Risk Comeback or Healthy Post Holiday Corrective Rally?

Market price action in 2012 thus far has been on the whole risk positive, with the moves likely the result of some short-term profit taking on flight to safety trade in the final weeks of the previous year. However, economic data has also been impressive, with a slew of PMIs out from China, Australia, Switzerland, UK and the Eurozone all exceeding expectations over the past two days, in addition to some other encouraging releases. Also seen propping sentiment has been the first Eurozone auction for the year out of Belgium, which was well received. The commodity currencies have unsurprisingly been the relative outperformers on familiar correlations, with Aussie back to some solid resistance in the 1.0300 area, Kiwi trading towards 0.8000, and CAD contemplating acceleration towards parity.

Still, we retain a broader risk off outlook and continue to recommend fading the strength in these commodity currencies, in favor of some material underperformance in 2012 as the global recession intensifies and spreads towards China. China’s Premier Wen Jiabao echoes our sentiment after saying that Q1 2012 will be hard for the Chinese economy. The EUR/AUD cross rate has been an interesting one to watch, with the market trading by +20 year lows and threatening a break to record lows below 1.2500. But given the extent of the rapid depreciation of some 85 big figures since 2008, we see the formation of a major base and trend reversal over the coming months. Our technical outlook aligns with our fundamental view, and we will be looking for opportunities to be buying aggressively over the coming days.

Relative performance versus the USD o Tuesday (as of 11:08GMT)

1. NZD +1.23%
2. AUD +1.10%
3. CAD +0.85%
4. EUR +0.80%
5. CHF +0.72%
6. GBP +0.51%
7. JPY +0.22%

Although the holidays are finally behind us, it will take a few more days before investors can fully shake off their holiday hangovers and refocus on markets. Another currency which should be watched closely is the Yen, which managed to find some relative bids in the final days of 2011, particularly on the crosses, with EUR/JPY dropping through major psychological barriers at 100.00. While we are risk negative in our macro outlook, we also see the Yen at risk for relative underperformance even in this environment with the prospects for more official intervention looking increasingly probable to us. As such, any additional weakness below 100.00 in EUR/JPY, or below 76.55 in USD/JPY is seen limited in favor of a major bout of Yen selling over the coming months.

Looking ahead, the focus on Tuesday will be on any progress and developments (if at all) from talks between France’s Sarkozy and Germany’s Merkel. Meanwhile, on the data front, US construction spending, ISM manufacturing and the Fed Minutes are all slated for release. Global equity markets are well bid on the day thus far, while commodities are also tracking considerably higher.

ECONOMIC CALENDAR

TECHNICAL OUTLOOK

EUR/USD: After finally taking out the 2011 lows from January by 1.2870, the market seems poised for the next major downside extension. Overall, we retain a strong bearish outlook for this market and look for setbacks to extend towards the 1.2000 handle over the coming months. While we would not rule out the potential for additional corrective rallies, any rallies should be very well capped above 1.3500.

USD/JPY:Despite the latest pullbacks, we continue to hold onto our constructive outlook while the market holds above 76.55 on a daily close basis. We believe that any setbacks from here should be limited in favor of a fresh upside extension back towards 79.55 over the coming weeks. Look for a break above 78.30 to confirm and accelerate, while only a daily close below 76.55 negates and gives reason for pause.

GBP/USD: Rallies have been very well capped ahead of 1.5800 and it looks as though a lower top has now been carved out by 1.5780 ahead of the next major downside extension back towards the October lows at 1.5270. Key support comes in by 1.5360 and a daily close below this level will be required to confirm bias and accelerate declines. Ultimately, only back above 1.5780 would negate bearish outlook and give reason for pause.

USD/CHF: The recent break above the critical October highs at 0.9315 is significant and now opens the door for the next major upside extension over the coming weeks back towards parity. A confirmed higher low is now in place by 0.9065 following the recent break over 0.9330, and next key resistance comes in by 0.9785. Ultimately, only back under 0.9065 would delay constructive outlook.

Me and Ze 2012 Outlook & Strategy

I hope everyone had a great holiday weekend and are ready to start some serious contemplation about our investment strategy for next year. There is nothing earth shattering about this approach since I have laid the groundwork for the basic plan through regular commentary on  Yet still there is often a benefit in putting all the dots together in one place to see the full picture. That is what we will do today.

Economic Outlook

Even with the recession scare from the summer, it very much looks like the Muddle Through Economy for the US continues to stay on course. That is where we have positive GDP growth for the nation. It just never gets above the traditional 3% level we are used to relating to a healthy economy.
And yes, this is the same level of modest GDP growth that we have seen for the last two years which was good enough to keep corporate earnings on the upswing, and good enough to attract investors to stocks.

What About Europe? 

