FYI | Dec 01 2008
(This story has been republished from Wednesday last week to make it available to non-paying subscribers at FNArena).
There are probably a million reasons why share prices can rise. Hmm. I think I better correct that one. One reads so often about millions, billions, trillions these days – it is easy to get lost in the numbers, and lose all perspective. Let’s do this again.
There are probably a hundred reasons why share prices can rise, and still not one of these reasons necessarily means that investors will make a profit if they jump in and join. Such are the follies of the share market at times like these.
As we approach the end of November, about halfway from where we were this time last year, it is probably a fair assumption to make that the main question on most investors’ mind is whether we will finish this dreadful year on a high note -meaning: with a well-deserved, traditional Christmas rally- or on a not-so-high-note, which would be more reflective of sales expectations for most retailers across the world, and the health of major economies in general.
I read somewhere that if history can be taken as a guide, the odds are not in favour of a Christmas rally this year. According to this analysis, end-of-year rallies only occur less than four times out of every five years and the principle appears to be “as the year goes, so goes its end”. In other words: if we’re up this time around, we’re likely to see a rally to add something extra on top of the gains we already enjoyed. If we’re down, we’re likely to miss out.
We’re down. I forgot how much exactly, but there’s no denying share markets are currently at much lower levels than when they started the year fresh in early January. Taking this principle as our guide, we should have no hope at all for a Christmas rally this year.
Offsetting all this is that history can only provide us with guidance, not with certainty. It wouldn’t be the first time financial markets would leave the usual script behind and simply did their own thing. It’s what makes investing interesting, sometimes.
I note, for instance, there are quite a few technical chartists around who are calling for a big bear market rally following the significant losses share markets suffered earlier in the month. Such a view would coincide with commodity bulls who have noted the increased chance for a big spike upwards in commodities such as copper, gold and crude oil. This is because the investment community has gone predominantly short commodities. Under such circumstances it can only take a small spark to trigger big price movements to the upside.
So far, however, all we’ve seen is continued absence of any conviction. Rallies have remained short in duration. Share markets and commodities have been unable to hold on to gains made.
Last week I reminded you all about the new role the US dollar is playing in the global financial market. For those who missed it: the US dollar has become the world’s thermometer of economic growth. In a reverse manner. In other words: the worse the global economy is faring, the stronger the US dollar becomes.
This process has been going on since July-August this year. Everyone can see the US dollar has played its new role almost to perfection. As economies in Japan and Europe fell into recession, and others where experiencing serious slowdowns, the greenback kicked most other currencies from corner to corner in a not so subtle way. The euro weakened from 1.60 to 1.29 now and the Aussie fell from near parity to 60c-something. And that’s just those two.
However, the US dollar in its role of reverse benchmark for global economic growth comes with one major flaw: the fact that US authorities constantly have to bailout one Citigroup after the next General Motors. If you listen very carefully, you can hear in the background a persistent sound. One that wasn’t there before. That sound is the sound of the printing presses in the US. They’re busy, very busy these days.
There’s also a seasonal pattern that calls for a breather, if not worse, in the US dollar’s upswing. History shows end of calendar years often tend to come with US dollar weakness. I have seen many observations and analyses about this phenomenon throughout the years, but nobody has been able to put a consistent and trustworthy explanation to this. Fact remains: the US dollar tends to lose some of its value this time around each year, and that’s exactly what has been happening in the week past.
Will the US dollar weaken in the remaining weeks of the year? Or will it continue its upward path, true to its role of the world’s reverse benchmark for global economic growth?
I’d say it’s a difficult call. Currency specialists are divided on the matter as well.
Maybe investors should focus on the Japanese yen instead.
While I have been keeping a close eye on US dollar movements since August -I already explained previously my view that the US dollar would reverse course formed part of my conviction at the time commodities were in for a very tough time- others have been closely watching the Japanese yen instead. There is one very straightforward reason for this: while the US dollar has become the world’s public indicator for global economic growth (or more accurate: for the lack of), the yen has become the indicator for investors’ risk appetite.
As such it may be better to watch the movements in the yen to gauge whether we will see any end of year rallies this year. You won’t be the only one paying attention to the currency. Traders and market strategists at various stockbrokerages and hedge funds have been doing it for months.
Here’s why: the yen has strengthened close to 15% against the USD since August and nearly 30% against the EUR. This despite the fact that Japan was the first major economy to fall into recession. The strong movement in favour of the yen is an indication of how risk adverse the financial sector has become over the period. One only has to look at how share markets in general, and commodities in particular, have suffered over that period to see how accurate reading the yen has been over the past months.
Here’s how Joe O’Leary, currency expert at SVB Capital, explains the new role for the yen in today’s financial market: “In the past, risk-taking investors were enticed to borrow cheap yen, and then invest the borrowed money in other countries where returns can be higher – often called the carry trade. Historically, this weakens the yen because the borrowers are essentially selling yen to buy other currencies, which in turn strengthen.”
In today’s context this means whenever investors get scared, or worried, or disappointed, the yen strengthens – commodities and share markets weaken. If hope and confidence return, the opposite happens.
Now you know why US market trader Dennis Gartman comments on EUR/JPY movements on a near daily basis in his newsletter these days. As the yen goes, so go share markets and commodities has been his credo since August. He has been remarkably correct in his predictions.
At CIBC, however, market strategists pay close attention to the USD/JPY cross instead. This is what they had to say this morning:
“This morning, the Federal Reserve announced even more measures to ease pressures on bank balance sheets, and to spur more direct consumer and small business lending. Stocks rallied and the greenback sold off, inciting feelings of euphoria that a solution for the world’s financial problems might finally be here. However, there is only one problem: USD/JPY did not rally and in fact moved lower despite all of this supposed ‘positive’ news. This currency pair continues to be the barometer for risk taking and the fact that it moved to a new daily low despite a USD sell off elsewhere is a signal for more USD gains and equity losses down the road.”
As such, CIBC confirms what my gutfeel was already telling me: the US dollar might well ignore the usual historical pattern and rise further into the new year.
What’s O’Leary’s prediction?
“As the global economy slips into a deeper recession, the USD and JPY will continue to rise against every other currency around the globe.”
I am not even going to mention what Gartman has to say about all this. You’ll have the full picture by now.
Keep your attention firmly to what the US dollar and the Japanese yen are doing. Especially the yen is likely to provide you with all the answers you are looking for.
With these thoughts I leave you all this week.
Till next week!
Your editor,
Rudi Filapek-Vandyck
(as always firmly supported by Greg, Sarah, Grahame, Chris, George, Joyce, Pat and Andrew)
