Currency War

December 10th, 2014
in contributors

Macro Strategy Report for December 2014

by Jim Welsh with David Martin and Jim O'Donnell, Forward Markets

Happy Holidays

We would like to wish you and your family a year of good health and contentment in 2015. And we will do our best to add a bit of prosperity.

Follow up:

Deflation Battle Becoming Currency War

The three largest central banks share a common goal: increase the rate of inflation in their domestic economies. The European Central Bank (ECB) and U.S. Federal Reserve (Fed) also aim to prevent deflation from taking hold. The Bank of Japan (BOJ) has been waging its deflation battle for almost 25 years while the Fed and ECB joined the fray in earnest after the financial crisis in 2008. In November, global investors cheered when the BOJ significantly increased its quantitative easing (QE) program and the ECB promised to as well.

The additional monetary steps taken by the BOJ and ECB are a tacit acknowledgment that all prior efforts have failed in their quest to lift inflation and economic activity, so the gleeful reaction of global investors is somewhat puzzling seeing as failure isn't usually cheered in other endeavors. Imagine a group of bystanders, who, while watching a five-alarm fire, break out in ovation when they learn that what they are witnessing has become a six-alarm fire. Global investors are cheering not because they have confidence that additional steps will succeed, but because they expect additional monetary accommodation to lift equity prices and keep longer-term bond yields under wraps.

The fundamental problem with a Pavlovian response to central bank intervention is that asset values are becoming further detached from the economic reality in Japan, the European Union (EU) and the United States. We don't know when the music will stop, but when it does, we don't want to be on the dance floor.

Global investors are so enamored by central bank intervention and its effect on financial assets they are ignoring the negative fallout from large currency devaluations. With the significant devaluation of its global trade pond. It will take many months for the waves of this modern version of protectionism to come ashore in all the countries involved in global trade. Much like a tsunami, there will not just be one wave but a series of repercussions that will export the deflation that has gripped Japan for more than two decades into the global economy.

For a long time prior to the 2008 financial crisis, Japan's deflation remained contained on the island while the global economy hummed. With Japan's desperate attempt to reverse the tide of deflation, what happens in Japan will no longer stay in Japan.

Since November 2012, the yen has plunged more than 32% versus the dollar. However, the impact from the plunge in the yen extends far beyond U.S. shores and represents a trade headwind for many countries that compete globally with Japan for exports. Since November 2012, the yen is down more than 25% against the currencies of Taiwan and Singapore and more than 30% versus the South Korea won and China yuan.

While Japan derives 14.2% of its gross domestic product (GDP) from exports, many of its competitors are far more export dependent: exports represent 60.0% of Taiwan's GDP, 54.9% of South Korea's, 27.9% of the Philippines' and 26.4% of China's.

Since November 2012, the yen has fallen by almost 30% versus the euro, which will have an impact on those European countries that depend on exports for a large part of their domestic GDP. Exports represent 50.7% of Germany's GDP, 34.1% of Spain's, 30.4% of Italy's and 27.2% of France's GDP. Since early May 2014, the euro has lost more than 12% versus the dollar and declined against many Asian currencies as well. South Korea, Taiwan, Singapore and China will have a tougher time competing against European countries, especially powerhouse Germany.

Global trade is turning into a bare-knuckled slugfest and the country with the weakest currency is the best contender.

Changes in currency values take six to nine months to work their way through the trading system since most contracts are for production and services in the future. The impact of the large declines in the yen over the last two years and the euro since May will progressively affect any country competing with Japan and EU members. Companies in heavily export-dependent countries are facing a number of outcomes, none of which is particularly protect market share and accept smaller profit margins, or hedge sales by shorting the yen and euro. Even if the currency hedges work reasonably well, they represent another cost of doing business and a squeeze on profit margins.

If the loss of sales becomes a big problem, businesses will petition their governments to do something to offset the unfair trade advantage that Japan and Europe have created through the manipulation of their currencies. Even if the Japanese and European economies show improvement, complaints lodged against Japan and the EU are likely to be met with nods, promises and ultimately inaction. Eventually the objections from companies attempting to compete against Japan and the EU will force the leaders of export-dependent countries to either lower interest rates to cheapen their currency or enact tariffs.

