The exchange of artillery fire between North and South Korea is the biggest story in the financial markets today. Investors never respond well to geopolitical tensions and in the case of forex, they usually react to geopolitical risks by dumping the currencies of the countries in question. As a result, the South Korean Won has fallen more than 3 percent against the U.S. dollar. Investors also tend to bail out of any risky, high yielding currencies and move into the safety of low yielding safe haven currencies. In the current market environment, the low yielders are the U.S. dollar, Japanese Yen and Swiss Franc, which are all up strongly today. However Japan is only a stone’s throw from South Korea and they have demanded a firm response by the US, Japan and South Korea. By putting themselves in the middle of battle, they have effectively made the Yen a less attractive safe haven currency compared to the U.S. dollar and Swiss Franc. When the news first broke, the Japanese Yen actually sold off aggressively in response.
If tensions brewing between North and South Korea escalate into a full-fledged war, there will be global ramifications. South Korea returned fire but have yet to launch their fighter planes. The main beneficiaries of a war between North and South Korea will be the U.S. dollar and Swiss Franc. Despite low yields in the U.S., dollar denominated investments are still the most liquid in the world, providing a good shelter for safety. Switzerland is also geographically removed from Korea and a traditionally neutral country that still moves alongside gold making it an incredibly attractive haven for safety.
Stocks rallied significantly yesterday, leading many people to wonder if this is “the bottom” in equities. Given that none of the problems in the U.S. economy have been resolved, I think that this is a bear market rally.
With that in mind, it is interesting to look at how much equities could rebound in a bear market rally. The best analog for the economy today is the Great Depression. Therefore I’ve pulled up the chart of the S&P during the Great Depression. The index fell as much as 86.5 percent before it finally bottomed. The sell-off was not without relief rallies. Between 1929 and 1932, there was 6 “bear market rallies” that ranged from 12 to 110 percent. The S&P was trading at much lower levels then but on a percentage basis, bear market rallies usually extend 25 percent. With that in mind, since the S&P 500 bottomed out on Friday, the index is up close to 8 percent. A 25 percent move would put the index at 833.
How does this relate to currencies? Further gains in U.S. equities would mean further strength for the EUR/USD. So if the S&P 500 hit 833, the EUR/USD could break 1.30.
Click on the chart to enlarge
I read this fascinating study by Barclays Bank this morning on how the performance of the Dow in the month of January can set the tone for trading throughout the year. In the first month of 2009, the Dow Jones Industrial Average fell 12 percent. According to Barclay’s study, if there is negative equity market performance in the month of January, the odds of stocks ending the year low rises from 32 to 69 percent. This is based upon 74 years worth of data. Since currencies are taking their cue from equities, further weakness in the Dow could mean further strength for the low yielding US dollar and Japanese Yen.
I hope you find this chart just as interesting as I did.
The US unemployment rate soared to a 15 year high in the month of November as non-farm payrolls incur the steepest slide in 34 years. Although currencies and equities sold off aggressively following the release of the labor market numbers, they clawed their way back to end the US trading session in positive territory.
In the face of economic data that screams severe weakness for the US economy, the fact that currencies and equities recovered are nothing short of impressive. The counter intuitive price action in the financial markets makes us very skeptical of believing that the recovery is here to stay. There was nothing good in the jobs number and when it comes to the labor market, there is no such thing as a capitulated bottom.
The only explanation for today’s recovery in equities and currencies is the market’s increasing immunity to bad news. The 8140 level in the Dow and the 815 level in the S&P seem to be very important support levels. They have held all week and were also major points of support in October.
Non-Farm Payrolls Drop 533k, Unemployment Rate Climbs to 6.7%
The headline non-farm payrolls figure for the month of November was very weak, but the downward revisions to the October and September data made the report even weaker. The US economy lost 533k jobs last month, a number that was worse than the most pessimistic economist had estimated. The October and September numbers were both revised down by more than 100k. Instead of losing 240k jobs in October the US economy lost 320k while the September number was revised from -284k to -403k. This string of job losses is the worst since the 1981 to 1982 recession on a population adjusted basis and on an absolute basis, last month had the largest level of job losses since payrolls declined by 602k in December 1974. Anyone looking at these numbers will agree that the US labor market is in very bad shape because no industry has been spared from job losses. Although average hourly earnings increased, workweeks have been shortened. Since the beginning of the year, 1.911 million Americans have lost their jobs. Yesterday’s layoff announcements from AT&T, DuPont and Viacom suggest that major job losses will only continue.
In every recession, we have seen months where hundreds of thousands of jobs lost were followed by a month of negative non-farm payrolls in the tens of thousands of jobs. However do not mistake the inevitable slowdown in job cuts with a bottom because a bounce in past recessions tends to precede an even larger single month job loss.
The Consequences of the Abysmal NFP Number
With the Dow Jones Industrial Average hitting 5 year lows today, the burning question on everyone’s mind is, how far can stocks fall.
This is a perfect time to republish a post that I wrote in the middle of October titled DJIA: Does the Past Offer Hope?
Here is a very interesting chart published by Barclays Capital. They compare the current equity market movements to that of the “Panic of 1907.”
The similarities are striking. In 1907, the last leg lower in the Dow was the 37% decline that lasted from the second quarter to the fourth quarter. So far this year we have only seen a 34% decline from the August high of 11867 to the October low of 7882. Another 3 percent decline would bring the Dow down to 7475.
Click to Enlarge
The price action in the Dow in 1907 suggests that there could be one final push lower in equities before a long term bottom and when a rally does happen, it could be as much as 20 percent. Afterward, expect a long phase of consolidation. Back in 1907, there was a 15 year consolidation before the stock market picked up once again and we entered the Roaring 20s.
Here’s a chart of the Dow from 1900-2004 (click to enlarge)