After my last note there was a little rallye taking place due to good earnings reports. But today markets have changed. Inflation data suggests that the Fed needs to hike rates even beyond the comfort line and hit growth. So the story in the market has changed.
The USD didn't strengthen any more but weaken. Hence, interpreting the market there will either be a sell-off of bonds and equities which will cause the USD to lide downwards or a stop in rate increases with is USD negative anyway. However, it remains hard to tell which currency the USD should be shorted against as all economies will be hit by higher than expected inflation.
Commodities are stronger which is no surprise in spite of inflation fears. They are a natural hedge.
Stocks went down because market participants fear that growth could be hurt by the rate hikes which will probably real estate (the main consumption driver) hit the strongest. The slump today doesn't look like profit taking from last week.
I had to close out my TecDAX short. I fundamentally believe that there are only hope stocks in the index except solar shares. Solar is in a huge bull market and Solarworld has surprised positively. Hence, I have a very sour taste while being short in this index.

As written yesterday the market is falling further. The Bernanke speech didn't support anything. The USD is weaker and stock prices fell on weaker earnings releases. Base metals softened as demand weakens and precious metals appreciated due to the drop in the Greenback. Bond prices were stable.
For the stock market the rout in tech could be over and only selected stocks might fall causing an overall weakly declining trend in prices. So not much value to be found in a short position.
I will rethink my positions during the weekend and modify my portfolio on Monday. Hopefully, I will come up with a few trading ideas.

I went for a few days home and did not have the time or energy to write until now.

It has been an interesting time. Bernanke's comments led the market to believe that the interest rate tightening cycle is over. However, reading his official statement one needed a definite positive bias to interpret the testimony in such a way. Bernanke said that the Fed will adopt to upcoming data, no more no less. In my eyes, it seems that officials are aware about the mutually unsolvable problems inherent in the US economy. Global growth is pushing inflation beyond the values of past years. A tightening would be necessary to deal with this issue. On the other side, the trade imbalance would require a USD depreciation accomplished by lower rates to correct for the distorsions at the moment. Last but not least, home equity extraction and aggresive financing in the real estate sector during the past few years has driven consumption. To avoid a bust in the speculative housing market would need lower/stable interest rates.
Fed officials appear to hope for economic data that would release them from the contradictorily problems. Be it either a continuously slowing real estate market, or a drop in oil prices or the voluntary appreciation of the Chinese Yuan from Chinese officials.
When I compare the economic situation with a car, the US economy has been accelerating too fast during the past years fueled by low interest rates. Now, the economy is too fast and stepping weakly on the interest rate break does only work if the road is clear and straight. I expect the economy heading towards a turn and the gentle breaking meaneauvre will not be enough to avoid serious trouble.
The most likely action from the USA might be cooling of the US economy with higher rates to stop speculation in the housing market and bring oil prices down. Then, a major devaluation of the USD would bring the trade imbalance with China to a more sustainable level and also reduce the debt burden of the US economy (the trade deficit and fiscal deficit in real terms are reduced!). The cooling of the US which will also reduce growth in Asia will put some pressure of the energy markets and the devaluation of the USD would not cause such a great problem to the trade balance. The weak USD would then stimulate exports and the US economy could continue to grow.

A discussion yesterday made me feeling like I have played a sucker game during the last couple of weeks.

When I had a look at the German auto industry there were important events during March and April. First, Daimler's CEO Zetsche stated in March that high commodities prices will negatively affect earnings (on that day DCX dropped significantly relative to the market). Then, there were the first profit disappointments from Daimler, Volkswagen and BMW in the end of April. The auto industry is so important for global growth. A car is one of the highest discretionary expenses a private household can make. And with weaker earnings one could easily imagine that a rout was overdue in other sectors.

It took 14 days before the global sell off started and the rout endured for a month. Then after the rebound I asked myself whether it is over and the bull market continued. Since the end of April commodities prices haven't fallen significantly!! So profits were bound to disappoint and a stampede was the only logical consequence. The short that should have been built before the beginning of the earnings season appears now obvious, if not trivial. As if there was some free money available from suckers who thought that earnings keep on growing to heaven.

