by Cliff Wachtel, FX Empire
Strategic lessons for investors in stock indexes, forex and other global markets, both technical and fundamental outlooks, lessons about what's really moving markets now and what we need to watch in the future. Don't be fooled by the prevailing calm.
- -TECHNICAL OUTLOOK: Last week's selloff just a technical correction as indexes, EURUSD and other risk assets recover most or all of losses, indicators suggest risk assets look to continue drift higher.
- -FUNDAMENTAL OUTLOOK: The fundamental drivers of the current bull market remain in place, weekly data losing influence because they're not influencing central bank policy for US, EU, etc.
- -CONCLUSIONS: Likely market direction and what could change it even in this low volatility environment.
The following is a partial summary of the conclusions from the fxempire.com weekly analysts' meeting in which we cover the outlook for the coming week and beyond.
Technical Outlook: Gaining Importance In Absence Of Fundamental Drivers
We look at the technical picture first for a number of reasons, including:
Chart Don't Lie: Dramatic headlines and dominant news themes don't necessarily move markets. Price action is critical for understanding what events and developments are and are not actually driving markets. There's nothing like flat or trendless price action to tell you to discount seemingly dramatic headlines - or to get you thinking about why a given risk is not being priced in.
Support, resistance, and momentum indicators also move markets, especially in the absence of surprises from top tier news and economic reports.
Indeed, with markets mostly moving with central bank policy speculation, and a consensus that most central banks are keeping policy steady, the economic calendar has become less influential.
Thus although the charts are supposed to just reflect the underlying fundamentals, the absence of any meaningful changes in those fundamentals that could drive markets has to some extent left technical tools such as assorted support, resistance, momentum, and timing indicators to fill that vacuum.
Risk Appetite Medium Term Per Weekly Charts Of Leading Global Stock Indexes:
Weekly Charts Of Large Cap Global Indexes March 2013 To Present With 10 Week/200 Day EMA In Red: LEFT COLUMN TOP TO BOTTOM: S&P 500, DJ 30, FTSE 100, MIDDLE: CAC 40, DJ EUR 50, DAX 30, RIGHT: HANG SENG, MSCI TAIWAN, NIKKEI 225
Key For S&P 500, DJ EUR 50, Nikkei 225 Weekly Chart: 10 Week EMA Dark Blue, 20 WEEK EMA Yellow, 50 WEEK EMA Red, 100 WEEK EMA Light Blue, 200 WEEK EMA Violet, DOUBLE BOLLINGER BANDS: Normal 2 Standard Deviations Green, 1 Standard Deviation Orange.
Source: MetaQuotes Software Corp, www.fxempire.com, www.thesensibleguidetoforex.com
Our sample of weekly charts for leading global stock indexes, which are barometers for overall risk appetite, continue trending higher.
The most important point to note is that, as we predicted in last week's market preview, last week's pullback was just a technical correction for virtually our entire sample of leading global indexes. For reasons given in that report, there was little reason to suspect it would be more than that. Indeed, with the exception of the UK's FTSE 100 (which have predictably struggled due to rising expectations for a faster BoE tightening), our US and European indexes are essentially right back where they were 2 weeks ago.
Medium Term Momentum Suggests Continued Drift Higher: Note how all three indexes for which we provide more detailed momentum indicators (the S&P 500, the DJ Euro50, and Nikkei 225) all shown nothing but strong medium term momentum. In particular:
- All are at the upper end of their double Bollinger® band buy zones, indicating that upward momentum is strong enough for considering new long positions
- Our moving averages ranging from 10-200 weeks all continue to trend higher, suggesting entrenched medium and long term momentum.
As we discuss in the section on the fundamental outlook below, the fundamentals support this drift higher.
Daily Charts / Short Term Coming Weeks
As expected, these more sensitive charts show the above momentum indicators having recovered their lost momentum from last week. No other insights worth noting.
Fundamental Picture: Lessons, Market Movers To Watch
Overview: Why Global Stocks And Other Risk Assets and Currencies Closed Higher
- The fundamental pillars of this latest leg of the bull market (dating from July 2012, within the longer term bull that began in March 2009) remain in place.
- The prior week's selloff brought indexes back to near term support, leaving investors waiting for an excuse to buy this rare pullback, however shallow it was.
- The dovish fed statement provided that excuse. This was the big market mover last week.
If the above points aren't blindingly obvious, here's a bit more explanation.
