SUMMARY
- Stocks: Friday: Asia, Europe down, US up, Monday morning Asia mixed, Europe down
- FX: Generally following stocks. Safety currencies [JPY, USD, CHF in order of safety appeal] generally up in recent days vs. risk currencies [AUD, NZD, CAD, EUR, GBP in order of risk appetite appeal], USD bouncing back, as traders pull back before FOMC meeting, USD becoming preferred funding currency for carry trade!! Major Implications – See Conclusions
- Main events today NZD Current account, bank holidays close Nikkei, Straits times and other Asia exchanges
- Big Theme: See Weekly Outlook for full details Global equity, commodity, and fx markets overall rising, indicating belief in recovery- but we believe assets are overbought with enough risk for flat or even double dip recession to temper current optimism. Declining USD and increased use as funding currency for carry trade has major implications – see conclusion below
STOCKS
US
U.S. equity markets picked up where they left off last week, rallying in four out of five sessions to close with solid gains. The S&P 500 rose 2.5%.
Continuing to drift up on low volume. Overall positive news, but nothing really new—just confirming the prevailing idea that the worst is over, we're bottoming out, modest growth expectations at best” sort of thing. Bernanke stated the recession was likely over, and even Warren Buffet announced he's going back into stocks (long or short?). However, revenues are flat or down, and jobs are still disappearing. Global equities are trading at levels unseen since 2003 relative to earnings. The world economy grew nearly 3% in real terms that year, whereas virtually every credible forecast calls for the first post-WWII contraction in real growth in 2009, pointing to lackluster revenues and overextended asset prices.
As Edward Harrison points out (It's Time to Sell Equities and Look to These 3 Areas)The S&P 500 is now up more than 60% from the lows, which is truly amazing and kudos to those who called it. But the question is whether the fundamentals will ever catch up to this level of valuation — usually after a 60% rally, we are fully entrenched in the next business cycle. Never before have we seen the stock market rise so much off a low over such a short time period, and usually at this state, the economy has already created over one million new jobs — during this extremely flashy move, the U.S. has shed 2.5 million jobs (as may as were lost in the entire 2001 recession).
If risk appetite is so strong, why are yields FALLING on US government bonds? It doesn’t sound like the bond market is expecting a very robust recovery. Pimco, the world’s largest bond fund, is already in this trade. They have been loading up on treasuries of late – bringing them to their highest relative weight in 5 years.
There were bullish developments, but for the most part this week's rally was just a continuation of the recent upward trend. With the possible exception of Wednesday's 1.5% advance, there were no sharp moves, just a slow upward drift with any market pullbacks limited in scope.
All ten sectors that make up the S&P 500 rose, led by Materials (+4.7%) and Financials (+4.5%).
Investors received good news on the economy this week. On Tuesday the Advance read on Retail Sales came in at 2.7% (consensus 1.9%), Sales ex-autos came in at 1.1% (consensus 0.4%) and Empire Manufacturing came in at 18.9 (consensus 15.0). That was followed by better-than-expected Industrial Production on Wednesday (0.8% vs. 0.6% consensus) and Philadelphia Fed business outlook survey on Thursday (14.1 vs. 8.0 consensus).
The Empire and Philly Fed numbers clearly signaled that the manufacturing sector is beginning to come on-line and we should expect strong manufacturing production over the next few months. Unfortunately it is still to early to declare how the increase in production will play out in GDP growth.
There was also positive commentary during the week. On Tuesday Federal Reserve Chairman Ben Bernanke stated that the recession is "very likely over". That same day reports circulated that investor Warren Buffett had returned to the market. Mr. Buffett confirmed it the next day, saying that while the economy "hasn't gotten worse" it also hasn't "gotten much better" over the past three months, and that he doesn't expect a 'double-dip' recession.
But not all of this week's headlines were positive. There was a slow trickle of earnings results that failed to live up to expectations, including Oracle (ORCL), Best Buy (BBY) and FedEx (FDX), although the latter was known after preannouncing results last week. Whether those expectations have been raised too far, reflecting more the equity markets' view of the economic recovery vs. reality, remains in question. Certainly, in our view, the concern next earnings season will be on the revenue line, which is where many companies fell short this week.