In the 1930s as the growth of the global economic pie slowed and contracted, trade barriers and tariffs to protect domestic producers and jobs were enacted, unfortunately led by the United States.  On June 17, 1930, the Smoot-Hawley Tariff Act was passed and raised tariffs on over 20,000 imported goods to the highest level in more than a century.  European countries didn't appreciate America's "Beggar-Thy-Neighbor" trade policy and responded with retaliatory tariffs of their own.

Between 1929 and 1934, U.S. exports plunged 70% and imports from Europe into the U.S. sank 66%. World trade collapsed 66% between 1929 and 1934. Although trade barriers were a consequence of the Depression and not a cause, they certainly contributed to its depth, longevity and greatness.

No doubt the authors of the Smoot-Hawley Tariff Act and their European counterparts felt a degree of pride that their trade protections were so successful back then. However, history has judged their actions far more harshly, and the lesson learned is that protectionism is bad economic policy for everyone involved. Unfortunately, desperate men do desperate things and decades of bad policy has led policymakers in Japan and Europe to engage in a modern day form of protectionism.


As we discussed in the June 2013 Macro Strategy Review (MSR) section entitled "Japan - Winning in a Zero-Sum Growth World," there isn't much difference between a country that cheapens its currency by 20-25% and a country that slaps import tariffs of 20- 25% on products from competing countries.  In one way, currency devaluation is worse since it affects every good or service offered by a competing country rather than targeted products like the tariffs of the 1930s.

The Keynesian tools of fiscal and monetary policy that policymakers have relied on since World War II to end every recession and foster economic growth have failed in Japan and Europe.

This is due in part to problems beyond the scope of monetary or fiscal policy. Political leaders have had many years to address their internal structural problems but have lacked the leadership skills and courage to make necessary changes. Ironically, labor laws erected to "protect" some workers at the expense of other workers within Japan and many EU countries are a form of internal protectionism. Labor market inertia has led to slower economic growth that has persisted despite unprecedented monetary and fiscal stimulus.

Given the political realities in these countries, central bankers have opted for currency devaluation in a desperate attempt to rescue their economies at the expense of Japan's newest round of quantitative easing, tax cuts and currency devaluation was triggered by a -1.6% decline in third quarter GDP after its economy contracted -7.3% in the second quarter. The weakness in the second quarter was prompted by an increase in Japan's sales tax from 5% to 8% on April 1. As we noted in the November 2013 MSR,

"As consumers rush to buy before April in order to save 3% on their purchases...first quarter [2014] GDP will be lifted by the surge in consumer demand, only to weaken significantly in the second quarter. This will be the first real test of the durability of Abenomics."
While the first quarter strength of 6.7% and second quarter weakness was predictable, the contraction in the third quarter illustrates how fragile the Japanese economy remains. In the August 2014 MSR we wrote, "
If Japan's economy does not show signs of recovering from the tax increase before year-end, the Bank of Japan may instigate another round of QE to cheapen the yen further and boost Japan's stock market."

With the contraction in the second and third quarters, Japan has entered its fourth recession since 2007. The BOJ vote to increase its QE program was a close 5 to 4, however, since some members are concerned about the precariousness of Japan's long-term fiscal health.  As Japan's total debt-to-GDP ratio is a mind-blowing 640%, their concern is more than justified.  The sales tax increase from 5% to 8% was in order.

However, Prime Minister Shinzo Abe has postponed a further increase in the sales tax to 10% from October 2015 to April 2017 and proposed cash handouts and tax cuts of $25 billion.  Annual growth has averaged just 0.85% since 1992 and without the structural reforms that Abe has promised but not delivered, we remain skeptical of the long-term viability of Abenomics. Think of a car driver whose car has not only left the road but is plunging into an abyss-the driver knows that putting the car in reverse will do no good, so instead steps on the gas pedal. In this situation, the only thing that matters is the depth of the abyss. We think that analogy sums up Abenomics nicely.

