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Use The Current Calm To Prepare For The Next Market Storm

Published 03/03/2015, 05:54 AM
Updated 07/09/2023, 06:31 AM

Hurry up and wait! Spring is just around the corner, but the activities of mankind and financial markets in general seem to be stuck in neutral, lacking a clear sense of direction. Yet this is the first week in the month, the week of Non-Farm Payroll data and so much more, the week when fireworks traditionally wake everyone from their lethargy. Perhaps this winter has been more severe, for whatever reason, but the thaw is nowhere near to be seen. Just when volatility seemed back at hand, another ranging malaise has suddenly taken over the trading community.

What is next, the primary question that greets a trader every morning? It was only a few weeks back when everyone was so sure that the dollar was headed higher, that the euro would fall to parity, and that lower oil prices would boost the global economy back onto the road to recovery. The eagerness to short the euro was palpable, but wait! Ms. Yellen suddenly turned dovish before Congress, leading everyone to change the Fed’s rate increase forecast to the third quarter. The euro flattened, even before the ECB had really begun its quantitative easing program, and oil prices bounced back 20% in a matter of weeks. China even cut their interest rates this weekend to a silent thud.

Analysts the world over have already researched the history books and checked out every arcane chart relationship known to man, only to come back with blank looks on their faces. The current situation is unlike any we have ever seen, as highlighted by the follow factoids unearthed by Bank of America (NYSE:BAC) Merrill Lynch:

  • 83% of global equity market cap is currently supported by zero interest rate policies (ZIRP);
  • 52% of all global government bonds yield less than 1%;
  • There is now $7.3 trillion of negatively-yielding government debt in the Eurozone, Switzerland and Japan;
  • 1.4 billion people are experiencing negative real interest rates across the globe.

Central banks in every region of the planet have created these artificial economic conditions ostensibly to force idle capital on the sidelines to commit to more risk-laden ventures, thereby spurring GDP growth. The added benefit for any country that pursues this path is that its domestic currency weakens, and, after a bit of delay, its export trade begins to pick up and thrive. The only problem is that everyone is chasing the same rabbit. Exports are a zero sum game in the end. At some point, capital must become the chief export to release the tension in this continually coiling spring. The recent Swiss Franc Debacle was only the first sign of steam escaping from this overheated kettle.

What is the latest consensus thinking about key economic variables?

Uncertainty is normally a speculator’s paradise, but only when analytical tools of the trade give an insider’s edge to what may be on the near-term horizon. Without this edge, one is just winging it on pure luck alone, not a very worthy strategy for making consistent net gains over time. Successful people will tell you that success comes from two things, each split “50/50” – working hard and good luck. In other words, the time to work hard is now in the preparation phase, so that when opportunity knocks, the luck part, you are prepared to run with it, no matter which way it takes you.

In the past few weeks, major arguments have come forward supporting every scenario imaginable in the coming months ahead, from a total resumption of this raging bull market to Armageddon and open chaos in the streets. Earnings season has come and gone. Winter snows have blanketed the nation, but Spring is near and portends a global economic recovery by most accounts. Here are a few other tidbits to think about:

  • Current doubts have not backed off any of the shorting going on with non-U.S. currencies. As one analyst remarked, “The long dollar trade is probably the most crowded trade on the planet right now. Whether one measures its value versus a barrel of crude oil or against the world's other fiat currencies the dollar is strong and well loved by global investors.”
  • The U.S. Dollar has had a great run, most of it in anticipation of the Fed raising its bench market interest rate in the late second quarter. Capital has flowed freely to the U.S. market, bolstering stock values to record levels, but creating other concerns, as well. Our stock market represents 38% of the world’s total market capitalization, while our share of global GDP sits around 22%. The only instance in the last 50 or so years that this ratio has been higher was during the irrational exuberance of the dot-com nineties. Are we at another crisis crossroads? Consequently, portfolio managers are feeling a strong need to shift capital away from U.S. equities;
  • Chairwoman Yellen’s testimony before Congress last week appeared to back down slightly from previous hawkish statements relating to policy shifts at the Fed. To date, the central bank has followed its playbook to the letter, discontinuing its last QE adventure, closely following employment and inflation data, and then gradually telegraphing when it will tighten the money supply. The third quarter now seems more likely for a change, but has the market factored in such a move completely?
  • China surprised most analysts over this weekend with a 25 basis point rate reduction. A host of other major central banks will also be considering rate changes this week. Australia may now be pressured to reduce in tandem. The UK and Canada may actually be leaning in the other direction, and, although the ECB will most likely stand tight, they may stoke the fires with a word or two about its upcoming QE program that appears to need a few more technical hurdles to clear. Nothing is ever easy in the Eurozone, but at least everyone kicked the Greek can of worms down the road one more time. Delaying and denial go hand in hand these days in Europe;
  • Lastly, will the price of oil be the deciding factor in how this latest act plays out? There have been more articles written about the latest oil glut than there are wells in Saudi Arabia. In fact, if the word “glut” cannot appear in the title, the editor will look elsewhere for a story. Analysts are beginning to believe that the real facts may be blurred. On the one hand, demand seems to be escalating in anticipation of an extending low-cost environment. Inventory supplies, however, have not been declining. There may be silent stockpiling going on, even when rigs are being shut down in record numbers, and Big Oil has been announcing severe restructurings and employment cutbacks as losses mount. Economic growth will improve as commodity prices remain low, and, contrary to what a few have written, price contraction has not been totally due to the rise in the USD’s value. Yes, the Dollar appreciated 18%, but oil prices fell 54%. Copper fell 20%, as well. $50 a barrel of oil may be with us for a while, but not for long.

Concluding Remarks

When the ancient explorers traveled to the southern hemisphere for the first time, they began to see the night sky filled with a multitude of new stars that did not appear on the charts of the day. Did these ancient mariners turn their ships around and head home to more familiar and safer waters? No – they began recording the new stars and making new charts, adapting to the changing world about them.

As forex traders, we must constantly adapt to changing market conditions surrounding us, but, unfortunately, that process cannot begin until we recognize the changes at hand. This process is made even more difficult when our physical world does not materially change, a psychological obstruction at times that can bring along with it a bit of anxiety, frustration, and outright fear, especially when so-called experts are in constant disagreement.

For the moment, things are calm. The first week of the month tends to be more eventful than most, so be prepared for a few surprises, but use this calm time wisely to prepare for whatever storm is about to rock the market waters. Stay focused on the variables that matter and to anticipate what others are not seeing. When change comes, you will be fully prepared to execute a plan, rather than blindly grasp at straws filled with chance.

Risk Statement: Trading Foreign Exchange on margin carries a high level of risk and may not be suitable for all investors. The possibility exists that you could lose more than your initial deposit. The high degree of leverage can work against you as well as for you.

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