Brian Dolan - The Week
Ahead updated January 29, 2010
· Risk is
off the cliff and the unwind has just begun
· 4Q
earnings better, not good enough
· US GDP in
perspective
· EUR
weakness not over yet
·
Fundamentals still bearish for oil
· Cable,
the path of least resistance
· Key data
and events to watch next week
Risk is off the cliff
and the unwind has just begun
Last week we expressed
caution that the risk sell-off that has characterized the month of January was
at a tipping point. That point has been broken to the downside and we are now
expecting a further unwinding of long risk positions, which should see stocks,
commodities and the JPY-crosses (EUR/JPY, AUD/JPY, etc) extend recent declines
more aggressively. The USD is likely to be the primary beneficiary of a further
risk sell-off, gaining ground on both better US data and on safe haven appeal
as risk aversion increases.
The fundamental backdrop
remains the same as over the past few weeks--China enacting measures to slow
its economy, undermining global growth outlooks; reduced expectations over the
strength of the global rebound; and heightened credit/fiscal concerns in Europe
(Greece-more below), the UK, and elsewhere--but we think long-risk positioning
is now likely to exert a stronger influence. Long positions in gold, oil and
other commodities continue to dominate, and we have seen only small reductions
in the face of recent weakness, suggesting the exodus is yet to come. Numerous
stock market analysts are pointing to January as a bearish reversal month after
a nine-month uptrend, and we would note that the S&P 500 closed just barely
below its daily Ichimoku cloud at 1074.82. Gold prices managed to hang on above
the weekly Kijun line at 1078.45, but the daily picture looks more ominous,
with a downside crossover of the Tenkan below the Kijun with price below the
cloud, constituting a strong sell signal. We prefer to sell bounces in the
commodity space, rather than chasing this move lower.
In currencies, the
JPY-crosses broke below recent range lows and appeared to be soundly rejected
on several intra-day attempts to rally. EUR/USD extended losses and made a low
so far around the 200-week mov. avg. at 1.3859. The weekly cloud is just below,
with the top at 1.3775 and the base at 1.3620. USD/JPY failed to sustain gains
above the daily Tenkan line at 90.51, but is still above the daily cloud
between 89.38-88.57; a break below the cloud would trigger another wave lower
in USD/JPY. Both Aussie and Kiwi have dropped below their daily clouds, with
strong sell signals coming on the downside Tenkan/Kijun crossovers. (We
highlight a short AUD/USD trade strategy in The Weekly Strategy.) As with
commodities, we prefer to be sellers of JPY-crosses and EUR/USD, AUD/USD,
NZD/USD, and GBP/USD on bounces rather than selling into a potentially
over-sold, month-end distorted market. While the overall picture suggests
'risk-off' is likely to dominate further in the weeks ahead, we can't rule out
a round of bargain hunting to start the new month, or some positive earnings
surprises sparking a correction higher. But we'll be looking to exploit any
such rebounds at technical levels highlighted in our Daily Technical Analysis.
4Q earnings better,
not good enough
With roughly 40% of the
S&P 500 having reported earnings, we thought it appropriate to give an
assessment of how things have shaped up thus far. Keep in mind that this will
continue to have implications for overall risk sentiment and thus the yen
crosses in the short-term. The overall picture for 4Q earnings looks marginally
better than the prior two quarters. That said, most of the gains continue to
come on the back of cost cutting and organic growth remains slim. Bottom line
earnings have come in nearly 13% better than expected by the consensus but
top-line (sales) numbers have only bested estimates by a mere 1.5%. We believe
the lack of positive breadth in the reports has contributed to the overall
negative tone in the equity space. Indeed, the intraday charts for the latest
week clearly illustrate a market that is being sold heavily on any semblance of
strength.
Next week is another
critical one for the US earnings picture and we have about 100 companies lined
up. An important caveat is that many of the companies reporting next week are
global in nature and their guidance (future earnings outlook) will be impacted
by the recent monetary policy tightening in China. As well, the turn in the USD
is likely to negatively impact multinationals profits in future quarters.
Traders should continue to keep these reports on their radar screens for
continued lackluster numbers should weigh on overall risk appetite. One of the
strongest correlations in terms of the risk trade has been between EUR/JPY and
equities (+90% in January). The next crucial level of support here is at 124.40
(April 2009 low) and below we would anticipate a potential move towards 122.00
next.
US GDP in perspective
While it is hard to argue
that the 4Q US GDP result was strong (+5.7% quarter/quarter annualized) some
perspective is needed here. Most of the increase was driven by a quirky
statistical phenomenon known as the inventory swing. Indeed, despite the fact
that inventories fell -$33.5 billion (real dollars) they contributed more than
3.8 percentage points to the headline because this decline was an improvement from
the -$139.2 billion drop the prior quarter (it’s the swing that matters). The
cleaner read on growth is ultimately real final sales, which excludes trade and
inventory distortions – an “organic” measure, if you will.
This number rose a much
more modest 2.2% in real terms, which is the highest since 2Q 2008 when it
printed 2.7%. Anyone that thinks the economy was on the verge of something
special back then needs to revisit what happened in the third and fourth
quarter of that year! The other thing to keep in mind is that following a
recession to the extent of what we just witnessed, real growth historically has
been closer to 7% in the immediate recovery quarters. We are a far cry from
there even if we take this week’s 5.7% result at face value. Bottom line is
that while the US economy does indeed seem to be carving out a bottom in
earnest, we are still a ways away from anything even close to resembling strong
growth.
EUR weakness not over
yet
Through most of last year
the EUR was passive; its value was driven higher in response to weakness in the
USD and a sell-off in the pound. In contrast, this year concerns about the
budgetary difficulties in Greece, Portugal, Spain and Ireland have made EUR
weakness a major driver of FX activity.