Japan produces only 16% of its energy used and, according to the Energy Information Administration, is the largest importer in the world of natural gas, second largest importer of coal and third largest importer of oil. Since these commodities are priced in dollars, the decline in the yen makes energy imports more expensive. While this has lifted Japan's low rate of inflation, it has also increased the cost of energy to businesses and consumers. Real household income, which adjusts for inflation, has declined for 15 consecutive months and has dropped from an increase of almost 3% in the first half of 2013 to -6.0% as of September 30, 2014.

Although wages rose for the seventh straight month in September and were up 0.5% from September 2013, the improvement in wages still lagged the 3.2% increase in Japan's consumer price index (CPI) in September. The purchasing power of the average Japanese worker continues to worsen. In fact, a BOJ survey released in October found that only 4.4% of households said they were better off than a year ago. As consumers account for about 65% of Japan's GDP, their finances and outlook are important.

The higher cost of Japan's energy imports has also had a deleterious effect on its trade and current account balances. Even as Japan suffered through years of very weak growth since 1990, it had always managed to post healthy trade and current account surpluses. That is no longer true. Japan has been running a trade deficit since early 2011 and recorded its first current account deficit in more than 20 years. The recent decline in oil prices since June has exceeded the fall in the yen, so Japan will experience some modest relief that should contribute to a narrowing in the trade deficit and improvement in the current account balance in coming quarters.

Since September 30, 2013, the BOJ has increased its balance sheet from 30% of GDP to 57%. Despite an almost doubling of the BOJ's assets, Japan's economy is not materially stronger, and we doubt expanding it to 70% will turn the tide. Japan's debt-to-GDP ratio has grown from under 540% in 1999 to 640% as of June 30, 2014, and this increase in debt did not lead to a pickup in economic growth. We have no idea how Japan will be able to repay its debts in coming decades, but we do know with such high debt levels any increase in interest rates will likely sound a death knell.

Japan's Government Pension Investment Fund (GPIF) has $1.1 trillion in assets and has announced it will undergo a major reallocation of its asset mix, lowering its domestic bond allocation from 53% to 35%. In order to prevent an increase in bond yields, Japan plans to have its central bank buy the government bonds sold by Japan's GPIF. The proceeds from the GPIF bond sales will be used to increase its allocation to domestic and international stocks from 33% to 50%. Since the reallocation has not yet occurred, international money managers are front running the GPIF and buying Japanese stocks knowing that they will be able to sell them to the GPIF down the road if the outlook deteriorates. This might be the biggest example of the "greater fool theory" in financial history.


The eurozone economy grew at an annualized rate of 0.6% in the third quarter, which is sluggish at best. The fourth quarter has the potential to be even weaker since Germany's composite purchasing manager index fell from 51.4 in October to 50.0 in November.

Germany is the largest economy in the EU and has until recently been the locomotive of growth. Inflation was just 0.4% in October throughout the EU while core inflation, which excludes energy prices, was up 0.7%. As there are no indications that inflation is about to lift, some companies have resorted to cutting prices in an attempt to spur demand for their products and services.

This is not a good sign since it suggests that companies do not expect the economy to improve any time soon and only reinforces the expectation that inflation will remain low. The recent weak economic reports, low inflation and the BOJ's move to further weaken the yen has ignited a sense of urgency in the EU.

At the Frankfurt European Banking Congress on November 21, ECB President Mario Draghi said that policymakers need to bring inflation back to the ECB's target of 2.0% "without delay" and "do what we must to raise inflation and inflation expectations as fast as possible."1

The ECB has initiated a plan to increase the size of its balance sheet by $1.3 trillion through purchases of covered bonds and asset-backed securities and has also hinted that it will purchase corporate bonds if it is unable to increase its balance sheet appropriately using that method. Draghi expects (or at least hopes) that these purchases will lift the valuations of debt instruments in general. This would have the salutary effect of strengthening bank balance sheets throughout Europe and allowing for banks to increase lending.  As we have repeatedly noted, bank lending has been MIA but is critical in the EU since banks provide almost 80% of credit creation versus 35% in the U.S.  As Draghi told the European Banking Congress on November 21,

"Given our relatively greater reliance on banks as a source of finance, these balance sheet effects could work particularly through the bank lending channel. On the bank side, rising asset prices would free up capital resources for additional lending."2
A survey of the attendees at the European Banking Congress showed that almost two-thirds thought quantitative easing would not boost the eurozone's economy. Their skepticism is understandable for two reasons. First, interest rates throughout the eurozone are already historically low and a decline of a few more basis points may not be that critical. Second, unless the EU economy shows signs of real improvement, the demand for loans from companies and consumers will remain weak irrespective of quantitative easing.

