Friday Recap … January 22, 2010

Key News

 

* Stocks, Commodities Fall on Obama, China; Emerging Markets Drop  (Bloomberg)

* GE Earnings Fall, But Its Optimism Rises (WSJ)

* US, UK to cooperate in unwinding troubled banks (Reuters)

* Pound Drops Versus Euro as Retail Sales Rise Less Than Forecast (Bloomberg)

 

The Event Agenda

Afternoon Run-Down

The financial markets are reeling from Obama’s speech from yesterday, which included tough talk on prospective restrictions on bank risk taking.  Stocks have sold off hard and the dollar gave up some of its early gains yesterday on the news — but is trading mixed against major currencies today. 

 

Important to watch in currencies, the yen caught a bid on the news … the natural knee jerk reaction for a steep slide in U.S. stocks.

But even if stocks go lower (which I think they will, dramatically), the fundamental divergence between Japan and other major economies, given the deflation fight being levied by the BOJ, should keep the yen on a weakening course.  The yen carry trade has gone through a 2 ½ year unwind.  If the forced unwind is over, the yen should go lower.

 

Market participants have tried to sort out if the Obama proposed bank regulation speech is a game changer.  To me, it seems like an obvious political ploy, without grounds in reality.  The idea that proprietary trading can be extracted from the banking business doesn’t seem to do anything positive for financial market stability.  In fact, it would reduce liquidity and increase volatility.  We’re seeing that reflected in the VIX already. 

 

Major global banks are in the risk taking business.  They make markets in a vast array of financial instruments to provide a service to clients, and in doing so they take on risk.  It seems nearly impossible to break out what’s a simple proprietary bet from risks being taken as liquidity providers for their customers.

 

In the end, the proposal seems like another attempt to pacify the angry masses on the back of another strong earnings report from former TARP recipient Goldman Sachs.  Goldman trading revenues attributed 76% of total revenues for the firm last year.  But don’t forget the competitive landscape shrank dramatically in 2009 and Goldman paid back TARP early, giving it a competitive advantage to see more trading deal flow … and make wider spreads.  “Principal investments” only accounted for 2.6% of revenue.

 

Overall, the news of recent weeks points to the perception of tighter regulation and tighter fiscal constraint … which means lower standard of living in the developed markets.  For the export-centric emerging market space, when the stimulus dries up and the economic engine has to start running itself again, you have to ask the question:  To whom do they plan to export?

 

Overall the moves in China to rein in liquidity, along with the political surprises in the U.S. (Massachusetts election and Obama bank reg proposal) have volatility moving higher, sovereign debt risk moving higher, and optimism about growth prospects diminishing.  Growth-negative news should be dollar-positive.  Under a slower, more fragile growth scenario – and one with looming threats to derail it — what are the better alternatives to holding dollars?

 

Here’s a look at the charts going into the weekend…

 

Key Charts

Dollar Index

On Thursday, the dollar index surpassed its December highs (and breached the 200 day moving average), confirming an impulsive C-wave of a corrective A-B-C Elliott Wave structure. This particular indicator projects a move to at least 81.50. That’s 4 percent higher from current levels and nearly 10 percent higher from the November lows.

 

Euro

The euro trades well below its 200-day moving average, which broke on Tuesday at 1.4308.  That should provide resistance and any retracements in the euro weakness should be well capped by the January 13 high of 1.4579.

Canadian dollar

The Canadian dollar continues to trade very closely with the U.S. stock market.  After closing in on October highs this week, the Cad made a sharp reversal trading 3.7% off of its highs against the dollar for the week as U.S. stocks fell.

New Zealand dollar

I showed this chart earlier this week.  The New Zealand dollar had yet to respond to the move lower in commodities.  After some weak inflation data on Tuesday night, the kiwi started playing catch up.  It’s now the worst performing currency of the weak, down almost 4%. 

VIX

The VIX (stock market volatility) has fallen all the way back, nearing levels of July 2007—just prior to the Bear Stearns hedge fund blow up.  That’s indicative of the level of optimism the markets have been pricing in about recovery.  Now, with the prospects of tighter bank regulation (less market liquidity provided by banks) the VIX has climbed 47% in four trading days.