Greece remains the biggest
threat to the EUR at present. This, of course, has nothing to do with the small
size of the Greek economy and everything to do with the risk to EMU itself that
may result if Greece cannot resolve its budgetary problems. Following a blowing
out of Greek bond yields official rhetoric is having some success in coaxing
markets towards the view that Greece will not be allowed to fall out of EMU.
Yields have fallen and the EUR has found some buyers. This may not last. Action
speaks louder than words and Greece has a long way to go before budget cuts are
successfully implemented. Portugal and Spain may bring additional risks. The
European Commission is yet to officially respond to Portugal’s recent budget
and to the news that Spain is targeting a cut in its budget deficit from 11.4%
of GDP last year to 3% of GDP by 2013.
The response of the
Commission could in turn impact of the decisions of credit ratings companies.
Ultimately the wealthier economies of EMU will eventually protect their system
and bail out Greece. However, they are likely to make Greece squirm first;
lessons have to be learnt and pledges have to be made. During this process the
EUR will remain vulnerable. The Feb. 4 ECB meeting is unlikely to provide any
new trading incentives.
Cable, the path of
least resistance
USD buying induced by
better than expected US Q4 GDP data and short-covering in the EUR has been
primarily responsible for GBP/USD falling below the 1.6100 technical support
level. Gains in EUR/GBP and a fall in EUR/USD meant that a break lower in cable
was the path of least resistance. If cable holds above the bottom of its recent
trading range it will be more susceptible to buying pressures if the BoE
confirms a ‘pause’ in its asset purchasing program on Feb 4.
Such news, however, would
not be a big surprise and is unlikely to have a lasting impact. Continued
weakness in UK M4 data suggests that while QE helped repair the financial
system it has little reach into the real economy and therefore is not the most
appropriate policy for the BoE this year. Also, recent comments from the MPC’s
Sentance highlight his hawkish stance suggested that he, at least, is unlikely
to vote for more QE. Sterling’s recent rally vs. the EUR suggests that any
additional fall in EUR/GBP is likely to become more difficult. Also, given the
approaching UK general election sterling’s fortunes are likely sour. Given the
EUR’s woes a bearish sterling position may be more profitable in cable
(GBP/USD). Assuming confidence about the US economic recovery is maintained, we
would look to sell rallies in cable.
Fundamentals still
bearish for oil
Risk appetite may have
improved during the course of the week but the factors that put the frighteners
on the risk trade over the last couple of weeks have not gone away. Monetary
tightening in China and widespread expectations of more policy measures to come
combined with slower than expected Q4 growth in S. Korea have propagated fears
that projected increases in Asian demand during 2010 may have to be reined in.
Intensifying these fears has been the acceptance by the market that growth in
the US economy this year will only be sluggish.
Yet again US inventory data
has indicated that stocks of petroleum are above the seasonal average. This
month’s warning from the German statistical agency that growth in Germany
slowed significantly in Q4 is also bad news for oil demand going forward. Not
all German economic data have been quite so gloomy and the release of German Q4
GDP on Feb 12 will bring some clarity with respect to the relative strength of
Europe’s largest economy into the final months of the year. Overall it seems
likely that last year’s rally in oil prices overestimated the pace of economic
recovery this year. This should limit the ability of oil to recover
significantly in the immediate term. We would continue to view bounces in oil
as potential selling opportunities.
On Friday, WTI/USD fell
below the daily Ichimoku cloud base (73.10), while BCO/USD (Brent crude) broke
below its cloud several weeks ago, suggesting a trend shift to the downside in
oil. In WTI/USD, the $70.00 level will provide some psychological support, with
the 200-day mov. avg. just below at 69.95. We reckon a WTI drop below $70 will
expose $65 in relatively short order, and ultimately we see scope down to around
$60/bbl in the current unwind
Key data and events to
watch next week
The US calendar has some
important data on tap in the week ahead. Personal income /spending, ISM
manufacturing and construction spending get the ball rolling on Monday. Pending
home sales and vehicle sales are due Tuesday while Wednesday brings the ADP
employment report and crude oil inventories. Productivity, initial jobless
claims and factory orders make for a busy Thursday while Friday closes out the
week with the all-important NFP employment report and consumer credit.
It is an important week in
the Eurozone as well. PMI manufacturing kicks off the action on Monday while
Tuesday has producer prices, German retail sales and the deadline for the EU to
issue a budget assessment on beleaguered Greece (this will be closely watched).
PMI services and retail sales are up on Wednesday while Thursday has the ECB
rate meeting and German factory orders. Friday ends things with French trade
and German industrial production.
The UK has top-tier events
lined up as well. The Hometrack housing survey is up on Monday along with
consumer credit, mortgage approvals and PMI manufacturing. Nationwide consumer
confidence and PMI services are due Wednesday while Thursday brings the crucial
BOE rate decision. Friday rounds out the week with producer prices.
Japan has a super-light
week and the leading index on Friday is the only noteworthy release.
Canada has a
characteristically light but important week up. Thursday starts the action with
building permits and the Ivey purchasing managers index. The highlight is
Friday with the employment report on tap. Look for a speech by BOC Governor
Mark Carney on Thursday as well.
The calendar down under is
busier than usual. New Zealand is relatively quiet with only the employment
report of note on Wednesday. Australia has the performance of manufacturing
index on Sunday, home prices on Monday, business conditions on Tuesday, trade
on Wednesday and retail sales on Thursday. Look for the RBA rate decision on
Tuesday as well.
Disclosure: No
Positions