The twin pillars of the current bull market, 1) ultra-supportive central banks (and the mountains of cash seeking limited opportunities to earn a decent yield that these imply) plus 2) a lack of crisis worries (which might check that yield seeking) remain firmly in place. These two conditions have kept keep cash flowing into risk assets. Since the latest leg of the bull market started in July 2012 on the ECB's claim that it would AND COULD (a pure, bold bluff that calmed fears of a new EU crisis) do all that was needed to save the EU, these have been enough to keep stocks and other risk assets drifting higher. Occasional signs of strong data have helped, but these have not been necessary as expectations for the global economy are not high.
The prior week's pullback to near term support had investors looking for any excuse to buy this rare dip, shallow though it was.
Wednesday's dovish Fed comments were the excuse that was needed. Not surprisingly, US and most other indexes made their biggest gains in the wake of that news (Asian indexes would reflect it in Thursday's gains).
In sum, after the latest ECB easing on June 5th, the past week's dovish Fed performance reinforced the central bank pillar, and with markets at near term support, they had their excuse to rally back up to near term resistance. No believes that the West cares enough about Ukraine to jeopardize business with Russia, and fighting in Iraq has yet to seriously threaten a massive oil price hike.
So, we've dovish central banks, and no imminent crisis risks. That's all that's been needed to keep markets drifting higher. Worries about historically high valuations get countered with historically low rates.
Fed Comments Were The Big Market Mover: What You Need To Know
The big news out of the Fed this week is that there is no big news. While many have pointed at evidence of rising inflation and how it might pressure the Fed to tighten sooner than expected, Yellen dismissed recent inflation data as "noisy," that is, too short term to influence policy. Evidence of improved labor markets were also countered with expressions of concern that there was still much progress needed.
As we've said repeatedly, the Fed is not changing policy based on any monthly readings. Instead it wants big convincing trends, which aren't coming soon as long as "slow but steady" characterizes the US economic recovery according to the Fed.
- Fed policy remains on autopilot for the coming months at lease barring a dramatic change in US growth or inflation.
- The FOMC under Yellen is the same as it was under Bernanke, dovish and far more concerned about tightening too early than too late.
- Although Yellen acknowledged the improvements in the economy, and noted that the Fed is discussing tools for normalizing monetary policy, she said that there would be a considerable period of time between the end of QE to the first rate hike, and when pressed to be more specific about that "considerable time" interval, refused to provide any details, saying only that there is no formula for it. That sounds more like "I really don't know" than "I'm not telling."
Stocks, the EURUSD, and other risk assets both jumped higher Wednesday, as investors saw any chance of earlier tightening disappear for now. The majority of FOMC members continue to believe the first hike is coming at some point in 2015. However given the EURUSD's bounce, it's clear that investors are thinking the first rate increase comes later 2015 rather than early or mid-2015, and even then, it will likely be minimal.
The IMF's cutting its US growth forecasts for the coming years, and warning the US to keep rates low (as if the Fed needed any such warning) further reinforced this impression.
Data Losing Near Term Relevance
Given that the prime drivers of global markets since the start of the global financial crisis have been central bank policy and contagion threats (or lack thereof). Because neither of these primary drivers is showing signs of change (most central banks holding steady regardless of near term data, as discussed here, and no imminent crises seen), so it's no surprise that top tier economic reports from top tier economies (US, EU, China-if you at all trust China's official data) aren't moving markets. They're not seen as moving central bank policy.
Both Fed And ECB Policy On Auto-Pilot For Now: As noted above, the Fed's holding steady for the foreseeable future. Meanwhile, although the ECB has pledged to add stimulus if needed, no one expects it to do so until it's had at least 3 months to see how the recent stimulus plan is working.
Therefore when we talk about potential market moving reports, it's looking increasingly likely that "market moving" is becoming a relative term.
Many have pointed at signs of rising US inflation, but Yellen dismisses the data as too short term to matter for now. Concerns about disappearing slack in the labor market are also dismissed as the job market is still far too weak per the Fed.
Oil Prices: How High & Ramifications
Energy in general has been trending higher all year. Ukraine tensions started it, and now expanding fighting in Iraq adds another potential threat to supply, as that fighting threatens to spread to Iraq's Southern oil producing region.
The note references two tables from Columbia University's Center on Global Energy Policy showing how disruptive fighting in the South could be. The first compares proven reserves in the North versus the South.
Reserves become irrelevant if Iraq loses its sole remaining functioning export terminal, which is also in the South.
