minds for a mandate for change. The unemployment rate rose to 5.7% from 5.5% projected and is the highest level recorded in the post war period. Meanwhile CPI drifted lower to -2.2% versus -2.1% eyed while household spending plunged -2.0% versus forecast of -0.5% decline.

The dour economic news is likely to produce an ironclad majority for DPJ. The DPJ may win more than 320 of the 480 seats in the Lower House according to the Asahi newspaper. Should DPJ win, it promised to increase domestic spending and shift the focus away from strict emphasis on export growth. The net result is that fiscal expenditures are likely to become a lot more aggressive and many analysts expect long term Japanese bond yields to rise as government issues more debt to finance its initiatives.

Higher yields could in turn put further upside pressure on the yen as both domestic and foreign investors flock to the Japanese fixed income markets. It will be interesting to see if the new shift in policy towards domestic demand will help to revive the Japanese economy. We continue to believe that Japan remains very dependent on export led growth and any benefit of higher yen in terms of purchasing power to the Japanese consumer will be more than offset by the potential profit squeeze on the Japanese corporate sector resulting on overall lack of growth for the economy. Nevertheless, this week-end’s upcoming election clearly signals a massive change of course for Japan and the near term impact on the currency market is likely to result in further appreciation for the yen with USD/JPY possibly targeting 9000 level by the fall.

NOK, SEK: Unemployment data encouraging: Swedish unemployment declined to 7.9% from 9.8% previously, beating expectations of a more modest fall to 8.2%. The figure itself is not seasonally adjusted and therefore does not allow for the seasonal increase in employment during the summer months. However, our economists note that expectations-beating print is a positive sign. In Norway, the unemployment rate held stable at 3.0% as expected. We remain short AUDNOK as a recommendation and initiate a new recommendation to go long NOKSEK as we think the SEK could be more vulnerable should risk aversion return.



Oil rose further above $72 on Friday after snapping a two-day fall from 10-month highs a day ago, boosted by better-than-expected GDP and jobs data in the United States that signal the economic recovery is on track. Crude oil prices were also given a lift by a weaker U.S. dollar versus the euro and the commodity-linked Australian dollar, as well as by a late rebound on Wall Street, but were tempered by falls in Chinese stocks.

"People are still looking at the stock markets and the weaker U.S. dollar against the euro, but the market still lacks clear direction," said Ken Hasegawa, a commodity derivatives sales manager at broker Newedge in Tokyo, adding that it would take up to a month for a clearer direction to emerge.

"A lot of people are expecting the economy to go well and the stock market to rise further, but I cannot be so optimistic about the economy. Though it has reached a bottom, real recovery will take two to three years -- I don't see a "V"-shaped recovery."

Analysts expect oil prices to hold in the $70-75 range for some time but not any higher.

The less-than-expected contraction in the U.S. economy in the second quarter, despite a record drop in inventories, and fewer workers filing new claims for jobless benefits, also cheered other commodities, including industrial metals such as copper.

Traders will now watch the Michigan business sentiment survey on Friday for signals that the economy is truly healing, and eye British, French, Swedish and Italian data for clues on how the Eurozone recovery is developing.

In Asia, investors continued to watch any moves by China to clamp down on lending and curb overcapacity, which is still causing chills among equities investors.

The Chinese market has surged more than 90 percent from the start of the year to early August, but fell by more than 15 percent since, sparking concerns over speculation. This prompted a senior finance ministry researcher to say on Friday that rising Chinese property and share prices mainly reflect economic fundamentals rather than a reappearance of asset bubbles


Gold lacked fresh factors distinct to the metal, which was one reason why traders were eagerly waiting the release of August gold import data from India, a large consumer of the precious metal. "Some traders are hoping this will show strong figures," he said. India gold traders were looking for bargains in the gold market this week in anticipation of festival demand.

Gold is being underpinned by buying from speculators, with the euro's recovery above $1.43 and a rally in oil to the year-to-date high levels increasing their risk tolerance," said Shuji Sugata, manager at Mitsubishi Corp Futures & Securities' research team. "But such buying is not sustainable. They stop buying when gold rises towards $960, which looks like an initial resistance," he said.


