24^thJanuary 2011

Equity Index

Overview

Last week the US equities lost ground for the first time in 2011 as fears of the Chinese economy overheating gripped the market. This week traders have a lot to get their teeth into; we will see the releases of the latest GDP numbers in the UK and US as well as the FOMC Rate decision. In addition earnings season continues with many US firms including Microsoft and Caterpillar releasing figures.

Thoughts from the trading floor

From a technical perspective the S&P 500 continues to look strong, however at current they are struggling to hold above support at 1277.00. A failure to hold above 1277.00 could see the market fall back to 1245.50 with further support found at 1216.00.

In the last few weeks we have seen Trichet warn of short term inflation risks at the latest ECB press conference whilst UK inflation continues to rise to worrying levels. This poses the central banks with a serious dilemma, it is clear that the main drivers in the recent inflation rise are commodity and Oil prices; not overheating domestic economies. In such instances we can consider that the inflation is being imported and rate rises will simply sacrifice domestic growth to the benefit of countries currently better positioned. However the central banks mandate stipulates that they must control inflation, to do so their main tool is interest rates. Rate changes are a crude tool which fail to provide the subtlety central bankers crave but at this stage they find themselves with few options.

If inflation continues to rise particularly in the UK we may see the BOE forced into a rate move they struggle to justify from a macro growth perspective but they deem necessary to stave off price rises. This would have a serious negative impact on any recovery as it would put overwhelming pressure on mortgage and credit markets placing substantial downward pressure on house prices and spending levels. This would undoubtedly have a large negative impact on equities as future growth levels would be revised much lower. The main way that such a scenario may be avoided is if we see a drop off in world commodity prices, the most likely catalyst for this being a slowing in the Chinese economy. This could either come about naturally or more likely through aggressive tightening in monetary policy. In either scenario world equity markets would take a nose dive as so much current world growth levels are associated with China. Considering all of this any further signs of inflation in the UK or Europe may be the signal that the current bull market is reaching its peak.

Important events this week.

• Tuesday: GDP (Advanced) (UK), Consumer Confidence (US)
• Wednesday: New Homes Sales (US), FOMC Rate Decision
• Thursday: Durable Goods Orders (US)
• Friday: GDP (Advanced) (US)

Bull View

Bulls will now be targeting resistance at 1313.50 hopefully aided by strong data releases this week. Their main concern will now be profit taking as investors look to realise profits after 18 months of strong performance.

Bear View

Bears will desperate to see the S&P drop below 1277.00 opening the door for a break lower. Continued inflation fears could support their cause.

Futex View

We believe that the current bullish trend in equities is coming to an end and a pullback is around the corner. When it finally arrives it will likely be aggressive; further European sovereign concerns may provide the catalyst for the move.

Overview

This week’s Weekly Strategy Session reviewed the reaction of the equity and bond markets to last week’s Portuguese and Spanish debt auctions and considered the market sentiment going into the third week of 2011.  High on this week’s agenda for our traders is the release of further important fourth quarter earnings in the US and key German sentiment data.  Also, our traders are still very aware of the state of affairs in the Eurozone and will be keenly watching the Spanish auctions to gauge sentiment and seek out trading opportunities.  Our leading indicator throughout the European debt crisis has been the peripheral sovereign yields.  We will continue to monitor these closely to help us pre-empt impending market instability and the volatility we thrive on.

Thoughts from the Traders

Last week witnessed market uncertainty on Monday morning with high peripheral European yields and question marks hanging over the future of the Eurozone.  This state of affairs was ahead of Wednesday’s Portuguese debt auction and Thursday’s Spanish debt auction.  Monday evening brought back a level of certainty to the markets when Japan announced that it planned to buy into the European Financial Stability Facility (EFSF), injecting much needed confidence back into Europe. This was the first of a chain of positive events for the Eurozone which included successful bond auctions in Portugal on Wednesday and Spain on Thursday, demonstrating that investor confidence had returned to the Eurozone and market stability was renewed.  A key beneficiary was the Euro currency which strengthened against its major partners, as well as Portuguese and Spanish yields which dropped and stabilised.