The second table compares exports emanating from the southern port of Basrah with those out of the northern terminal at Kirkuk before and after Kirkuk was shut down (after a key pipeline to Turkey came under attack, so Kirkuk is now gone and Basrah is now the only port from which Iraq can export oil.
The note concludes:
If the conflict migrates to the South, an unlikely but possible worst case scenario in which all production is lost, oil prices could spike to $160 a barrel.
Immediate risks to production appear limited, meaning that oil prices remain around $110/bbl.
On Consumer Spending
Unfortunately, analysts noted last week that the crude price increase that's occurred is expected to send U.S. gas prices to a six-year high of $3.652 this summer.
There is debate over long that will last and how much it will matter. Michael Santoli believes that $4.25/gallon is the red line at which consumer spending would start to suffer.
Professor James Hamilton is an expert on the relationship between energy and the US economy. He has a useful calculator (that shows the relationship between oil and gasoline prices) that translates into ~$137/barrel for Brent crude, and $4/gallon suggests $127/barrel (hat tip to Jeff Miller for that fine source).
On Global Markets
Of course markets are forward looking, so it's anyone's guess how far south the fighting has to travel before speculators start driving up oil prices and risk asset markets like stocks start pricing in the damage of this added tax that carries no corresponding benefit from added government spending or reduced debt service expense.
Gold: Bottoming On USD, EUR Weakness From Central Banks Policies, Rising Oil
Oil isn't the only hot market. Gold was a big winner last week, and has been trending higher since December. In the past three weeks it's risen almost 6%, driven by both new Fed and ECB dovishness as well as rising oil prices.
Unlike most other liquid globally traded instruments, or commodities, gold does not fit neatly into either the risk or safe-haven asset category, because it does not consistently rise or fall with risk appetite. Most of the time gold is best characterized as neither of these, but rather as a "currency hedge," rising or falling with the perceived value of the most widely traded currencies, especially the USD, and to a lesser extent, the EUR. Without getting to technical, gold also tends to rise with rising inflation risk, which is related to, but not necessarily the same thing as, currency weakness.
New ECB easing as well as Fed signals that rates will stay lower for longer are seen as dilutive for their respective currencies. Oil is priced in dollars, so rising oil is usually bearish for the USD (except for times of great fear that drive investors into safe-havens like the USD).
Oil And Gold: Moving In Synch For 2014
Weekly Charts For Gold (Top), Oil (Bottom) August 2012 To Present
Key: 10 Week EMA Dark Blue, 20 WEEK EMA Yellow, 50 WEEK EMA Red, 100 WEEK EMA Light Blue, 200 WEEK EMA Violet, DOUBLE BOLLINGER BANDS: Normal 2 Standard Deviations Green, 1 Standard Deviation Orange.
Source: MetaQuotes Software Corp, www.fxempire.com, www.thesensibleguidetoforex.com
Key Points To Note:
They've been basically moving in synch since mid-2013, both recording double bottoms in December 2013, trending higher since then, and accelerating upwards in recent weeks on the effects of EUR and USD weakness as well as rising oil prices (for gold) driven by turmoil in energy exporting areas like Ukraine and Iraq.
Inflation Debate: Don't Base Investment Decisions On Short Term Inflation Data
The rise in oil and gold matter most to the extent that they may signal rising inflation. These days, inflation matters mostly for investors insofar as it influences sentiment on the biggest market driver of all, central bank policy.
Boring, low volatility markets have the financial media searching for something to write about, and recent signs of rising inflation have been a hot topic, because in theory they should influence sentiment on Fed policy and perhaps increase volatility and thus give traders and financial writers something to do and justify their jobs.
For now, we advise ignoring suggestions that coming inflation means accelerated tightening for the Fed.
The Fed has made clear that it will only change policy based on longer term trends, not monthly inflation data, which Yellen dismissed last week as too volatile to take seriously.
Jeff Miller has a great summary at the end of his weekly market preview of the specific reasons why you should not anticipate any changes in Fed policy based on rising inflation data over the coming weeks or next few months. The most important are:
- The Fed will tolerate inflation over its 2% target for a while
- It believes many metrics overstate inflation
- It doesn't consider food and energy prices as much as consumers do, both because these are volatile and because the causes of higher food and energy prices are beyond the influence of Fed policy.
- Again, the Fed is cautious and will not tighten due to inflation unless it sees dangerous long term trends forming. Periodic but monthly price spikes that don't form a trend of rising prices won't raise Fed inflation concerns.