Japan's Jobless Rate Climbs to Record 5.7% in Blow to Aso Before Election
Consumer Spending in U.S. Probably Climbed in July on `Cash for Clunkers'

Japan unemployment rate hits record high in July and prices fell at record pace- both threatening to undermine a nascent recovery for the world's #2 economy(AP)

The FDIC labeled more than 100 additional banks as “problem banks” indicating that their liquidity and earnings are not up to par. Add on to that the continued instability in Chinese markets and it seems unlikely that stock market gains will be able to continue for long

Jobless claims are becoming the one weekly report that provides a reality check to the fact that recessionary conditions are still very much alive. Despite the constant market rallies and improvement in growth and manufacturing indices, if we do not see a rebound in the employment market it is virtually all for nothing. Jobless claims for the week ending August 22 did fall slightly from the prior week to 570K but missed estimates for an improvement to 565K. In addition, it is troubling that last week’s claims were revised upward to 580K. Even though we have ended a streak of three consecutive weeks of rises and the 4-week average claims fell, we are nowhere near what would be considered conditions typical of a normal employment market. Economists estimate that a reading of 325,000 claims is considered healthy, far below our current stubbornness to fall under 550,000. The employment risk will start creeping back into everyone’s minds as we head into next week’s Non-Farm Payroll report which may show that unemployment creeps closer to the Obama administrations 10% estimate

The weekly jobless claims may become the key economic indicator for the currency market as we enter the fall season. If claims persist above the 550K level and worse even escalate towards the 600K handle the recovery thesis will begin to unwind as final demand will not be materialize. On the other hand, if jobless claims begin to drift toward the 400K zone, the recovery trade will no doubt get a second wind and the risk trade in FX could go on to set new yearly highs.

Global Market Direction?
Because global stocks have set direction for commodities and currencies, we present links and key points of articles arguing for and against further upside.While we remain skeptical, there is growing evidence for further upside with stocks. In the interest of presenting a balanced picture, consider the following.

Bull in a China Shop [Excerpt]

LONDON (Reuters) - Investors have one overarching fixation as they head into next week -- is China's volatile stock market going to trigger a global correction that will eat up many of the stock gains made since March?

They will also be keen to get the latest consumer confidence news from the U.S. economy, along with related data on house prices.

Japan, too, is likely to come into view as its general election approaches.

But it is easy to see how much of the focus next week could be on Shanghai. The bourse's Composite Index .SSEC lost more than 20 percent in 11 trading days to Wednesday. That -- at least by tradition -- takes it into a bear market.

Fund trackers EPFR Global calculates that jitters about China during the latter part of that period pushed net outflows from Asia ex-Japan and global emerging markets to 24-week and year-to-date highs, respectively.

The fear among investors is that a further fall could be contagious and nudge other risk assets into a correction after so many weeks of gains.

Concern may be overblown, however. For one thing, the Shanghai index bounced back more than 6 percent in the last two sessions of the week, underlining just how volatile it is.

Then there is the issue of low August volumes exaggerating moves.

China's economy is also in relatively good shape, especially when compared with developed ones. Factory output and capital spending are both rising and the authorities continue to hold to a cherished eight percent GDP growth target.

Stocks Set to Continue Rally?

If economic data along with the Fed can be used as a guide, there no reason to see global stock markets retreat to any appreciable degree going forward. Therefore, expect to see markets continue to rally over the third and fourth quarters.

The Fed has basically raised its assessment of the economy, noting in the latest statement that “economic activity is leveling out.” Inflation figures to remain “subdued for some time” and the market has again been reassured that rates will not rise for an “extended period,” a sign that policymakers are in no rush to end their efforts to boost the economy. Language slightly less optimistic helped stocks rally over 12% since the previous meeting on June 24.

German and French GDP rose 0.3% in the second quarter which helped limit the overall European contraction to just 0.1% over the period, an indication that much like the U.S. the worst recession in the post-war period has just about ended and that economic expansion will occur over the third and fourth quarters of 2009. The ECB is likely to remain cautious however, and looks to continue its program of offering banks unlimited amounts of cash while keeping borrowing costs at record lows.

