A Real Yen for Stocks?

Let's see a show of hands. How many of you out there struggle from time to time to ascertain why Ms. Market is doing whatever the heck she is doing on a given day?

Monday was a perfect example of why the word logic is rarely used in connection with the action in the stock market. In short, anyone perusing the headlines or watching the economic data may have expected stocks to take a dive when the opening bell rang at the corner of Broad and Wall. So, what did stocks do on Monday? Oh, that's right; run toward new all-time highs, of course. Hmmm...

The News Wasn't Great

Before the opening bell, traders were treated to several headlines that may have caused the words "uh oh" to be spontaneously uttered. First, there was word that the Ukraine Parliament had tossed the President to the curb and that the folks in charge were talking about needing the equivalent of €25 Billion to keep the country's lights on over the next two years. And hey, didn't the mere mention of a country needing a bailout once turn the market on its head?

Then there were the reports out of China. Stocks in Shanghai has been slammed for big losses (-1.74 percent to be exact) in response to word that Chinese banks had been tightening credit to developers during January. As a result, the yuan moved lower due to the fact that the reports suggested the government had actually engineered the weakness. The Chinese currency wound up heading lower for the fifth day in a row and is now trading at its lowest level since October. Uh oh, indeed.

In case you are one of those that doesn't put a lot of stock in the goings on in China, a recent survey of 51 CFOs from Europe and Asia asked the company heads to identify the biggest global risk factors to their businesses. The survey found that respondents saw weakening consumer demand as the top threat while Chinese growth was number two and the economies of the emerging markets came in a close third. Oh, and 76 percent of the CFO's surveyed see Chinese growth falling below 7 percent in 2014.

Then came the Markit Services flash PMI for the U.S. The preliminary report, which is designed to indicate the state of the services sector, came in at 52.7, a far cry from January's reading of 56.6. Normally, this would be viewed as a disastrous report. However, as usual, the weather was a ready-made excuse.

The Response in the Stock Market Was...

Given the inputs from both overseas and here at home, one might have expected to see stocks decline at the open. Or at the very least, move sideways.

So, again, let's see those hands. How many were a little surprised that the S&P 500 spiked up 16 points in the first 10 minutes, erasing Friday's entire decline in the process? And then how many more were surprised - albeit pleasantly so - to see the venerable market index burst through the old highs and start to march to fresh all-time highs? Yea, that's what I thought.

When In Doubt, Look To The Yen

Admittedly, what we're about to discuss may sound a bit loony. However, when you find yourself in doubt as to the reason why stocks are moving on a given day, look to the yen. Yep, that's right, the Japanese yen is indeed a factor in the stock market these days.

The relationship is simple. When the yen weakens, the U.S. stock market tends to rise, and when it strengthens, equities fall. The question, of course, is why?

The yen has always been a key component of something called the carry trade. This is where hedge funds and traders at the big bank trading desks first borrow money in yen and then turn around and spend the cash on risk assets. And for some time now, the U.S. stock market has been the primary destination for those "carrying" their stock investments in yen.

All About The Carry Trade

So... Anything that gives traders the idea that the yen will weaken - or correspondingly that the U.S. dollar will strengthen - winds up being good for stocks. Wacky yes, but true.

And right now there are a handful of key macro factors that support the yen-carry trade into U.S. stocks. First, is the economic recovery in the United States. Second, is the calmer political climate in Washington. In other words, the U.S. still looks pretty attractive on a global macro basis.

Then there is a little something called Abenomics. The bottom line is that Prime Minister Abe's plan to wrestle his country from a decades-long bout with deflation involves a massive QE (bond buying) program. In case you're not aware, the BOJ is buying bonds to the tune of $78 billion a month, which due to the relative size of Japan's economy is an even more powerful QE program than Ben Bernanke & Co's. Abe's stated goal is to double the monetary base and get some inflation going in the process. And if you remember your economics courses, this should cause the yen to fall. Which, in turn, further incentivizes the carry trade.

But Wait, There's More!

Now mix in the fact that the U.S. Federal Reserve is in full-on "taper" mode with their own QE program, and you've got one whale of a reason to just keep on keepin' on with that yen-carry deal.

So, if you find yourself confused as to why stocks might be moving up (or down) for little reason, remember that traders have a real yen for U.S. stocks these days!

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Turning To This Morning... Chinese stocks suffered again overnight as speculation around the PBoC's management of the yuan continued and the currency weakened throughout the session. The Shanghai composite experienced its worst loss in five months and has now fallen 5.1% in the last four days. The concerns about China appear to be spilling over into European trade this morning as the bourses are down almost across the board. And while the degree of pain is significantly lower, futures currently point to a modestly lower open on Wall Street.

Pre-Game Indicators

Here are the Pre-Market indicators we review each morning before the opening bell...

Major Foreign Markets:
- Japan: +1.44%
- Hong Kong: -0.32%
- Shanghai: -2.06%
- London: -1.02%
- Germany: -0.52%
- France: -0.46%
- Italy: -0.49%
- Spain: +0.15%

Crude Oil Futures: -$1.19 to $101.63

Gold: -$3.70 at $1334.30

Dollar: higher against the yen, lower vs. euro and pound

10-Year Bond Yield: Currently trading at 2.740%

Stock Futures Ahead of Open in U.S. (relative to fair value):
- S&P 500: -3.16
- Dow Jones Industrial Average: -20
- NASDAQ Composite: -8.90

Thought For The Day...

You are in charge of how you feel. -- Unknown

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The opinions and forecasts expressed herein are those of Mr. David Moenning and may not actually come to pass. Mr. Moenning’s opinions and viewpoints regarding the future of the markets should not be construed as recommendations. The analysis and information in this report and on our website is for informational purposes only. No part of the material presented in this report or on our websites is intended as an investment recommendation or investment advice. Neither the information nor any opinion expressed nor any Portfolio constitutes a solicitation to purchase or sell securities or any investment program. The opinions and forecasts expressed are those of the editors of StateoftheMarkets.com and may not actually come to pass. The opinions and viewpoints regarding the future of the markets should not be construed as recommendations of any specific security nor specific investment advice. One should always consult an investment professional before making any investment.

Posted to State of the Markets on Feb 25, 2014 — 8:02 AM
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