Germany is not a fan of quantitative easing since it believes France, Italy and a number of other countries need to address structural labor market problems that are hurting growth. Germany fears additional monetary accommodation will only take the pressure off political leaders to make the difficult but necessary changes.

The backsliding within the EU on fiscal discipline was apparent with the pass France and Italy were given after their budgets failed to reduce their budget deficits to less than 3% of GDP.  Given Germany's resistance, Draghi's November 21 speech to the European Banking Congress is an attempt to marshal support for the ECB to be able to include sovereign bonds as part of the ECB's quantitative easing program.  Germany has strenuously opposed these purchases out of concern they may ultimately weaken the ECB's balance sheet (think Greece and Cyprus debt).  As the EU's strongest and largest member, Germany would be forced to pay much of the bill should defaults occur. There could be a showdown within the ECB over the legality of buying sovereign bonds in the first half of 2015, especially if inflation remains low and the EU economy doesn't materially improve.

In his speech to the European Banking Congress, Draghi also suggested the expansion of the ECB's balance sheet would weaken the euro as international investors swapped euro-denominated instruments for higher-yielding assets available in other currencies (e.g., U.S. Treasury bonds).  In the May MSR we discussed the ECB's implicit goal of depreciating the euro, but this is the first time we have heard Draghi express the ECB's intention so explicitly.


In response to the financial crisis and contraction in economic activity, policymakers in developed countries ramped up deficit spending to offset the steep falloff in private demand as unemployment soared. Monetary policy was loosened so that real interest rates were negative in developed countries, which represent more than half of global GDP. These measures were sufficient to stabilize the financial system and markets but proved insufficient in generating a self-sustaining recovery in most developed economies. This lack of recovery led to the introduction of quantitative easing programs and now currency devaluations.

Emerging economies snapped back smartly in 2010 and 2011, in large part because China's domestic stimulus plan was a far larger percentage of their GDP in 2009 than in the U.S. China ramping up its growth rate led to recoveries in other developing countries supplying China with the raw materials it needed.  The hangover from China's credit binge and real estate boom began to be felt in the first half of 2011 and has led to a persistent decline in many raw material prices.

China garners 26.4% of its GDP from exports and Europe is China's number one export market, so the depreciation of the yen and the euro is painful. The yen's decline hits especially close to home since it has led in recent months to declines of 3-5% in the Singapore dollar, New Taiwan dollar and South Korea won.  These countries and Japan are all trade competitors of China so the currency declines are making China's exports less competitive at a difficult time.

China is attempting to unwind a credit and property bubble against a back drop of slowing growth. China is also dealing with excess capacity in the sectors that benefited most from China's export growth and the infrastructure and real estate booms after the financial crisis. According to the National Bureau of Statistics, home prices fell for the sixth straight month and were down 2.6% from October 2013.

China produces half of the world's steel and demand for steel within China has slackened. Efforts to curb excess capacity within China have not curbed production, so there is a glut of steel in China. As a result, Chinese steelmakers have been selling at low prices around the world. Chinese stainless steel exports to Europe have surged 115% from levels a year ago, according to Macquarie Bank. In early November, the U.S. Department of Commerce imposed duties of 110% on the imports of carbon and alloy steel after complaints of dumping by U.S. producers.

In an effort to increase credit availability to small companies, China's State Council announced in October that it would relax the loan-to-deposit ratio from $0.75 for each $1.00 of deposits and help banks write off more bad loans to small firms. These steps would allow banks to increase lending and provide a modest lift to overall growth. In September and October, the People's Bank of China (PBOC) injected more than $126 billion into Chinese banks in an effort to spur lending.  Lending growth has remained weak, however, due to a lack of demand.

In October, Ma Jun, the PBOC's chief economist, said China would not need a broad- based monetary stimulus plan even as growth slows and that any monetary accommodation risked more credit flowing into industries already suffering from excess capacity, like real estate and steel.