The Libor-OIS spread, the premium banks charge over the expected daily Fed Funds rate, narrowed to 25 basis points overnight, a level that former Fed Chairman Allan Greenspan labeled as “normal.” And while the banks still remain reluctant to lend, cash has been and likely will remain readily available in the capital markets. High grade U.S. companies sold $898 billion of bonds this year, the busiest period since at least 1999 according to Bloomberg, while European firms have issued a record $1.2 trillion this year, more than was sold in all of 2007. Ten year investment grade spreads, the difference between corporate borrowing costs over risk-free Treasuries, narrowed from 603 basis points down to just 254. Liquidity has been just as available in the high-risk markets; non-investment grade firms have sold at least $19.8 billion of debt this week and sales this year total about $858 billion compared with $648 billion during the same period last year.

Emerging-market stocks increased by the most in almost two weeks on Thursday after the Fed’s statement reassured investors there. The DJ Stoxx 600, a European index, gained 1.6% heading into the N.Y. open.

The dollar will likely continue declining against the euro, pound and A$ as those currencies resume their months-long rally against the yen. Commodities will remain strong while government debt prices decline. Expect to see the normal in and out breathing along the way, but just ignore it for the time being because more cash is likely to come into the market as investors grow even more fearful of missing the rally and give up waiting for a significant retracement.

Why Markets May Be Ready to Pull Back: Links to articles worth seeing.

Preview from Europe: Non-Farm Payrolls Add to Bullish Tone
Very good graphs on Bob Farrell's Rule # 8: bear markets have 3 stages 1. sharp downturn 2. reflexive rebound 3. drawn our fundamental downtrend & shows we're in reflexive rebound stage, prelude to a further downturn in stocks and other risk assets.

Preview from Europe: Stocks Consolidate at Lofty Levels
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Key points include:
A record 13.9% of companies beat their EPS estimates, prior record was 7.9% in Q1 of 2004. Does this suggest the game of lowball estimates have become far more exaggerated?

Year over year profit growth still at -29.5%. Yes, that's better than the -31.7% consensus estimate before Q1, but at the start of the year estimated growth rate for Q2 was -11.3%, So actually, earnings are coming in below expected by more than 18 percentage points on this basis, but believe me, there is nary a newspaper or a bubblevision TV program that is going to make mention of that particular statistic.

What about guidance? Again, not a broadly reported statistic but there have been 39 negative EPS pre-announcements versus 15 positive pre-announcements thus far for 3Q. That yields a negative/positive ratio of 2.6x, which is actually well above the 1.8x at this same juncture during the Q1 reporting season three months ago and the long-run average of 2.1x.

What about valuations? The S&P 500 is trading at 16.5x calendar year 2009 earnings estimates; 14.7x four-quarter forward estimates; a 13.2x calendar year estimates. These are forward estimates, which are merely analyst projections, and they are based on operating, not reported earnings. And the best, the very best, multiple that can be drummed up is 13.2x. That doesn’t exactly sound like bargain prices from where we sit, especially when dividends are being slashed and the corporate bond market is still offering up coupons of over 7%.

Coming Soon: Banking Crisis of Historic Proportions

Key Points:
Banks are not doing enough business to earn their way out from under a still growing mountain of loan default losses
Bank failure rate much higher than anticipated two months ago. For 2009, may have about 230 vs 125 forecasted, and amount of assets involved is much larger than in past per bank failure
Loan defaults increasing for several more quarters, especially commercial loans
FDIC is in trouble, probably bankrupt
May be going to historic lows in bank credit
Best case US GDP Growth of about 2% per year for 2010-11 will not be enough to allow many mid sized and smaller banks to survive.


As noted in the summary, there are three real possibilities regarding market direction, at least for the short term. The most likely, however, appears to be continued range trading unless some very potent news comes along. This week's calendar is relatively light on market moving news, however with markets still near highs, there is potential for volatility.

Next week will likely be dominated by a slew of manufacturing data from around the world, central bank comments, and climaxed by US non farms payrolls data.

DISCLOSURE & DISCLAIMER: Opinions expressed do not necessarily represent those of AVA FX. The author has positions in above mentioned instruments

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