Tuesday, June 18, 2013

Data Shows Pressure on YEN to Strengthen - Risk to S&P

Why the Pressure is on for the YEN to Strengthen

The break-down of the YEN weakening relative to the US stock market may seem incidental to many.  But strong correlations of a foreign currency to an exponential rise in the S&P500 since the first of 2013, after already significant gains from the lows of 2009, is a sign that something is changing.   In other words, it is time to pay attention.   Unfortunately, when things begin to change after large advances in asset prices, it usually means there is a busted trade and the risk of cascading losses start to build up in the markets.  I raise this concern because since the first of this year investors have witnessed a growing number of market unwinds – gold, emerging markets, U.S. Treasury markets and the Nikkei.   And now we see a changing dynamic in the YEN relative to the dollar, at a time when many are expecting further YEN weakening. 

To assess the risk and understand why this is happening, I decided to do an in-depth review of the capital flows into and out of Japan that would influence the price of the JPY relative to the USD.

The following series of charts examine the investment capital flows from sales and purchases of investments by various groups that would influence the relative strength or weakness of the YEN over the last year (YEN has been converted to USD based on the prevailing average monthly exchange rate in all data obtained from the Japan Ministry of Finance).

Monday, June 10, 2013

Correlation of USDJPY to S&P500 Explains Why Economic Fundamentals Have Not Mattered

The S&P500 (SPY) started this year at 1425.  In May it reached an intra-day high of 1690, a gain of 18.5%, before pulling back to its current range.  The economic fundamentals have been weak during this time period and the outlook is not cause for making a big bet on “hope”.  Fourth quarter real GDP was first announced negative, and subsequently was updated to a slight positive of 1.6%.  The first quarter was a similar anemic growth rate of 1.8% TTM growth.  When you add in inflation the constant dollar growth rate of the U.S. economy is between 3-4%. 

On what basis would these results cause buyers of the market to rush out and bid the market up by 16%-18% in the first 5 months of 2013?  Do some investors know something everyone else is missing?  Is the market just so undervalued because of the 2008 sell-off that now it can still go up without fundamental economic support?  Count me as skeptical, but I do have a good idea why it has been rising in spite of the numbers, and it is contained in the chart below:

Friday, June 7, 2013

Interest Rates Up - Senior Bank Loan CEFs and BDCs Down, What’s Up?

In my recent articles concerning the upward directional change in interest rate ( Data Shows Interest Rates will Continue Higher In 2013 - What to Do Now ) I have described strategies which are intended to hedge or deaden the blow of basis loss in an investment  portfolio as the market trades lower in price, higher in yield on fixed income investments.   One of the strategies that many investors assume should work is the purchase of variable rate bank loans, either through a Closed End Fund, [CEF] or a Business Development Corporation [BDC].    But when you look at the market trading data since the beginning of May across the board on these companies, there is a definite under performance in the issues.  It is an under performance which in relative magnitude equals the decline in the highest duration Treasury ETFs.

A bank loan which is variable is supposed to be a low duration, not high duration security.  So, there must be something else going on which is driving the trading pattern across an entire market sector; and, I will explain what it is in this article.

Monday, June 3, 2013

Strength in the US Dollar Shows Support for US Stocks – But for How Long

In a never ending quest to unlock how the Central Bank monetary actions and Government fiscal policies around the world are inter-acting to move the stock markets and interest rates, my research drew me to a review of the changes in the value of the US Dollar Index (DXY).  

When looking at the Dollar Index over time based on the changes in Federal Reserve quantitative easing (QE) policy, there is very little relational value.   When the Fed increased QE in the late 90s, the dollar went up.  When the Fed increased QE in post 9/11, the dollar went down.  Looked at today with the Fed’s massive QE program in place since 2009 the dollar has been fairly flat and is now strengthening.   The directional move in interest rates gives a little better understanding in what makes the dollar move.  When interest rates rose in the late 90’s, the dollar went up.  When interest rates fell dramatically after 9/11, the dollar went down.  What about the past several years and today?  Historically low rates, major Fed quantitative easing (QE), and the dollar since 2011 has been on an - uptrend?  Confusion.

 I finally found a much better way to understand the movement of the USD, and therefore get better signals on directional moves in interest rates and equity markets from its change in value.  What I track is the  relative change in the amount of borrowing the U.S government needs to finance its on-going deficits, and the change in financing levels supplied by foreign entities (inflows).

With this framework in mind, I have created the chart below.  The top line (blue) tracks the value of the dollar index for the last 18 years. 

The red line in the chart is the trailing twelve month average in net investment into the U.S. Treasury market by foreign investors.  As the graph shows, when the relative magnitude of inflows are on the decline, the dollar generally strengthens.  And the opposite happens when inflows go up.