Monday, October 19, 2009

GLOBAL MARKET OUTLOOK Full Version 10/19: Risk Appetite Becoming Indigestion?


- Stocks: Friday: Asia, Europe, US down, Monday morning Asia closing lower, China higher, Europe opening higher

- FX: Friday lower equities, bias to safety currencies [JPY, USD, CHF in order of safety appeal] in favor of risk currencies [AUD, NZD, CAD, EUR, GBP in order of risk appetite appeal], USD makes some gains

- Main events today: USD: Bernanke speaks, major earnings Monday: Monday: AAPL (tech), HAS (toys), TXN (tech)

- Big Theme: Rising risk appetite becoming indigestion? Will depend on how mkt responds to earnings & if leaders can show increasing revenues and upbeat Q4 guidance. Quiet news day means big earnings announcements the likely drivers if surprising.


US: ( Earnings, commodities, and the USD, in that order, drove global equities this week, as economic data took its usual backseat role when major earnings announcements begin, and could have only minor impact on markets for the next week or so until the overall theme of US earnings clarifies, barring any major surprises.

US earnings mostly overshadowed economic news throughout the week, with added attention on how the market would respond to revenue misses. The market overall reacted positively to several earnings beats, though it is clear that expectations have been raised as shares of GE (GE) and IBM (IBM) tumbled after their quarterly results.

Earnings got off to a strong start, with JPMorgan Chase (JPM) reporting a hefty earnings beat, with Q3 EPS coming in at $0.82 versus the $0.51 consensus. Goldman Sachs (GS) and Citigroup (C) reported earnings the next day, both topping estimates. But both shares came under a pressure in a "sell-the-news" trade.

Later, Bank of America (BAC) broke the trend of upside earnings surprises from the major banks, posting Q3 EPS of -$0.26 per share versus expectations of -$0.20. Banks continue to be hampered by increasing credit losses, though this was largely anticipated as poor jobs data continues to undermine consumer wealth.

Similarly, IBM and GE fell despite EPS beats. IBM's disappointment came due to relatively weak services orders, while GE's revenue was well short of expectations ($37.8 billion versus $39.5 billion).

Risk Appetite Turning to Indigestion?

Friday’s sharp decline across the spectrum of risk correlated assets on the back of disappointing earnings from Bank of America (BofA) and lower than expected revenues from General Electric (GE) could prove to be a significant signal of risk appetite turning to indigestion. The BofA has long been seen as a relatively weaker link amid the big US financial firms, so the result was not so bad for the sector as a whole considering the much better outcomes from other leaders earlier in the week; meanwhile, the GE report offered few surprises and beat expectations on the actual earnings portion of the report. Overall, it seems the fast, violent selloff that followed may have reflected a market that was looking for an excuse to take profits as recent gains increasingly look overextended.

Equities have jumped to the highest levels since 2003 relative to earnings, which seems more than a little overdone in a year when the world economy is set to see the first contraction in global output since the Second World War. If bullish momentum has in fact been exhausted, a deep correction lies ahead for risk assets in general, and so very oversold USD and other safe haven assets could move up fast.

There were some reports that the market liked, however. Google (GOOG) bested its consensus EPS ($5.89 versus $5.42 consensus), and seemed more upbeat about the economic outlook, and Intel (INTL) was also upbeat about the future.

After earnings, a major driver of trade was commodities and the dollar. The dollar tumbled to a fresh 52-week low at 75.21, giving a lift to commodities (+5.2%). As a result, gold hit an all-time nominal high of $1070.20 per ounce, and oil surged to the highest levels in 2009 at $78.75 per barrel. Crude prices also benefited by a smaller-than-expected increase in inventory levels. In turn, energy and commodity companies outperformed, with oil & gas equipment & services surging 7.8%.

Economic data had a modest impact on the market this week. Retail sales surprised to the upside with a softer-than-expected decline of 1.5% versus the -2.1% consensus. Excluding autos, retail sales increased a better-than-expected 0.5% versus the +0.2% consensus.

