- Risk is off the cliff and the unwind has just begun
- 4Q earnings better, not good enough
- US GDP in perspective
- Fundamentals still bearish for oil
- Cable, the path of least resistance
- Key data and events to watch next week
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
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.
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.
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.
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