Nov 4, 2014

Why Are there So Many Angry Traders at Wall Streets

The highly anticipated market correction for 2014 came... and went, with the damage barely even felt in the US stock market. The US S&P500 fell 7% within 2 weeks, and recovered everything and more, within 7 days. However, the damage caused by this correction, can still be felt in other markets, primary in Europe and the Energy markets. A series of actions by the 3 most important central banks in the world basically cause the correction to reverse it's track almost immediately. The best quote on this whole episode can be sum up by the chief market technician at Sterne Agee & Leach Inc: “?%$!&#!!”

The global stock rally is further driven by the additional stimulus measures by the Bank of Japan at the end of Oct. The BOJ, concerned by the slow-down in the domestic & global economy, the potential drag from increasing their consumption tax from 5% to 8%, lead to an unexpected and unprecedented monetary loosening in Japan. The measures are two-folds:

1) Increasing the asset-purchase program (equivalent of the US QE Program) by another 20 trillion yen from the current 60 trillion yen

2) Japan’s $1.1 trillion government pension fund, simultaneously announced its intentions to increase its overall equity holdings from 24% to 50% reduce its domestic bond holdings from 60% to 35%.

 Essentially, the BOJ is printing money to buy both Japanese bonds and international equities. If the Japanese government is going on a shopping spree to buy global equities, there is no better reason for the stock market to rally.

With the BOJ so aggressive with their monetary policies, all eyes now turn to Europe, which has been criticized of being too slack with their asset purchase program.

Potential Impact of the Currency War

The developed nations of the world, once the key importer of goods and services from Emerging Market, is suddenly devaluing their currency to try to export their economy out of their slump. With key developed markets currencies falling so drastically in the past few months, emerging economies that are dependent on manufacturing and export will be the ones that will be hit the most. With the sharp fall in oil prices and other commodity prices, Emerging Market economies, which is the main producer of these commodities, will suffer a double whammy in their export capacity. This will no doubt lead to a sharp deterioration of the trade balance of these export oriented emerging market leading to a slow down in these economies. The race for the developed nations to devalue their currencies lead to heavy casualties in the Emerging Markets. The last time such an event happened lead to the 1997 Asian Currency Crisis.

Sharp fall in Oil Prices. Russia & Middle East feeling the heat...
One of the potential victim of this trade imbalance will probably be China. The export oriented Chinese economy is becoming increasingly uncompetitive as their manufacturing cost shot up due to internal inflation and at the same time, the Chinese Yuan has been appreciating steadily against key export markets. The Chinese Yuan is the only currency that has appreciated against USD despite USD appreciating against all other global currency. China also registered a fall in property prices across all but one province and it's economic indicators have pointed to a slowdown in the Chinese Economy. The Chinese government has since reverse some of its property tightening measures and only the future will tell if the measures are sufficient.

Portfolio Strategy

With the Euro zone losing the currency devaluation war, there should be more monetary loosening coming from Europe, which will potentially lead to a rally in the European stock market, like what we have seen in the Japanese stock market, which has rallied 17% within 2 weeks. On the other hand, that will lead to more flight to quality as international funds will flee to the relative safety of USD and the equity markets. The greatest loser in the current environment will be small export oriented economies such as Korea, Taiwan, Malaysia, Vietnam and Thailand. Commodity exporters will also be hit by the rising USD and falling commodity prices such as Australia, Indonesia and Middle Eastern countries. Countries with huge potential domestic consumption markets such as China and India may be buffered from this currency war if they are able to stimulate their domestic consumption.

Therefore, I feel that we should mainly focus on the American and the European markets as I see those two markets with the best risk-return factor and avoiding emerging markets in general. Equities should have a clear road ahead until April 2015, when volatility will set in again as the world will hold its breath and await the decision from the US Central Banks on their decision to rise the US interest rates.   

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