Looking ahead, next week will be extremely busy. There will be the usual economic data, most notably Existing Home Sales on Thursday, Sept. 24 and Durable Goods Orders on Friday, Sept. 25. But the Fed is up first on Wednesday, Sept. 23, with investors watching to see if the FOMC has changed its policy directive. Longer term Treasury auctions also return, including $43 billion of 2-years on Tuesday, Sept. 22, $40 bln of 5-years on Wednesday and $29 bln of 7-years on Thursday.
Asia
HONG KONG (AP) -- Asian stocks are modestly lower Monday as investors look to this week's Federal Reserve meeting for more clues about the strength of the U.S. recovery.A number of markets across the region including Japan were closed Monday for holidays. Oil prices fell, while the dollar was little changed against the yen and the euro.
Europe
FTSE rises Wednesday on miners, oils, banks, Thursday futures point to higher opening
FRI. GLOBAL
MARKETS RESULTS
ASIA- DOWN NIKKEI -0.70% HS -0.67% SSEC -3.19% FTSTI -0.92% AORD +0.0%
EUROPE - DOWN FTSE +0.17 % DAX -0.48% CAC-0.19 %
US- UP DJIA +0.37% S&P +0.26% NASDAQ +0.29%
MONDAY
ASIA MID DAY MIXED
NIKKEI closed HS -0.14 % SSEC +0.15% FTSTI closed AORD -0.20 %
EUROPE: AT OPEN DOWN
FTSE +0.04 % DAX -0.54% CAC-0.23 %
COMMODITIES
Oil
BANGKOK (AP) -- Oil prices fell below $72 a barrel Monday in Asia as high crude stockpiles and weak demand tempered enthusiasm about recent signs of improvement in the world's largest economy.
Benchmark crude for October delivery was down 40 cents at $71.64 a barrel by midday Bangkok time in electronic trading on the New York Mercantile Exchange. The contract gave up 43 cents Friday to settle at $72.04 a barrel.
The recession has sapped American fuel consumption, and U.S. oil stockpiles are 14 percent larger than last year even as recent data suggests the economy is clawing out of recession.
The Energy Information Administration said Wednesday that the country also is sitting on a sea of distillate fuels including heating oil, with stockpiles approaching a 27-year high.
"Most of the macro data from the U.S. over the last month has been supportive of oil prices," said David Moore, commodity strategist at Commonwealth Bank of Australia in Sydney. "But inventories remain high and demand is weak, so that's capping prices."
Moore said crude will likely average $64 a barrel in the fourth quarter before rising to average $80 in the October to December period of 2010.
Gold
SINGAPORE, Sept 21 (Reuters) - Gold slipped further on Monday after failing to revisit last year's record around $1,030 an
ounce, with sluggish offtake from jewellers across Asia stepping up the selling pressure.
Gold rallied to $1,023.85 on Thursday, its strongest since March 2008, on uncertainties over the sustainability of the global economic recovery, but the dollar's rebound from a 1-year low against the euro eventually spurred selling.
Bullion
has gained as much as 16 percent this year.
"I think investors are probably a bit cautious. We've got here, where does it go next? Some people might sort of view now
the upside from here has been more limited," said David Moore, commodities strategist at Commonwealth Bank of Australia.
"I am a bit of a bear on gold. I think gold would go back under $1,000. I think the physical demand for gold is still very
weak. When investors start to look elsewhere, I think the gold price will fall back."
Trading was muted in Asia, with Japanese markets closed for a long holiday. The physical market in Singapore was also closed
for a Muslim holiday.
CURRENCIES
General: Per the latest Commitments of Traders report (week ended Sept 15) increasing USD, GBP shorts, while some increasing long positions in AUD, CAD, CHF. Biggest change: long EURUSD contracts doubled. This suggests the short USD position overextended, AUD, EUR due for correction. This week, however, saw the commodity currencies retreat against the USD as commodities consolidated. Stock markets will be the likely decider of further currency moves this week.
USD Getting a temporary technical bounce. FOMC and G20 meetings the major events, barring a stock pullback, which would be the best support for the USD. The U.S. dollar has been steady against the EURin thin trade on Monday, after staging a rebound late last week on short covering ahead of a Federal Reserve policy meet on interest rates and a Group of 20 summit. Lowest 3 mo. LIBOR rates add selling pressure when risk appetite pushes carry trades.
EUR- Strong against the suffering USD, GBP, trading in a range against other crosses. In terms of yield its in the middle of the range, ditto for economic prospects, as growth in Germany and France is balanced by downgrades for Spain, Italy, and others.