People have to separate a European slowdown from a European implosion. It appears to me, and a growing number of experts, that the Europeans have done enough to fend off the “Lehman” type implosion that would have rocked the world’s economy. Instead, they will likely go through a modest recessionary period as their nations take the austerity medicine that will make them stronger in the future.
(For more insight on my view of Europe, then http://mezecm.blogspot.com
Simply a European recession does not derail the US economy and our Muddle Through Scenario stays on track.

What About China?

No nation can grow at 8-10% forever. So there is nothing naturally ominous in the fact that their growth is slowing at this time. Too many investors are taking this as a case that China will go through a deep recession. That is possible, but not probable at this time. Especially because China has AMPLE stimulus at the ready to keep their economy going if need be.
We should continue to keep an eye on this situation because any significant decline in their ravenous demand would have negative consequences for the world economy. I just think they are more likely to grow at 3-5% in the near future versus going into a recession.
Outlook for US Stocks?
As noted above, I expect the US economy to continue to Muddle Through and that is good enough for corporate earnings growth. Right now earnings projections for the S&P 500 next year are around $106 per share. That means the market is only trading at a paltry PE of 12. Well below the historical norms of 14-15.
Now consider your alternatives. The 10 year bond only pays 2%. And shorter term cash instruments like CD’s, money markets etc pay next to nothing. Real estate is dicey at best. And the allure of gold and silver has tapered off. Add it all up and stocks remain the best game in town.
As people worry less about Europe and China then it will create a tractor beam pull towards stocks. I can easily see the market getting to 1400 on the S&P 500 which equates to a PE of just 13.2.
Why not higher if the historical norm is a PE of 14-15? Because Muddle Through Economic growth means lower than normal earnings growth and that should be accompanied by a lower than normal PE. However, if the pendulum switches from fear to greed, and bond/cash yields remain low, then touching 1500 is not out of the question.

Portfolio Strategy

Just because I am looking past Europe and China doesn’t mean the rest of the investment community is in full agreement. Nor does it guarantee that it will play out as smoothly as I might hope.
So I suspect that a lot of the volatility of the last several months will be in place for the beginning of 2012 as well. That is why I am not advocating a 100% long portfolio strategy at this time. Yet we are clearly on a path towards that posture as those dark clouds disappear.
I think the groups that will do the best in 2012 are the ones that did the worst in 2011. And those are cyclical and growth oriented groups that got pounded down when the recession fears took hold. This also means that the defensive positions that served us well in 2011 will underperform if people become less risk adverse as they are now.

Hope for the Best. Prepare for the Worst

Yes, I am putting my money where my mouth is with this forecast. But I also realize that what lies ahead may be very different from what I just described and my strategy would adjust accordingly.
Gladly I am not an investor who falls in love with their predictions and becomes paralyzed when the facts change. I stay open to all possibilities and will invest based upon the preponderance of the evidence. And thus I recommend that you do the same. In the meantime, I like the odds of more upside for stocks for all the reasons noted above. . 

Wishing You All a Happy, Healthy & Profitable New Year.

Me and Ze Capital Mnagement

Worst Case Scenario for 2012

I am not in the doom-and-gloom camp. If anything, I have a fairly positive view of the U.S. economy and the stock market in 2012. I am looking for the S&P 500 to be trading above 1400 at this time next year, which translates to a 10%-plus gain from current levels.  I expect modest earnings growth, driven by a U.S. economy that chugs along at a growth rate around 2%, while Europe avoids an implosion, and China manages a soft landing.

Having a positive view does not mean that we lose sight of the downside risks. In fact, a good appreciation of such risks should be an integral part of arriving at our outlooks.

From recession in the U.S. and/or China to the break-up of the Euro-zone, there are a number of scenarios  that will have serious implications for the market. All of these and many others can’t be just brushed aside as symptoms of paranoia; they represent real risks.

As problematic and headline-grabbing as Europe has been lately, my worst-case scenario is about China. I don’t subscribe to the view that China is one giant bubble about to burst. The Chinese economy is slowing down and my concern is that the market may be too complacent in assuming that this no more than a modest deceleration from the 10%-plus pace of the last few years to something in the 7% to 8% range. A major Chinese slowdown, something bigger than consensus expectations, is my worst-case scenario, though I would put the odds of something like that happening at less than 20%.

What is your worst-case scenario in 2012? And what do you think at the odds of that happening?

Zeshan Muhmmad Ali Awan

Dollar Faces Tough Week Ahead as Focus Turns to US Economic Data

Major Currencies vs. US Dollar (% change)

Talking Points

• Markets to Focus on US Data, Eurozone Debt Crisis in the Background
• Signs of Improving US Outlook to Boost Risky Assets, Weigh on US Dollar

Tight correlations between most major currency pairs and the S&P 500 put broad-based market sentiment firmly in control of FX market price action (USDJPY remains an exception, with intervention fears insulating the pair from larger market themes). While the Eurozone debt crisis presents a lingering worry, the absence of scheduled event risk on this front until next week puts the spotlight on US economic data over the days ahead.