Initial jobless claims for the week ending Oct. 10 totaled 514,000, which was a bit below the consensus forecast of 520,000 initial claims and down 10,000 from the previous week. Continuing claims slipped below 6.0 million for the first time since March by coming in at 5.99 million. The consensus called for an even 6.00 million continuing claims, and many believe any coming declines are more due to expiring benefits than improved employment.

The Empire State Manufacturing Index for October , came in at 34.57, which beat the 17.25 consensus and boosted stocks.

Earnings will remain in focus in the upcoming week, with added attention placed to companies' top lines and commentary regarding the economic outlook for the coming quarters.

Asia: Chinese markets up on hopes for US earnings, China data, rest of Asia mostly down on profit taking following US drop Friday

Europe: Opening higher on follow through from US gains



ASIA- DOWN N225I +0.19% HS -0.31% SSEC -0.11 FTSTI -0.30% AORD -0.41 %

EUROPE - DOWN FTSE -0.63 % DAX -1.50% CAC -1.45 %

US- DOWN S&P -0.81% DJIA -0.67% NASDAQ -0.76%



N225I -0.21% HS +0.39 % SSEC +1.83 FTSTI -0.25% AORD -0.84 %


FTSE +0.93 % DAX +0.84% CAC +0.80%

COMMODITIES: The dollar tumbled in Friday US trade to a fresh 52-week low at 75.21, giving a lift to commodities (+5.2%), lifting oil and gold.

Oil: In Friday US trade, oil surged to the highest levels in 2009 at $78.75 per barrel. Crude prices also benefited by a smaller-than-expected increase in inventory levels. Oil prices jumped above $79 a barrel to a 2009 high Monday in Asia as investors looked to the corporate earnings of big U.S. retailers this week for signs the consumer may be regaining confidence. Up nearly 10% on the week due to an upward revision in demand by OPEC & larger than expected inventory drawdowns in the US, though inventories remain high. Futures currently around $79 in Monday morning trade.

Gold: As a result, gold hit an all-time nominal high of $1070.20 per ounce. Gold was little changed around $1,050 per ounce on Monday, pressured by a firmer dollar, as the precious metal took a breather and consolidated gains from last week's fast paced climb to historic levels. Rising crude oil prices are causing a rotation of speculative funds into crude. Consolidating around $1052 in Monday morning trade.

CURRENCIES: Stocks ended lower Friday on disappointing results from Bank of America and bellweather GE. Because currencies have been tracking risk appetite, risk currencies predictably retreated while the USD and other safe haven currencies regained some of the past week’s losses. SEE WEEKLY ANALYSIS, FULL LENGTH VERSION FOR MORE DETAILS ON EACH PAIR

USD: Up on Stock Pullback: After hitting fresh lows Friday, rallied dramatically as stocks pulled back, ending Friday higher against nearly all major currencies including the EUR and AUD. Given the extended nature of the risk asset rally, many wonder if we have the beginning of a major reversal in risk appetite.

Although we believe that there are many reasons for why the dollar should continue to fall, we also recognize that it has become extremely oversold. Every trend in the currency market has shallow or deep retracements and the latest “reversal” should be just that. In order for a full fledged turn to occur, the dollar would need to rise more than 3 percent. This past week, we learned that the Federal Reserve is still open to the idea of further asset purchases and monetary stimulus which is one of the primary reasons why the dollar may have a hard time rallying. In a world where other central banks are growing more hawkish and taking active measures to unwind their stimulus, the possibility of the Federal Reserve moving in the opposite direction is unequivocally dollar bearish.

Unless and until the Fed suggests otherwise or other central banks step in and actively weaken their own currencies via physical or verbal intervention, there is no reason why the trend in the dollar should change.

With that in mind however, we have a number of central bank related events next week that could help the dollar. The Bank of Canada has a monetary policy announcement and if they express extreme concern about the strength of their currency, it could boost the dollar. The same is true if the minutes from the Bank of England revealed continued to desire to increase stimulus. Also, the Beige Book report will be due for release and it will shed more light on the latest developments in the U.S. economy. In addition to these event risks, producer prices, housing starts, building permits, jobless claims, leading indicators, and existing home sales are due for release.