On November 21, the PBOC did an about-face and lowered interest rates for the first time since July 2012. The one-year lending rate was reduced from 6.0% to 5.6%. We have no doubt that the renewed depreciation in the yen played a significant role in the PBOC's decision to apply broad-based monetary accommodation. The balancing act of letting the air out of China's debt and real estate bubbles while maintaining sufficient growth to service debt and generate enough jobs to avoid civil unrest has become more difficult with the depreciation of the yen and euro buffeting export sales.

The liquidity event we have forecast for China is now more likely as is the probability that China will ease monetary policy further and potentially take steps to cheapen its currency in coming months.

Currency War Benificiary: The U S Dollar

There is the perception that the world is safer now in the wake of the financial crisis since the financial system has deleveraged. It's true that banks have lowered their leverage ratios in response to new banking regulations from the outrageous levels of 30- and 40- to-1 that existed in 2007. However, the global economy is actually more leveraged today than it was in 2007 since global debt levels are higher while global growth is significantly lower.

With less cash flow supporting a larger mountain of debt than in 2007, the risk of debt deflation has risen, especially if interest rates defy central bank repression and rise.

The more immediate risk comes from the rising dollar since a lot of debt is denominated in dollars and a stronger dollar often results in weaker commodity prices. The stronger dollar puts pressure on countries with dollar-denominated debt and countries dependent on the sale of raw commodities, which often manifests itself through currency weakness. We've already seen Japan and the EU intentionally weakening their currency. The dollar has strengthened by 12% since May, which is beginning to cause emerging market currencies to weaken as we expected.

Dollar strength continues to increase as more currencies are pulled into the devaluation vortex. Given the intentions of the BOJ and ECB, the dollar is likely to trade higher, even though this is a very crowded trade. Normally, crowded trades should be avoided. But with virtually no risk that the BOJ or ECB will intervene to support their currencies, this crowded trade can continue to work until currency volatility rises and begins to cause instability in financial markets.

When asked to explain the dollar's strength, most strategists point to better U.S. growth compared to Europe and Japan as the primary reason. This has led strategists to conclude that the U.S. economy is strong enough to "go it alone." This analysis, however, overlooks a couple of salient points.

In a global economy there is no such thing as one economy decoupling from the rest of the world. Economic growth in the U.S. has been outpacing the recession-plagued European Union and Japan for years. The trigger for the dollar's rally was not U.S. growth but Draghi's strong hints that the ECB wanted the euro to decline in March and April. This led to a reversal in the euro's uptrend in early May and its subsequent fall from 139.93 to below 124.00 on November 21. In the first estimate of third quarter GDP, the Department of Commerce reported that U.S. GDP expanded by 3.5% with trade representing more than 1% of the total.

The 12% rally in the dollar is likely to exert downward pressure on exports in coming quarters, which will lower its contribution to GDP growth. This drag will be mostly offset by the decline in energy prices that are causing consumers' disposable income to increase. As some of this newfound wealth is spent, it will help support the economy, especially in the short run. The dark side of lower energy prices won't materialize for some time, unless oil drops to $60 a barrel.

As we discussed in the October MSR, a strong dollar was likely to buffet the currencies of emerging economies as it approached the 89.00-90.00 range. Japan announced they were ramping up their QE program on October 31. Since then, the South Korea won has dropped about 5% and is at its lowest versus the dollar since August 2013. A governor of the Bank of Korea said, "Efforts are necessary to prevent the weakening yen from moving sharply."3 Simple translation: the Bank of Korea is willing to see the won fall so it doesn't become uncompetitive with Japanese exporters. The Singapore dollar has sunk to its lowest level in almost three years and the New Taiwan dollar recently reached its lowest point in more than four years. A Taiwan central bank official told the Wall Street Journal on November 19, "We are closely watching foreign exchange movements."4

Countries are accepting a weakening of their currency to protect their export business, which only adds to dollar strength and fosters a vicious cycle of even more dollar strength. According to the International Monetary Fund, $650 billion has flowed into emerging markets as a result of quantitative easing by the Federal Reserve. There is a significant risk that some of this money will flow out of emerging economies as their currencies depreciate. A rush for the exit has the potential of igniting a currency crisis as affected central banks are forced to defend their currency through direct intervention or interest.

