Saturday, November 5, 2016

Dollar Index Trade for November 2016 (maybe longer)

Despite (or because of) the uncertainty, and on some levels, unease that hangs over global financial markets and in particular the US financial market at the moment, the Dollar Index fundamentally is a buy. Factoring in the relative glide path of monetary policy in the US versus those of other developed economies, interest rate parity theory suggests further dollar appreciation. Or, if the news narrative further perpetuates the market uncertainty, investors will seek out the relative safety of the US dollar and US dollar denominated assets. Either way, the sell-offs in the dollar can be used to get better price positioning, though increases should be marginal as the price momentum is currently short.

Buy US dollar exposure at current levels through futures contracts on the index, or through futures and spot contracts on exchange rates of major financial trading partners of the United States. The profit target for the trade is an index level of 100.

Saturday, October 22, 2016

A New Home for Government Bond Investors

With the current monetary policy stance of the Federal Reserve System, and the tone being conveyed by the Fed's forward guidance, and market expectations for the path of monetary policy normalization in the United States, the exodus out of US government debt has begun. Net selling of bonds by investors tends to increase the market interest rate associated with the bond, which is in-line with the overall direction on monetary policy in the US. In anticipation of this, some investors adjust their portfolio allocations to reflect the expected downside to bond prices.

For those investors however, that must maintain their allocated levels of different asset classes, the expected downside for US government bonds means they need to find somewhere else to park their investment capital. An ideal candidate is Japanese Government Bonds (JGBs). Conceptually, the same reason why there will inevitably be a capital outflow from US government, is the reason why there will inevitably be a capital inflow into Japanese government debt.

Interest rates and bond prices move in opposite directions, therefore, the Fed raising interest rates will depress the prices of US government bonds, meanwhile, the Bank of Japan is firmly committed to Quantitative Easing and has no plans to raise interest rates any time soon. This monetary policy stance by the Central Bank supports the prices of Japanese government bonds, as these bonds are used as collateral for cheap money from the Central Bank. As an added bonus, the long-term deflationary trend of the Japanese economy means the future cash flow from the government bonds should have more purchasing power than the cash used to purchase the bonds. This should supplement the low nominal yield earned on the bonds.

Friday, September 30, 2016

S&P500 Trade for October 2016 (maybe longer)

From a purely technical viewpoint, the S&P500 can be sold at current levels (2,145) down to a target of 2,100. At that level I expect the market to then trade sideways while institutional traders consolidate their positions before the US equities market takes another step down to its next consolidation level.

Equity market sentiment can be expected to be bearish in the short term, therefore traders can look to sell holdings into price rallies while investors can look to increase holdings on price drops.

Happy trading.

Thursday, September 15, 2016

Is The Fed Stuck in a Liquidity Trap?

When both stocks and bonds are overpriced, and commodities which were considered overpriced less than five years ago and are now well on the way to correcting, where can an investor turn? It's sort of a trick question, because the answer is cash. Well enough, the Fed and most other major central banks are maintaining very accommodative monetary policy stances, providing ample dollar supplies to match the growing secular demand for liquidity. Institutional money inspired by the Fed Quantitative Easing (QE) programs has inflated and benefitted from the inflation of both stock and bond prices.

Now that the Fed's Large Scale Asset Purchase (LSAP) programs have ended, and the road to alleged monetary policy normalization has been embarked upon, the institutional investors no longer see the need for broad-based accumulation of financial assets. With no buyer-of-last resort, financial market participants (on the institutional level) will have to go back to relying on market demand to support the prices of the assets they buy and sell daily. This phenomenon is apparent in the mid-term price patterns of the S&P500, and the Dollar Index, which have both been advancing higher. Especially when compared to the price patterns of crude oil, gold, and the US 10-year interest rate, which have all been retrogressing.

According to a 2014 issue of The Regional Economist, by the St. Louis Fed, the article titled "The Liquidity Trap: An Alternative Explanation of Today's Low Inflation", states ...Conventionally, the expansion of the money supply will generate inflation as more money is chasing after the same amount of goods available. During a liquidity trap, however, increases in the money supply are fully absorbed by excess demand for money (liquidity) investors hoard the increased money instead of spending it because the opportunity cost of holding cash --the foregone earnings from interest-- is zero when the nominal interest rate is zero. Even worse, if the increased money supply is through LSAPs on long-term debt (as is the case under QE), investors are prompted to further shift their portfolio holdings from interest-bearing assets to cash.

To get away from this scenario, which sounds a lot like the one the US economy is in now, the article prescribes that the Federal Reserve attempt to raise inflation expectations by manipulating long-term interest rates. The idea is to not just stop the LSAPs and let the securities mature on the Fed's balance sheet, but rather to reverse the LSAPs and sell securities in the open market. A direct result would be financial asset prices falling as the market would seek to clear the increase in supply. This would push long-term interest rates higher, and theoretically lift long-term inflation expectations, which would in turn drag short-term inflation up with it. A downward trend in financial asset prices should prompt investors to shift portfolio holdings towards real and commodity based asset classes, pushing those prices higher, and further perpetuating short-term price increases.

The logic appears to be direct, so much so that it's a wonder that the Federal Reserve has not yet adopted and started implementing a similar policy. The issue may simply be that the real world does not flow as seamlessly as the theoretical world of financial economics, meaning the disconnect can represent years of waiting for sticky prices to adjust to economic fundamentals and for new market equilibria to be achieved. Pivots in monetary policy can be very disruptive to macroeconomics, which is why fiscal policy should be introduced to smooth out economic readjustments. This mix of monetary policy and fiscal policy can only be utilized effectively however, if there are no major budgeting constraints on the fiscal side, i.e. too much existing debt.