This renewed stability painted a calm backdrop for the ECB Interest Rate announcement on Thursday which saw rates being left unchanged at 1%, as widely expected.  However, it was Jean Claude Trichet’s press conference which turned out to be the key market driver as he commented upon Eurozone inflation increasing from 1.9% to 2.2% and the ECB’s bond buying programme.  Trichet’s hawkish tone, highlighted by his use of the key phrase “monitor closely” when referring to the current level of inflation in Europe, caused a general sell-off in core European bond markets.  New traders must familiarise themselves with such key phrases and words.  Their use by the ECB in the pre-prepared statement, or during the press conference, has historically highlighted to the markets an important shift in policy thinking/strategy.  Such preparation is key to trading successfully as it allows you to rely upon your trading instincts safe in the knowledge that they are built upon a sound foundation.  The mental clarity that this affords will make executing effective trading decisions much easier giving you the ability to recognise market trends and patterns swiftly, providing you with money making opportunities.

Going into this week we currently see stability concerning the state of the Eurozone as a whole.  However, following Thursday’s ECB press conference we know that any hawkish or dovish comments/news concerning Eurozone inflation and/or interest rates has the potential to unsettle the markets.  With this in mind, our traders will be paying special attention to ECB speakers - both scheduled and unscheduled.  It is your responsibility to research which ECB members are hawkish/dovish in order to provide you with an advantage upon the release of any relevant comments.

 Aside from the Eurozone debt crisis and ECB comments, a key driver of the markets this week will be fourth quarter earnings.  Traders should pay close attention to price patterns upon the release of earnings from sector leaders or other important companies, as these patterns often repeat in the markets on the back of subsequent earnings releases.  A profitable trade historically for our traders has been to fade aggressively the release of Goldman Sachs’ earnings.  This pattern and trade concept is very difficult to execute accurately whist containing your risk but will be something we will be paying close attention to this week.  Such trade ideas do not always endure over the quarters so you have to be quick to spot them and fearless in your execution of them.  The markets’ reaction will also give you an indication of overall market sentiment.

On the third Friday of every month we see final positioning before the expiration of standardised options contracts.  It is important that traders are aware of such events as they can produce volatility and thus tradable, short-term price movements.  Good traders will again identify repeated patterns in the markets around these specific events and develop money making opportunities as a result.

Summary

This week witnesses plenty of fundamental market drivers which should provide daily opportunities in the markets.  Bond traders will be very conscious of ZEW and IFO from Germany, whilst equity traders will be looking extremely closely at fourth quarter earnings and the markets’ behaviour in advance of options expiration. The Eurozone crisis has once more faded slightly to the back of our minds, but with the Portuguese yields now settled around the 6.8% level, it would not take much for them to breach the key 7% level once again and for the crisis to return to the forefront of our trading.

14^th January 2011

Macro-events overview

Developments in the Eurozone debt crises this week

The latter half of this week has seen euphoria enter the markets on the back of easing fears regarding the Eurozone debt crises. Peripheral debt yields have witnessed solid retracements from their recent highs and peripheral stock indices, such as the Spanish Ibex and the DJ EuroStoxx 50, have surged higher since dipping sharply lower on Monday.

Thoughts from the trading floor

There have been several macro news factors that have hit the markets this week to help stabilise the ongoing issues in the Eurozone:

1. On Monday evening the Japanese government released a statement which reassured investors that they are looking to invest in the European Financial Stability Facility (EFSF). This helped markets stabilise after sharp risk aversion trading seen on Monday morning. The previous week also saw China making several statements to this effect.
2. There has been talk emanating from the European Commission that steps are being taken to expand the EFSF, with the Core Eurozone countries being asked to increase their contributions. However, several leading German politicians have expressed concerns over this.
3. Wednesday saw Portugal successfully sell their debt to the markets, a very positive event for the peripheral markets. Spain also managed to successfully sell its debt yesterday.

These Factors have helped stabilise the markets this week. However, we are still far from reaching a logical conclusion to the debt crises. Almost certainly we will see peripheral markets under pressure again during this quarter. At that point, bulls will need to see China and Japan turn their rhetoric into action and come to the aid of the Europeans. However, such aid will likely be required to save Spain rather than Portugal as it seems as though the market has already entered an end game with regards to Portugal’s fate.