JPY - Despite rising stocks in September, the JPY has stayed relatively stable. Along with fellow safe haven currencies the USD and CHF, the Yen stands to gain on any subsequent pullbacks in stocks, and recent experience shows that it can hold its own despite major S&P strength.
Thus we would argue that risks remain fairly bullish for the Yen. If stocks continue their aging rally, the JPY could pull back slightly. If stocks fall, the Yen will in all likelihood continue its previous ascent. While there are other factors to consider, overall JPY risks favor near-term rallies.
GBP – The British pound was easily the weakest of the majors last week as the currency fell more than 3 percent against the euro, Swiss franc, and Canadian dollar. The British pound even slumped 2.4 percent against the US dollar and 1.7 percent versus the Japanese yen! Continuing erosion of fiscal state (collapsing tax revenues, rising spending and deficits. That said, following the latest UK CPI results, which were stronger than anticipated, Credit Suisse overnight index swaps have shifted to price in 78 basis points worth of hikes by the BOE over the next 12 months, up from 66.7 basis points on Tuesday. As a result, if the minutes highlight a clearly dovish bias by the BOE, the market's focus may shift back toward the central bank's liberal stance on quantitative easing, and the British pound could fall sharply
AUD – Holding near highs, but came in a bit recently over dovish RBA statements. Still expected to be among first to raise rates, with economy in relatively good shape, benefitting from Chinese and other Asian demand for commodities.
NZD –Like the AUD, dropped against the USD most of last week, negative retail, manufacturing and business performance data hurt too. Main events this week expected to be negative for the NZD.
CAD – Tracking oil first, stocks and risk appetite second. With oil in consolidation stage, so is the CAD, though slight USD rise a factor too
CHF –SNB is succeeding in keeping the CHF steady against the EUR (60% of exports are to the EU), down or tight range against others as risk appetite has climbed over the past weeks Following yield prospects (thus up against USD) and risk, thus heavily influenced by stock and commodities markets.
CONCLUSIONS
The theme last week was continued equity strength on positive news, with commodities pulling back, and currencies generally following equities in expected fashion, with exceptions. USD made a slight bounce that is not expected to last, unless stocks finally make their much anticipated pullback.
While the USD appears well oversold, we await a catalyst to start unwinding all the short USD positions against the EUR and commodity currencies. A stock pullback, whenever it occurs, is the USD's best hope, as stocks advance further and further beyond any rational support for their prices, as noted above in the section on stocks.
Unlike stocks, the AUD's run has some real justification, it's just overdone and presents more downside risk at this time.
The big news: USD 3 month borrowing rates are now THE cheapest, making the USD the new preferred funding currency for 3 month carry trade ( i.e. borrowing USD for 3 months to fund purchases of higher yielding bonds/commercial paper, etc in another currency). If this condition persists, implications include:
Greater downward pressure on the USD when stocks or other risk assets rise, which then encourages more carry trade
Greater upward pressure with rising risk aversion and unwinding of carry trade, thus USD could see big rally when stocks pullback
Recovery brings challenges exporters to US, holders of US debt. More foreign purchases of US businesses, real estate, and other hard assets?
Another psychological blow to USD
More potential inflationary pressure when recovery actually starts as commodity inputs become more expensive for the US
On the bright side, weaker dollar should help US exports, earnings, and thus US stocks, especially those tied to commodities and that earn abroad. It will make US businesses, real estate, and other assets cheaper, encouraging foreign investment in these and other hard assets, especially from those holding large USD reserves who don't want to take losses converting these to buy assets in other currencies.
But will it continue? Japan still has higher US debt levels.
Trading Opportunities: 1. Be prepared to play a pullback in risk assets and get ready to sell stock indexes, commodities, and risk currencies, buying USD, JPY. 2. Trade the near term horizontal trading ranges that should hold until major news causes a change in risk appetite. 3. Those continuing to take long positions in risk assets should consider tight sell stops, though gold and crude may be approaching new breakouts. Always use sell stop orders.
Near term favors higher yielding and commodity currencies, but that could change fast if equities pull back.
Currency Pair in Play for today
NZD/USD will be the currency in play for Monday. New Zealand’s Performance of Services Index will be released at 22:30GMT or 6:30PM EST on Sunday followed by Credit Card Spending at 3:00GMT or 11:00PM EST. The U.S. will be releasing leading indicators at 14:00GMT or 10:00AM EST on Monday morning.
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