Take a moment and think about thing that annoys you the most.
Is it nails on a chalk board?
Someone who talks with food in their mouth?
Maybe it’s the “most annoying sound in the world” that Jim Carrey makes in the movie, “Dumb and Dumber.”
For me, it’s when someone says that the market is “risk off” today or this week. Let’s be clear. Risk is ALWAYS ON.
And while I acknowledge that investors’ appetite for risk waxes and wanes, there's no such thing as risk being “off.”
This past week was full of “risk off” commentary like: stocks “slide” “retreat” “sank” combined with pictures like this:
To be fair to this guy, he might have just remembered he left his lunch at home or gotten a call from his wife reminding him of their upcoming trip to see the in-laws.
Or maybe he’s only been trading for 18 months and has never seen the S&P 500 lose over 2% in one week. The last time that happened was 19 months ago.
Either way, “risk off” commentary and pictures of traders in despair sell newspapers and get page views but they certainly don’t inform and they don’t help us better understand what happened and what the long-term implications are, if any.
I’m not going to say much on the S&P or US equities in general. Last week’s S&P price movement was both overdue and a non-event. The S&P is down a mere 3% from its all-time high and last week’s decline was on below-average volume. There's a little more than 2% downside to the ABYSS line on SPY, which is a buyable area. If SPY breaks down below the ABYSS line – 174.50 -- that would be significant and things could get interesting.
This week I want to focus on what’s occurring in China and the Emerging Markets.
I originally titled this week’s report, “Anatomy of the Perfect Trade Idea.” But there's no such thing as perfection in trading. However, last week’s initiation of the SHORT trade idea in FXI was as close as it gets: The right bias on the right market with the right entry price, 12 hours before a 2-day, 6% correction is absolutely as good as it gets.
Now, don’t stop reading because you think this is going to be all about how prescient I am.
As Jefferson said, “I am a great believer in luck, and I find the harder I work, the more I have of it.” To be clear, nailing the timing of a trade like FXI is pure luck. However, nailing the right bias on the right market with the right entry price is a matter of process. And I find the more I refine and apply my process to the financial markets, the luckier I seem to get.
As is generally the case with the media, they begin to discuss something after its already happened. Last week was no exception.
The Bloomberg Headlines on Friday read:
“What’s Behind the Emerging Market Meltdown”
“S&P 500 Slides Most Since June on Emerging Market Turmoil”
“Contagion Spreads in Emerging Markets as Crises Grow”
I won’t waste a lot of time discussing the lunacy of using words like “contagion,” “crises” or “meltdown” after a single day decline. The more important point here is that the media started talking about a shift in emerging markets on Friday January 24, 2014.
Was there any way to know this type of decline was possible before it occurred? In short, yes.
No Surprise Here
There were fundamental and technical signals given to us well before January 24.
Here are some of the fundamental developments that I discussed in various reports leading up to last Thursday and Friday:
In the December 9 GMC, I stated that the data out of China was mixed. While the Chinese Manufacturing Flash PMI had hit an 18-month high, the services PMI had declined month-over-month.
On December 16, I once again described the Chinese data dump for the week as mixed. Retail sales and export growth had accelerated month over month but industrial production was slumping.
On December 23, the official manufacturing numbers for China had been reported. Manufacturing had declined month-over-month and hit a three-month low.
On December 30, I discussed the interesting development from the prior week where Chinese officials ordered financial journalists and some media outlets to tone down their coverage of a liquidity crunch in the interbank market. This order was quickly followed by the PBOC injecting capital into the markets for the first time in 3 weeks which resulted in the 7-day repo rate being cut in half.
On January 6, I shifted to a LONG bias in FXI, the first non-NEUTRAL bias since November 19, 2013. In the weekly commentary as well as in the Focus Market commentary I continued to reiterate that the fundamental data was murky at best. I went on to say that FXI was at a technical crossroads and that “Depending on how the market responds and how capital flows early in the year, I could very easily and quickly switch to a SHORT bias on FXI.”
On January 13, “We didn’t receive any more clarity last week on the fundamental front. And technically speaking FXI is right on the line of either being a good LONG candidate or a SHORT one. This week’s price movement should go a long way to telling us the intermediate term direction of FXI.” Turns out I was right.
Last week I switched FXI to a SHORT bias pointing out that “Australia reported much worse than expected employment numbers, losing 23K jobs when economists expected a 10K jobs gain. Then Brazil caught investors by surprise when they raised rates 50 bps, instead of 25 bps, in an effort to curb inflation that is getting out of hand.”
The point is, we had been building a fundamental picture of China that was murky at best in the weeks leading up to last week’s decline. And somehow, there was virtually no media coverage, much less concern.
Even earlier last week there were further signs of economic deterioration. On Sunday night, China reported that GDP in the fourth quarter had slowed from the Q3 growth rate of 7.8% down to 7.7%. China also reported that industrial production had once again slowed month-over-month.
This was followed by Wednesday’s announcement that Chinese officials would no longer be publicly declaring their intended GDP growth rate in order to move away from the “growth at all costs” mentality. This announcement was followed by Australia reporting that inflation had come in hotter than expected and at a 2-year high.
Reading The Economic Tea Leaves
And what were the markets themselves telling us about China and the Emerging Markets before last Thursday?
I picked several of the key emerging markets, and their currencies, to determine if they had given us any signals as to what occurred last week. The data below is through the close of trading on Wednesday, January 22, 2014.
Singapore – The Singapore Dollar peaked on October 23, 2013 and had declined 2.1%. The equity market peaked on October 30, 2013 and had declined 9.2
Brazil – The Brazilian Real peaked on October 18, 2013 and had declined 8.9%. The equity market peaked on October 22, 2013 and had declined 18%.
Thailand – The Thai Bhat peaked on September 23, 2013 and had declined 5.7%. The equity markets peaked on September 19 and had declined 20%.
Emerging Markets – EEM, the broad based emerging market exchange traded fund, peaked on October 22, 2013 and had declined 8%.
China – FXI peaked on December 2, 2013, the week after I shifted to a NEUTRAL bias. FXI had declined 9% heading into Thursday morning trading.
So, fundamentally we know things began to get shaky in early December. Now the technical picture shows us that key emerging markets, and their respective currencies, had been flashing a warning sign for up to 3 months prior to last week’s decline.
Why didn’t the media pick up on this?
Where Was The Financial Press?
The answer is simple. Over this same three-month time frame from late October through last week, the US Equity markets (SPY) were up 5.7% and the US Dollar (UUP) was up 1.7%. European Stocks (FEZ) were up 2.8% and the Euro (FXE) was essentially unchanged. No one bothered to look because Western markets were on autopilot to the moon.
Remember one of my core principles: Everything that matters in macro occurs at the margin. It’s the subtle shifts that occur when no one is paying attention that matter the most. It’s these subtle shifts, that if you pay attention, will position you to take advantage when the opportunity presents itself.
There is no better feeling than to be perfectly positioned and making money when everyone else is scrambling trying to figure out how they got caught blindsided and how they are going to repair the damage.
I hope you were able to join me in that feeling last Thursday and Friday.