Bull View

The bulls will look for the markets to brush aside concerns over the next 2-3 months. With global support for the Eurozone likely, should the peripheral markets start to disintegrate again, bulls need a period of stability so that the politicians and governing bodies can work out a system for extra market support.

Bear View

The bears will remain wary of these measures being put in place to aid Europe. The fact that every time further support is provided to Europe more has to be done at some later stage reveals that the markets lack long-term confidence.

Futex View

We continue to favour the bears. We believe that the Eurozone crises will enter the start of the end-game at some point during the first half of this year.

Overview

With the ECB’s latest interest rate announcement due on Thursday together with an array of peripheral European Government bond auctions in the early part of this week, the financial market’s focus is very much back on the Eurozone. Our Weekly Strategy Session included an assessment of last week’s Non Farm Payrolls figure and how the markets responded to the surprising news. We also look to draw conclusions from the associated price action to provide us with clues as to how the markets will move upon next month’s release.

Thought from the Traders

Last Friday witnessed a Non Farm Payroll figure of 103k versus analysts’ expectation of 150k. This disappointing news was countered by positives in the shape of an improved unemployment rate of 9.4% versus a prior 9.8%, and a revision to November’s Non Farm Payroll figure taking it from 39k to 70k. The markets’ sense of disappointment came after optimism was built up during the week as a result of an extremely high ADP Employment Change figure and a further decline in Initial Jobless Claims. Bond markets saw a strong rally on the back of the figure, whereas equity markets saw an initial drive-down and a rally going into the close. The movement in equity markets was to be expected and follows a pattern which has been seen in previous months i.e. a decline in the USD leading to strength in equity markets. This is something to keep in mind at the next Non Farm Payrolls; the USD has the ability to drive the equity markets giving you an opportunity fade the original move or exploit the momentum supported by a move in the USD.

As has been typical for the financial markets in recent times, the focus has quickly shifted from the US back to Europe and Monday morning witnessed a drive higher in peripheral European sovereign yields as the Eurozone crisis came back on the agenda. Irish yields remain at 9%, Spanish yields are up to 5.5% and Portuguese yields climbed to 7.5% sparking concerns not just about the state of the peripheral European sovereign debt markets, but the durability of the Eurozone as a whole. The key concern for market participants is whether Europe has the ability to bailout Portugal and Spain if things take a turn for the worse over the coming weeks. This negative sentiment is driving both Bonds and Equities down across Europe in the run up to Thursday’s ECB rate announcement and press conference chaired by ECB President Jean Claude Trichet. Throughout the press conference traders should be aware of the key points Trichet will discuss regarding ECB bond buying, escalating inflation and the ECB liquidity REFI operations. It is essential as a trader that you have a clear and concise plan detailing how both the market and you will respond to Trichet’s comments based on previous meetings and the condition of the markets leading into the meeting.

As illustrated in last week’s Weekly Strategy Session, it is your responsibility as a trader to establish which markets are correlated to the market(s) you trade. It is also vital to establish which factors are causing your market to behave in the manner which it does. This gives you additional profit opportunities and assists with risk/reward identification. Currently, European peripheral yields are leading indicators for both bond and equity markets.  Increases in peripheral European yields, as a result of growing concerns around the state of the Euro, are frequently causing declines in both of these markets.

The main focus for the novice traders this week follows on from last week’s strategy planning. This week they will be paying close attention to important technical levels/areas and the markets behaviour (price action) as when such levels are retested.  Previous significant highs and/or lows are of particular interest and value for our traders currently. Such levels present relatively low risk/high reward trading opportunities and are ideal for both our intra-day and long-term traders.

This time of the year also heralds the earnings season which is kicked-off by Alcoa, traditionally a bellwether for the rest of the market. This release, together with other early releases, gives a sound gauge of the economy as a whole and what effect subsequent releases will have on the markets. They give traders a good indicator of the type and size of the market reaction and how to approach the figures released over the rest of the period. N.b.  JP Morgan and Intel earnings are releases later in the week and are key for the markets.