The only economic report Friday for the US has little effect on currency trade. Foreign purchases of long term U.S. securities increased by $28.6B in August, but the rise was offset by a downward revision to the prior month's report. Total purchases including long and short term securities rose by $10B. After the large drop in foreign demand in July, a rebound is normal. Investors moved their money from short to long term Treasuries, reflecting increased confidence in the outlook for the U.S. economy. France was the biggest buyer followed by HK, Japan, the U.K. and Russia. China was actually a net seller, but the amount they sold was so small that it is barely meaningful.

EUR- Recovery Pace Slowing? Ended lower against the USD as stocks retreated on disappointing earnings Friday, particularly from bellweather GE’s lower revenues. The EUR has risen against the USD more as a result of rising risk appetite more than of its own fundamentals. China's gradual but steady diversification away from the USD via decreased US T bond purchases in favor of other currencies like the EUR is also giving support to the currency.

The big question for the Eurozone next week is whether or not the pace of recovery is receding. Germany and France were one of the first countries to rise out of recession but now there is growing evidence the recovery is losing traction.

--The trade surplus in the Eurozone turned into a deficit in the month of August as exports fell 5.8 percent.

--Imports also declined but by only 1.3 percent.

This clearly suggests that the strength of the euro is indeed having a detrimental impact on the Eurozone economy. If this trend continues, the ECB may not be able to ignore it for long. However in the meantime, comments from ECB officials suggest that they are still focusing on when to implement an exit strategy. They have made it clear that they do not believe now is the right time but the tone of their statements indicate they are thinking and preparing the market for an eventual exit.

Even though the slowdown in the pace of recovery is coming primarily from Germany, it appears that the Germans themselves are not worried. Economy Minister Guttenberg said this morning that “the dollar’s weakness is not a cause for concern for exporters. EU Minister Junker who is usually the first to complain about the euro’s strength also added that “they are not too concerned” with the euro exchange rate. So for the time being, European officials are not worried about the euro rising further and therefore the market should not be all that wary of intervention.

The most important economic releases to watch this week will be German producer prices, Eurozone current account numbers, German IFO report and PMI figures from the entire region. These reports will shed more light on whether the pace of recovery in the Eurozone is really receding.

JPY - One of the big breakout moves in the currency market this week was the rally in USD/JPY. The currency pair has been tracking U.S. bond yields for the past year and the recent uptick in 10 year bond yields coincided perfectly with the breakout in USD/JPY. It may be fruitful for USD/JPY traders to keep an eye on this correlation. Reasons to question yen strength going forward include:

• Policy makers' conflicting statements about favoring or discouraging yen strength

• Stronger risk appetite

• Growing interest rate differentials as other G10 central banks get closer to rate increases

• Increasing demand by Japanese banks and investors for higher yielding currencies

• Recent moves by competing Asian exporters to weaken their currencies against the USD to gain cost advantage for their exports may lead Japan to do likewise.

BoJ and DPJ Differ on Policy: The Cabinet Office released their economic assessment today, the first under the new ruling Democratic Party of Japan. The report explained that while recovery does seem to be taking hold, the country remains in a “difficult situation”. Members from the cabinet concluded that because of some fundamental weaknesses they could not be “optimistic about the outlook.”

However, in the same day, BoJ Governor Masaaki came out and largely discredited such findings. He concluded in a speech today that the economy was improving thanks to the moderation in capital spending. This is the second occasion so far this week that clearly painted a divided government, with the BoJ on one end, and the DPJ on the other.

When the BoJ gave optimistic guidance after their rate decision, Finance Minister Fujii quickly shot it down as being unrealistic. The Cabinet also announced today that it will free up more than $30 billion from the country’s stimulus package in efforts to fulfill on some of its campaign promises to revive growth.

On the way for next week will be the BoJ’s Minutes which should further clarify the bank’s optimism, along with the Leading Index for Tuesday and Trade Balance for Wednesday

GBP – Able to Hold Last Week’s Gains? After Thursday’s impressive short-squeeze rally, the pound only managed to come away with small gains against the dollar on Friday. However, the run-up in the pound is much more impressive in EUR/GBP which posted its weakest week since June. The Pound appears to finally be coming around after lagging other currencies throughout August and September.