Only to reduce heavily positions on May 15 was a semi-sucker play. I thought of prices going down but could not put the pieces of the puzzle together. After yesterday I could see more clearly.

The third day of the long expected earnings week brought a few negative surprises up. Dell received a downgrade and prices went downwards. By the way, Nasdaq 100 is one of very few indices that could not rebound on the second rebound up to the level of the first one but instead kept on falling. Those stocks are very vulnerable these days as growth concerns rise. Growth is THE thing a global macro analyst should think about when investing in stocks. The interest rate hikes have trimmed growth. Hence, the drop is not much of a surprise. Rate hikes have the effect that sooner or later they affect corporate earnings. It appears that sooner or later is now. If I see more disappointments in other sectors I will go net short next week. Global conflicts played in the cards, too.
After the news were spread into the world that Israeli troops went into Lebanon there started a continuous sell off across European equities. As a consequence, commodities such as gold and oil rose (they usually do during conflict times and especially now as they are scarce). That rise in case will cause higher inflation. That will increase the probability that the Fed will continue to raise rates which led to a very strong dollar today (I know, the save haven argument also played in favor of the greenback). But the rates story is more important as 10y-Treasuries prices fell.
It is neither a good time for stocks nor for bonds. Growth is @ risk for many reasons which hurts equities. The US has to finance a huge load of short-term dated debt that will put a strain on the bond market. Only higher yields will attract investors to bring their money to the US bond market. And, as in a beauty contest, when US yields "try" to look more attractive other yields have to rise as well or they will lose their appeal.
Unlike last year in October, where a lot of selling was fear induced (hurricane consequences) and the rewards were high for those who bought that fear now fundamentals are changing.

Major stock and bond futures have been trading in a range waiting for new input the last 4 or 5 days. It appears that everybody is waiting for the earnings season to start before we see some more action.
Good earnings might on a short term push stock prices higher. However, the outlook for long term is dim if one is looking at domestic demand and the "housing bubble & equity extraction for consumption" story. But one should not forget business investment. Many CEOs and CFOs don't see the future so pessimistic. They are in a hurry to take on additional debt to expand their businesses and use their balance sheets before rates increase even more thus lifting borrowing costs. Corporate debt is amounting to around $450bn, two thirds of the record 2000 level. That could be the factor holding economic growth up and leaves some room on the upside.
It is not the time to get bearish on stocks but to wait for further data input, as many central bankers used to say duing the past weeks.

written @ 5pm

Today, non-farm payrolls were weaker than expected and led market participants to rethink their view on interest rate hikes. Currencies moved heavily. The USD immediately shot up from 1.2750 to 1.2850 and the $/Yen hit through 114 (traded above 115 in the morning). Bond prices rose as the market thought of a rather dovish Fed after the economic release. The stock markets went also up on interest rate expectations but not for long as crude oil hit a new high which negatively affects corporate earnings.
Copper prices were puzzling me. On the one hand there were a lot of news about speculative fund buying and on the other hand some market participants commented on the deteriorating fundamentals for the copper price. Copper and crude have moved in tandem the last two years as both markets suffer from supply/demand imbalances. However, on a historical perspective, a high correlation (100d) between the two always preceded a downturn in prices. Political fears are were not on the rise as gold didn't rise much today.
While the story unfolds over time, my view is confirmed by today's events. Growth is slowing and the inflationary impact on the market is increasing which will lead central bankers to push rates beyond a level that ensures maximum growth. Otherwise, the oil bill could become be extremely high (look at copper and check out what happens to a market that suffers extreme shortage) and nobody wants that to happen.
Referring to my prior comment, I am not sure about the amplitude, that a positive surprise would have on the market. After today, I think the market seems more vulnerable to me than assumed.