Trading Tip of the Day: When trading you must continuously be asking yourself 2 key questions:

1. 1.       What is the market trying to do?
2. 2.       How successfully is the market achieving this?

 All our best traders ask themselves these questions before, during and after every trade. This constant analysis and reflection gives traders the ability to recognize the right opportunities to enter the market, when to exit and when to remain patient; all key traits in a profitable trader.

Summary

Gauging the sentiment of the market by paying close attention to the peripheral debt auctions on Tuesday, Wednesday and Thursday, as well as peripheral sovereign bond yields is essential to build a picture of the whole market. This is vitally important to allow you to build a foundation before Thursday’s ECB rate announcement which looks sure to provide trading opportunities for those that are well prepared.

Weekly Strategy Session

Overview

With the latest Federal Open Market Committee (FOMC) meeting taking place on Tuesday evening, this week’s strategy session turned from the peripheral European sovereign debt crisis to the current situation in the US.

Thoughts from the Traders

The previous FOMC meeting saw the introduction of Quantitative Easing Round 2 (QE2) by the Federal Reserve. Our traders do not expect any further action on Tuesday as there has been insufficient time for the markets to fully digest this latest policy move. However, government bond yields in the US have risen in the last few weeks which could cause the Fed to introduce further QE in the not too distant future. Discounting the latest Non Farm Payroll Employment Data, the smaller US indicators have been strong/stable causing growth expectations to rise and the perceived threat of deflation to no longer be a leading concern.

Sustaining growth in the US by keeping bond yields down is very much at the forefront of the Fed’s intentions, hence the introduction of QE (and QE2). However, fears have grown following suggestions by Moody’s credit rating agency that the AAA credit rating given to the US could come under threat as a result of the ever-growing budget deficit. These comments followed the decision to extend the Bush-era tax cuts for a two-year period.

The US Government yield curve has steepened as a result of rising 10 and 30 year bond yields. In the past, a steep yield curve has been witnessed at times of economic growth. Therefore, this phenomenon is of less concern to the market than a sharp rise in short-term yields which would cause a flattening of the curve. Such a move would be of significant and something to be very aware of as it will be interpreted as a leading indicator to further Fed action.

Another area of concern to be addressed by the FOMC is the unemployment level which has risen to 9.8%. The low unemployment levels of 2007, around the 7% mark, seem to be a distant memory. With the unemployment rate increasing towards 10%, it is becoming a factor in need of serious attention by the US Government and the Fed; something traders must remain well aware of.

Trading Tip: When trading you must constantly be searching for the indicator(s) which leads price movement in the markets you are trading. For example, we previously discussed how strength in the USD was correlated to weakness in the equity and bond markets. These indicators come and go and it is your job to identify them swiftly.

The current mood surrounding equities remains bullish and therefore clever money, leading up to January, will be looking to buy any dips and then sell at new highs. December is known to be a time for rallies in equity markets so this must be the sentiment after the first week.

Returning to the situation in the Eurozone, these events (e.g. concern over peripheral Sovereign debt) are producing regular news, albeit in small doses. As a result, their influence over the market comes and goes. This week, the focus for the Eurozone is the vote on Wednesday in the Irish Parliament on the EU/IMF financial aid package and Tuesday’s vote of confidence concerning the Italian Prime Minister. The Irish vote is crucial for the markets because a rejection by the Irish Government of the bailout package will raise questions surrounding the credibility of the Eurozone and undermine confidence across other European nations. In Italy, a vote against the current leader could lead to an election which would delay austerity measures and lead to further climbs in Italian Government bond yields. In turn this would escalate fears that the Eurozone’s third largest economy will become the next country to require bailing-out.

Summary

The situation in the US should take centre stage this week with the focus being the FOMC meeting, speculation regarding the QE programmes, tax cuts, unemployment, the budget deficit and increasing yields. The primary focus for the first time in a few weeks is no longer the Eurozone crisis but it remains essential that the situations in both Ireland and Italy are monitored closely and that the German economic indicators remain positive so as not to reignite concerns.

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