According to the Bank for International Settlements, more than two-thirds of the $11 trillion in cross-border bank loans are denominated in dollars and an unknown amount is not hedged.

This has the potential to be a big problem since nonhedged dollar debt becomes more expensive as the dollar rises. For instance, if the dollar rises by 12%, which it has since May, a $100 million loan that is nonhedged may now be effectively $112 million if the currency of the loan holder has fallen 12%.

This is another aspect of why the depreciation of the yen and euro amounts to those countries exporting the very deflation they are attempting to ward off in their own economies. The volatility in the currency market that the BOJ and ECB have initiated is likely to intensify in coming months. If it does, it is easy to see how it could spill over into global equity markets, which have greeted every central bank intervention by lifting stock valuations.

Federal Reserve

Some of the dollar's strength can be attributed to the better performance of the U.S. economy and the perception that the Fed will raise interest rates in mid-2015. Members of the Fed have dismissed the economic weakness in Europe and Japan and the rise in the dollar in having much impact on the U.S. economy. We aren't as sanguine as the Fed and think growth will gradually slow and inflation will likely fall, especially if oil prices remain under $80 a barrel.

In order for the Fed to manage the next slowdown, interest rates must be comfortably above 0% if the Fed is to have any leverage through lowering the cost of money to offset economic weakness. The Fed must balance its need to raise rates against a slowly growing domestic economy, inflation holding below its 2% target, a soft global economy and signs of speculation in the stock market and certain sectors of the debt market.

Our guess is that the Fed will raise rates at least once in 2015 just to take some air out of the stock market and overextended sectors in the bond market much like it did in May 2013. This would allow the Fed to employ a stairstep approach of gradually raising rates over an extended period of time. Any rate increase will not represent a true tightening since the Fed will make sure there is more than ample liquidity in the financial system as it raises the cost of money. Whether this will work remains a big question mark. A big risk in raising rates is that the dollar would be likely to rise more and eventually cause problems somewhere else in the world or result in a larger correction to equity markets than expected.


We have been expecting the 10-year Treasury yield to trade between 2.20% and 2.66% for the balance of 2014. As this is being written on November 21, the yield on the 10-year Treasury has traded between 2.30% and 2.38% for 17 consecutive days. The interest rate differential between the yields offered on comparable bonds in Europe make U.S. Treasury bonds a compelling value.

Inflation expectations have been falling and growth in the U.S. is not likely to accelerate in the face of slowing global growth. The threat from the Fed is both distant and outweighed by these other factors. Although the Fed has stopped buying new bonds through its QE program, it is not going to be selling current holdings anytime soon and will reinvest the proceeds as bonds mature. This suggests that the yield on the 10-year Treasury is not likely to increase much in the first half of 2015.


Based on global economic fundamentals, there are three issues that could cause the stock market some trouble in the first half of 2015. As we have discussed, volatility in the foreign currency market could become disruptive if the yen or euro begin to cascade lower or if one of the emerging market currencies falls precipitously.

The Fed may decide to take some air out of the stock market and leveraged loan market by openly discussing the need to raise rates sooner and by more than the market expects. Since the spring of 2013 and the "taper tantrum," various Fed governors have at times targeted segments of the financial markets they deemed excessive (e.g., leveraged loans and biotechnology stocks).

The rally since the mid- October low has been virtually straight up, supported by a series of central banks' moves (mainly the BOJ) or discussion of more easing (ECB). Remember that the rally really started on October 16 after a Fed governor said the Fed would consider QE4. Finally, China is not likely to navigate perfectly through the unwinding of their credit and real estate bubbles while dealing with weakening domestic demand and export growth.

Since we can only surmise what issues may cause the stock market some consternation, we use technical analysis to gauge when the market may be most vulnerable to negative news. In the September MSR we warned that the market was vulnerable to a 7% correction but not likely more than that since the overall fundamental story was still healthy (a good guess, as it turned out).