On a technical side, we are trading at the moment at the peak before the second sell-off in June. I couldn't find many stocks breaking through that resistance level. The stock market trades undecided at the moment and waits for new input to decide on the further direction.

written @ 8am CET

Yesterday, the reading of the ISM Non-Manufacturing index was weaker than expected @ 57. Generally, this year’s readings are below the readings of 2004 and 2005 (ex. Hurricane data) and are in concordance with a slowdown in growth. So, there was the confirmation of a slowdown and markets rallied. Why? Some buyers saw the end of the Fed rate increase which will stimulate growth and concluded to buy.



There have been many underestimations about future rate hikes in the US and Eurozone around for quite some time causing the whipsaw like currency fluctuations in major FX markets. Eurozone rate hike expectations rose yesterday again after Trichet used the word “vigilance” in his speech. Hence, I am a bit reluctant to forecast a bull market even though valuations are cheap (is the stock market already pricing in a slowdown in growth?) and M&A activity is at records. The 2Y-10Y Treasury Spread is negative and the Fed target rate is approaching 6% slowly but steadily. Both are harbingers of recessions! Current data points to strong growth today but sentiment points to a slowdown. What shall one say when companies are cheap but prospects are perceived to be dim? Since sentiment is already negative, I would put my chips mid-term on the bull case as positive surprises might push markets higher than negative surprises which would push them down but not by so much.



Tobacco



Florida’s higher court ruled that Altria’s Philip Morris USA and other cigarette makers don’t have to pay $145bn to smokers. With a smarket cap of the biggest five companies at $290bn that translates into a pretty convincing trigger for a rally in tobacco stocks.

I am not too much working on fund and benchmark analysis. Hence, I found the following fact quite interesting as I have never come across it before in my thinking process. The mathematics behind is not overwhelming but a few interesting questions have appeared.

Regularly, a Sharpe Ratio is used to analyze the capabilities of a fund manager to generate “good” risk-adjusted return. If you are using Sharpe ratios in your fund selection process you are taking a view on future interest rates at the same time!

The math is simple. Portfolio 1 has an annualized return of 5% and a volatility of 10%. Portfolio 2 has an annualized return of 10% and a volatility of 35%. If the risk free return is assumed to be 3% both portfolios have a Sharpe ratio of 0.2. If the interest rate increases, then the more volatile portfolio has a higher Sharpe ratio. If the interest rate decreases, the less volatile portfolio has a higher Sharpe ratio. So far nothing new, except that one has to be careful with the risk free rate.


The questions that arise when choosing funds are besides typical questions concerning the fund management style:


1.) How do the fund manager strategies respond to a high/low yield environment?

2.) When is a reasonable time to change the fund if we are in a rising yield environment (such as today)?

3.) How much risk should I add in a rising yield environment?


Any answers?

This day will definitely go into the research that I mentioned the day before. The DAX dropped by more than 100 points! However, the trigger was not the soccer world cup. North Korea tested its missiles (on the independence day of the US - a clear provocation) and US interest rate fears contributed to a stronger dollar, higher crude oil prices and an increase in gold and a drop in stocks and bonds.

Rate expectations increased and the housing market is cooling off. I remember a few comments by market participants where they have stated that a cooling down of the housing market was possible as was observed in UK and Australia. I am not so sure about whether that analysis was correct. Inflation will most likely increase above expectations since commodities prices are not decreasing yet. Growth in the US has been incredibly strong (above 5% for quite some time) pushing the unemployment rate below 5%. There is still a lot of demand pull inflation pressure to come. And if the Fed continues to be an inflation hardliner (I am wondering when the market understands, whether Bernanke is a hawk or a dove) rates are poised to rise. That would definitely bring down the housing market. Furthermore, the other housing "bubbles" are not absolutely comparable to the US one. Global rates were low then. Now they are increasing (except for Japan).
The measures taken by India and China to cool down home price increases also let one think that this asset class has the potential to run out of control (boom/bust) on a global scale.

There has been some research around that if the Germans lose in the soccer world cup they are likely to drop by about 100 points the next day. So let's check if the DAX is really falling. If I see a -100 I am most likely going to buy until 11am and hold on until the US opens as the important Initial Jobless Claims and ISM Services are published on Thursday and a solid open in America should help the DAX advance.
There has been some turbulence during the German election period in 2005 and I hope for similar volatility tomorrow.