Economists’ consensus forecasts (as polled by Bloomberg) suggest GDP growth in the United States will accelerate to 2.1 percent in 2012, separating it from the other two leading engines of global output (the Eurozone and China) where performance is expected to deteriorate. This it will be up largely up to the North American behemoth to mitigate the severity of the worldwide slowdown now widely expected this year. With that in mind, the data docket appears broadly supportive: the ISM Manufacturing gauge is set to show factory-sector growth accelerated to the strongest in six months, Factory Orders are set to add the most since July, and the all-important Nonfarm Payrolls reading is forecast to reveal job creation continued to accelerate as the employment grew by 150,000.

On balance, this favors a cautious recovery in risk appetite and appears to bode ill for the safe-haven US Dollar against most of its counterparts. Needless to say, an unexpected headline reminding investors of the danger still posed by Eurozone sovereign solvency issues may upset this dynamic. Indeed, countries in the currency bloc will need to refinance a whopping €157 billion in maturing debt (likely at punitively high borrowing costs) just in the first three months of the year.

EURO

Key Upcoming Events

DAY	GMT	EVENT	EXP	PREV	IMPACT
04 JAN	9:00	Euro Zone PMI Composite (DEC F)	47.9	47.9	Medium
04 JAN	10:00	Euro Zone CPI Estimate (YoY) (DEC)	2.8%	3.0%	High
06 JAN	11:00	German Factory Orders (MoM) (NOV)	-1.8%	5.2%	Medium
06 JAN	11:00	German Factory Orders (YoY) (NOV)	-1.2%	5.4%	Medium

BRITISH POUND

Key Upcoming Events

DAY	GMT	EVENT	EXP	PREV	IMPACT
04 JAN	09:30	Mortgage Approvals (NOV)	52.5K	52.7K	Medium
05 JAN	09:30	PMI Services (DEC)	51.5	52.1	Medium

JAPANESE YEN

Key Upcoming Events

DAY	GMT	EVENT	EXP	PREV	IMPACT
05 JAN	5:00	Vehicle Sales (YoY) (DEC)	-	24.1%	Medium

CANADIAN DOLLAR

Key Upcoming Events

DAY	GMT	EVENT	EXP	PREV	IMPACT
05 JAN	15:00	Ivey Purchasing Managers Index (DEC)	54.8	59.9	Medium
06 JAN	12:00	Net Employment Change (DEC)	17.5K	-18.6K	High
06 JAN	12:00	Unemployment Rate (DEC)	7.4%	7.4%	High

AUSTRALIAN DOLLAR

Key Upcoming Events

DAY	GMT	EVENT	EXP	PREV	IMPACT
04 JAN	22:30	AiG Performance of Service Index (DEC)	-	47.7	Medium
05 JAN	00:30	Trade Balance (A$) (NOV)	1650M	1595M	Medium

NEW ZEALAND DOLLAR

How to Avoid Taking Profits Too Quickly and Staying with Losing Trades Too Long

Does this sound familiar…

“Most of the time I earn a few pips and close out the trade because I want to catch it while it is still profitable. But when the trades goes against me I will hang onto it too long thinking it will come back to profitability but I get scared and close it out so I end up losing more. And then, what’s really frustrating is that the trade ends up moving in the direction of my original trade. How can I learn to ‘stick with my trade’ ?”

This is a great question and it is something that all traders, especially in the beginning, have a challenge with. It is also something that is gained through experience.

A key thing that a trader must do is acknowledge that you will have losing trades. If a trade moves against you, as a trader you need to be willing to accept that loss just as you are willing to accept the winning trades. Since you are trading with risk capital, money that you can afford to lose, a trader must be OK with that loss as it will not affect their life style one tiny bit. Losses are simply a part of trading.

(If you are not trading with risk capital, stop trading!)

Once a trader accepts that concept, they will be more inclined to let a trade “play out” and not jump at the chance to lock in a tiny bit of profit or become distraught as a trade begins to move against them and close out the position.

Next, be certain that you are taking only the higher probability trades, those that are in the direction of the trend, and that your entries are based on a solid technical reason such as a break of support or resistance. When a trader knows that they are trading a pair that is in a strong trend, they will have the courage of their conviction to be able to “stick with the trade” as it is in a strong trend. (This does not mean that sticking with a trade in the direction of the trend will insure a winning trade. It does mean, however, that you will be taking trades that have a greater potential for success.)

Once you have decided on the higher probability pair you will trade and know where you will place your initial stop and limit, when the trade executes…leave it alone! Promise yourself that you will only let the trade limit out or be stopped out.

Lastly, be sure that you are following the principles of Money Management. So when the losing trades occur, your losses will be small and manageable.

Practice this discipline many, many times in a Demo account until you become comfortable with it.