In the October MSR we sensed the odds favored a new high in the S&P 500 Index since the rebound occurring as of October 23 was strong. At that point we said if the S&P 500 managed to make a new high we would evaluate whether the New York Stock Exchange (NYSE) advance- decline (A/D) line was also making a new high and if there were a healthy number of stocks making a new 52-week high (i.e., close to 300 stocks). We also wanted to see our proprietary Major Trend Indicator at least surpass its early September high.

The S&P 500 made a new closing high on October 31 (the day the BOJ decided to expand its QE program) and has continued to grind higher ever since. The overall technical health of the market has improved but is in the category of better, not great. The number of stocks making a new 52-week high has expanded but is not back to the levels of early July. The NYSE A/D line has marginally made a new high compared to the August 29 peak, but the Nasdasq A/D line continues to make lower highs since peaking back in early March. The Major Trend Indicator has bettered the early September high but not the July peak.

At a minimum, the upside momentum has bought the market some time and the calendar is potentially the biggest plus, putting increasing pressure on underperforming money managers to be fully invested and chase the strongest stocks. As long as the S&P 500 does not close below 1,960, the market will probably press on until year-end. We continue to believe that the S&P 500 has the potential to trade below the mid-October low during the first half of 2015.

  1. Opening keynote speech by Mario Draghi, President of the ECB at the Frankfurt European Banking Congress, November 21, 2014.
  2. Ibid.
  3. Trivedi, Anjani, "As Yen Slides, Investors Shun Other Asian Currencies," Wall Street Journal, November 19, 2014.
  4. Ibid.

Definition of Terms

10-year Treasury is a debt obligation issued by the U.S. Treasury that has a term of more than one year, but not more than 10 years.

An advance-decline line is a technical indicator that plots changes in the value of the advance-decline index over a certain time period.

Asset-backed security is a financial security backed by loans, leases, credit card debt or receivables against assets other than real estate and mortgage-backed securities.

Basis point (bps) is a unit of measure that is equal to 1/100th of 1% and used to denote a change in the value or rate of a financial instrument.

Cash flow is a revenue or expense stream that changes a cash account over a given period.

Consumer price index (CPI) is an index number measuring the average price of consumer goods and services purchased by households. The percent change in the CPI is a measure of inflation.

Debt-to-GDP ratio is a measure of a country's federal debt in relation to its gross domestic product (GDP). By comparing what a country owes to what it produces, the debt-to-GDP ratio indicates the country's ability to pay back its debt.

Devaluation is a monetary policy tool whereby a country reduces the value of its currency with respect to other foreign currencies.

Gross domestic product (GDP) is the total market value of all final goods and services produced in a country in a given year, equal to total consumer, investment and government spending, plus the value of exports, minus the value of imports. The GDP of a country is one of the ways of measuring the size of its

The Major Trend Indicator is a proprietary technical tool that measures the strength or weakness of the market and helps identify bull and bear phases. During bull markets it helps indicate when the market may be vulnerable to a correction, and during bear markets it helps identify a potential rally.

Purchasing managers index (PMI) measures the health of the manufacturing sector and is based on five major indicators: new orders, inventory levels, production, supplier deliveries and the employment environment.

Quantitative easing refers to a form of monetary policy used to stimulate an economy where interest rates are either at, or close to, zero.

S&P 500 Index is an unmanaged index of 500 common stocks chosen to reflect the industries in the U.S. economy.

Smoot-Hawley Tariff Act is the U.S. law enacted in June 1930 that caused an increase in import duties by as much as 50%.

Valuation is the process of determining the value of an asset or company based on earnings and the market value of assets.

Volatility is a statistical measure of the dispersion of returns for a given security or market index.

One cannot invest directly in an index.


Investing involves risk, including possible loss of principal. The value of any financial instruments or markets mentioned herein can fall as well as rise. Past performance does not guarantee future results.

This material is distributed for informational purposes only and should not be considered as investment advice, a recommendation of any particular security, strategy or investment product, or as an offer or solicitation with respect to the purchase or sale of any investment. Statistics, prices, estimates, forward-looking statements, and other information contained herein have been obtained from sources believed to be reliable, but no guarantee is given as to their accuracy or completeness. All expressions of opinion are subject to change without notice.

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