Thursday, September 1, 2016

Gold Trade for September 2016 (maybe longer)

As another proxy for financial market participants' expectation of general price inflation, gold as of recent has been expressing signs of weakness and downward pressure. In the longer term, gold has resisted the market forces that have been pushing crude oil lower, but trading opportunities still present themselves ever so often.

The preceding chart outlines the last three months of Gold prices. The timeframe for the trade is one month. Sell gold at its current levels ($1310) down to $1245, represented by the green line.

Happy trading.

Monday, August 15, 2016

Gold, Crude, and other Inflation Gauges

Long-term gold prices appear to be in a consolidation range, with the $1,000 price acting as a support level, and by my approximation the $1,500 price acting as a potential resistance level. Industrial supply and demand for gold has always seemed in line with each other, while investment supply and demand, on the other hand, are subject to mismatching. This is usually the source of price shocks in the precious metal. The consolidation range that the price of gold is currently in, represents an equilibrium without any short-term inflation in general price levels. This means that investors are less likely to increase their inflation insurance. In cyclical terms, gold prices will consolidate around industrial fundamentals until investors have cause to increase their hedge against general price inflation.

The 10-year Treasury note price is exhibiting signs of strength, and a buildup of long momentum with both short-and long-term regressions trending higher. Strength in 10-year Treasury prices can signify investor belief that interest rates will not be increasing any time soon in any meaningful way. The S&P500, which has been the driver of financial asset price inflation, no longer has monetary policy as a tail-wind. The overall effect should be the S&P500 switching from a clearly defined upward trend, to a sideways trend. This is the type of environment where the ability to select stocks should yield higher returns compared to passive or index investing.

The dollar index appears to be finding long-term support above the 96.00 level. Overall strength in the dollar index provides little support to short-term price inflation, and consequently depresses commodity and import prices. Without increases in the price of goods and services, there is no justifiable reason for raising wages, and the resulting spillover.

Long-term oil prices are exhibiting signs of weakness, and a buildup of short momentum. The regression trends on one-year, five-year, and ten-year prices all have negative slopes. Longer-term trends in the crude oil market suggest that prices are consolidating around an equilibrium level that represents the matching of global supply and global demand for oil. When there is finally a mismatch of more demand than immediate supply of oil, we will see increases in headline and then eventually core inflation. Until then, we can expect more sideways movement in oil prices with a downward bias, and the same can be expected for general price levels.

When the time comes, and crude oil prices increase and push up the cost of everything that uses it as an input for creating a good or providing a service, investors will sell gold and government debt. As would be expected, any signs of inflation would be met with more monetary policy normalization through interest rate increases. Gold being an inflation hedge, will experience weakened investment demand, and government bond prices would respond to any monetary policy adjustments.

Monday, August 1, 2016

Crude Oil Trade for August 2016 (maybe longer)

I've been looking at Crude Oil in longer-term time frames in relation to its impact on general price inflation, and inflation expectations. The trends are clear in the intermediate-term, but within the intermediate-term there are also short-term trades.

The preceding chart outlines the last three months of Crude Oil prices. The timeframe of the trade I have in mind is approximately one month, with the first leg being long from current levels to within the $45 range, followed by a second leg short to within the $30 range. The trade fits within the overall intermediate- and long-term trends that Crude Oil prices are exhibiting. Over time, the price may extend lower past the target of the trade but, I expect there to be sideways consolidation in the price action before another clear trade makes itself apparent.

Happy trading.

Friday, July 15, 2016

Summer 2016 Part Two: Short S&P500

Last summer, the S&P500 ended a six year bull-run which started in early 2009 and entered into a defined trading range, which we'll call a lower-bound of 1,800 and an upper-bound of 2,500. Historically, equity prices have exhibited an upward bias, so it's easy to guess which direction the S&P500 will be heading in over the next three years. The direction over the next three months however, is not so easily deciphered. The bull-run that ended coincided with the burst of global economic activity concentrated in the emerging and developing markets. The S&P500, which earns a large percentage of its revenues from outside the United States benefitted from the international growth, as well as universally accommodative monetary policy, and multiple rounds of quantitative easing by the Fed.

Fast-forward to summer 2016, and the S&P500 no longer stands to benefit from further systemic increases in financial market liquidity, and the current environment of global economic uncertainty will shift safe haven positioning by international investors out of equities and into government debt. This appears to be the underlying trend playing out in most developed non-commodity exporting economies, where mid to long-term interest rates are considerably low, with no signs of support from inflation. The overall effect will be upward pressure on the US dollar, filtering through to upward pressure on long-term bond prices keeping interest rates low. The shift in investor sentiment will also exhort downward pressure on US equities, and to an extent global equities.

Furthermore, with it's first (albeit arbitrary) interest rate increase, the Federal Reserve is attempting to communicate that financial market stability does not dictate the course of monetary policy. That first step has effectively removed the implicit guarantee to support equity markets in the short-term. Without the artificial supports of Large Scale Asset Purchases as they were by the Fed, the US equity market now has to realign with the underlying macroeconomic reality. A reality where long-term inflation expectations may be beginning to shift lower than the long-held central bank targets, and both financial and real asset prices over time must reflect their underlying fundamentals.