However, despite recent rallies, some analysts believe that the weakness in the pound has reached “emergency levels”. Mr. King, who is the chief economist at HSBC, Britain’s largest bank, indicated that there was a distinct risk of a “sterling crisis”. He believes that the currency has been “seriously undermined” thanks to the “benign neglect” coming from the Bank of England. In fact, the BoE’s interest in the falling pound has not reached any level of prominence. However, when considering the currency has fallen 17% year-to-date, there is a distinct possibility that the bank may have to address the issue if current strength does not hold up. Mr. King also sees fit that the central bank maintain its quantitative easing purchases.

Hints by BoE's Posen in a weekend article in the UK's Sunday Times that he favored extending QE may pressure the pound too.

We are heading into a busy week that includes the BoE’s Minutes for Wednesday, Retail Sales for Thursday, and GDP for Friday. The main thing to look for in the minutes is any hints that the BoE will continue to ease, because if there is, the pound could fall just as quickly as it has risen. Later in the week, GDP numbers are due for release. Current consensus shows that economists expect the economy to finally grow after five quarters of contraction, which would mean that the recession in Britain has finally ended.

AUD: While in solid uptrend, retreated against the USD as stocks and risk appetite in the US pulled back. Fundamentals are perhaps the best in the developed world, rate increases expected, but considered very overbought and vulnerable to pullback.

NZD: Like the AUD, considered very overbought and vulnerable to pullback, despite very positive economic news last week that increased the likelihood of rate increases coming sooner.

CAD: BoC Decision Time: Like all the commodity currencies, lost ground against the USD Friday as stocks pulled back. Consumer prices held steady in the month of September, which actually drove annualized CPI growth from 0.8 percent down to 0.9 percent. This week is a big week for Canada. The Bank of Canada has a monetary policy decision and even though they are not expected to lift interest rates from their record low level of 0.25 percent, there could still be a great deal of volatility in the Canadian dollar. The BoC will be faced with the tough of decision of deciding whether to put greater emphasis on the improvements in the economy or on the rapidly appreciating Canadian dollar. Last month Canada reported the second month of positive job growth with the unemployment rate dipping from 8.7 to 8.4 percent. If the BoC emphasizes the damaging impact of their currency over the improvements in economy, we could see a near term peak in the Canadian dollar. Alternatively, if they downplay the constraints brought by a strong currency, the CAD could accelerate its move towards parity.

CHF: Despite poor fundamentals that include continuing deflation, rising unemployment, stagnant exports, and constant SNB intervention threats, the CHF has gained on the USD over the past months on sheer USD weakness from rising risk appetite and poor US employment figures which make US interest rate rises less likely.

CONCLUSIONS: Friday’s pullback on disappointing earnings and especially GE’s soft revenues highlight the popular concern that stocks and other risk assets may be overpriced relative to growth prospects, even if these are improving.

Trading Opportunities: Near term favors higher yielding and commodity currencies, but that could change fast if equities pull back, no trend continues forever. Thus: 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. Crude oil breaches key $74 resistance, implying more upside unless stocks pull back on earnings disappointments. Always use sell stop orders.

for Wednesday.

USD/JPY: Currency in Play for Next 24 Hours

USD/JPY will be the currency pair in play for Monday. In Japan, we will see the release of the BoJ’s Meeting Minutes and the Tertiary Industry Index at 7:50 pm ET or 23:50 GMT on Sunday. We will also have Nationwide and Tokyo Department Store Sales on Monday at 1:30 am ET or 5:30 GMT. Momentum in USD/JPY appears to be waning but the currency pair is still hovering near the Buy Zone, which we determine using Bollinger Bands. If the rally should find new legs, resistance stands at 91.73 which was the low from July 13th. On the way down, support should stand at 90.00, which is not only a psychological level but also corresponds with the 20-day simple moving average. If optimism is confirmed through the BoJ minutes or a further slide in equities, we could see USD/JPY approach the critical 90.00 level.

Crude Oil

Breaches new highs at $78, up from $74 at the start of the week. OPEC officials have said before they are comfortable with up to $80/barrel, suggesting that playing the pullback is the higher probability play ONCE IT BEGINS (NOT BEFORE).



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