FT's Munchau: Markets Badly Underestimating "Debt Sentence" Risks In The EU
In his post last week, Europe faces the horrors of its own house of debt, FT's Walter Muchau warned that investors pouring money into the markets of the EU's most vulnerable economies are far too optimistic about the EU's recovery prospects and the ability of the ECB save the EU from its self-inflicted "debt-sentence" of slow growth which it may not survive. Key points include:
- As in the US, the EU too is suffering from a balance sheet recession caused by too much debt, similar to what Nomura's Richard Koo saw happen in Japan 20 years ago. Therefore what appears to be a credit crunch is actually a lack of demand for loans. Lower interest rates will not spur a credit-driven recovery because businesses and consumers are still trying to cut debt, not add it.
- Europe has barely begun its deleveraging. Low inflation makes that process harder because it raises the real value of debt and limits the ability to reduce prices.
- Yet reducing debt risks insolvency, lower growth and even higher unemployment, so the EU could be killed by either the disease (debt) or the cure (cutting debt).
- Thus the most likely scenario in the coming years in the EU is a long period of weak growth, low inflation, and a constant threat of insolvency and political insurrection (read: nations opt out of the EU or their debt obligations) as the EU fails to grow fast enough to avoid falling incomes, living standards, and employment.
- The implied real solution is debt forgiveness, which means private sector lenders and investors will share far more of the pain than the fallen borrowing costs of rising prices of EU bonds and stocks suggests they realize.
My guess is that if the Europeans had to choose between deleveraging and default, they will pretend to do the former and end up with the latter. By reducing political instability, they will end up increasing financial instability.
I am just not sure that investors understand the risks. Nor do they seem to understand the implications of recent EU legislation establishing a new pecking order of who pays how much and in what order when a bank fails. When the house of debt collapses, it is they, not the taxpayers, who come first.
We agree. The recent EU banking union puts lenders and creditors first in line to take losses when trouble hits.
Top Calendar Events To Watch
As noted above, as long as policies of the major central banks remains steady
The top US events to watch include existing and new home sales (Monday and Tuesday), consumer confidence (Tuesday), revisions to Q1 GDP and durable goods on Wednesday, personal income, personal spending and revisions to the University of Michigan consumer sentiment survey later in the week. The majority are expected to show minor improvements.
Final Q1 GDP on Wednesday, however, should be revised significantly lower, especially after the Fed, IMF, Goldman Sachs, and everyone else, including Bubba (my German Shepherd) have all cut their forecasts.
For those who choose to ignore Janet Yellin's dismissal of climbing inflation data as just so much noise, the core PCE price index report Thursday would be worth watching, because it's believed to be a favorite Fed metric.
The top EU events to watch include the batch of flash manufacturing and services PMIs on Monday, the German Ifo sentiment survey Tuesday, German preliminary CPI on Friday.
As long as the stocks and bonds of the EU's periphery continue to see demand, the EUR's prime fundamental support remains in place, so watch the related indexes and bond sales.
Italian and Spanish yields have moved still lower in recent weeks, as investors seek yield and apparently believe the ECB alone can offer a credible, implicit backstop as more or less eliminating credit risk. Certainly the EU's bank union pact doesn't provide much comfort.
Other Top Tier Risk Appetite Influencers
Beyond US and EU data, the other potential risk appetite mover is the China HSBC flash manufacturing PMI on Monday.
We would also pay careful attention to oil prices, for reasons discussed in the conclusions section below.
With both ECB and Fed policy on autopilot for at least the coming 3 months, the twin pillars of dovish central banks and no major market risks, fundamentals like weekly or monthly economic data are less influential, technical factors becoming more influential
Rising energy prices are the most likely source of new volatility, but as those are beyond the influence of central bank policy, they're unlikely to move central bank policy, which is already dovish.
Investors' bidding up of EU assets implies they're underestimating EU risks
Fed, IMF, slash US growth projections, EU's weak growth, China slowdown to keep biggest central banks dovish.
Barring a big risk off development like Iraq oil cutoff, low volatility to be reinforced as we enter summer and big institutional traders go into summer vacation mode.
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DISCLOSURE /DISCLAIMER: THE ABOVE IS FOR INFORMATIONAL PURPOSES ONLY, RESPONSIBILITY FOR ALL TRADING OR INVESTING DECISIONS LIES SOLELY WITH THE READER.