Important Themes Going Into The New Year
First of all I trust
that the holidays were enjoyable and all the best here in the new
year. While I will be the first to admit that my negative bias was incorrect in
2003 from an investment standpoint, my one and only sector which I chose to be
long beginning in the late Spring, gold mining stocks, managed to put in an
impressive performance. The unrealized total return as of December 31st was
roughly 16%. Some of the individual issue were up as much as 90% and some were
down 19%. So while my portfolio did under-perform the market, it was still
respectable and done within what I believed at the time to be a prudent risk
exposure.
The old adage, “Don’t fight the Fed” rang true in
’03, and it posed an opportunity cost to me. However, I have no regrets, it is
all part of the learning process. My edge for the last 10 years has been
short-term trading, longer-term investing is still a work in progress for yours
truly. What I find most humbling is that while most of my reasons for avoiding
the stock market are still true and factual, it all boils down to timing. Until
the market wants to pay attention to them, the market will continue to frustrate
everyone out there who is looking for a lower market. With the stock market,
fundamentals simply take a major back seat to technicals.
Some of the most important questions and themes I
see going into the new year are the following:
1. Will volatility and range pick up in
individual stocks across multiple sectors, or will it be isolated and
rotational? We all know that the first 3/4 of the year were some of the worst
HVT conditions most of us have ever seen.
Luckily that changed in the last quarter, I suspect it will continue.
2. Will the weakening dollar finally do the
markets in, or will its steady and orderly decline be ignored? Again, this is a
timing issue. For now, the market seems quite content with a weak dollar, keep
the analysis to a minimum. The gold mining stocks are the obvious
beneficiaries.
3. Will the upward trend in the currencies (EUR,
JPY, CHF and CAD) continue? For now, why fight it? Place a generous stop loss
and forget about it.
The one question I did want to expand on is
number three. As you know, I have begun to rely more and more on the FX market
as a compliment to my HVT. Given that I trade them on a longer-term time frame,
it works out quite well. The one fact that is difficult to ignore with the FX
markets is that both fundamentals and technicals play a huge role. The
fundamentals are really what drive the trending nature of each FX pair. A
nations economy does not turn on a dime, it is a long drawn out process. I look
at FX from 2 perspectives:
1. A core position in a pair based primarily on
fundamentals with the idea of holding it for some time (several months)
2. A trading position based on the same
fundamental analysis, but using technicals on faster time frames to navigate in
and out (several days to several weeks)
I learned early on that the latter approach alone
would always leave you with far less to show for your efforts, these trends
persist for too long and the range always shakes you out of trading positions.
So, with that in mind, let me share with you my thoughts on what I am looking to
do in the FX market right now.
Euro
(EUR)
– The fact that the dollar cannot gain any
ground versus the Euro despite some impressive economic numbers is puzzling.
However, as we all know, the fiscal situation in the US is a bit troubling.
Secondly, in recent years and also in recent months, Central Banks, particularly
in Asia, have been increasing their exposure to the Euro. A recent IMF
publication noted that the percent of Euro holdings has gone from 12.7% in 1999
to just over 18.7% as of the end of 2002. There are now estimates from Goldman
Sachs that Euro holdings are to increase towards 32%. This would require the
additional purchase of $300 billion of Euros over time.
– The US current account deficit seems unlikely
to reverse. Net imports still are moving higher versus exports, a structural
change in this pattern seems quite unlikely. Further dollar weakness is the
only was to offset the account deficit.
– M&A activity from the US to Euroland appears
poised to continue higher, hence continued pressure on the $.
– Interest rate differentials favor the EUR vs.
$. In fact estimates are for a 3/4% point hike in the second half of ’04 in
Europe, while a rate increase here in the States seems less likely with an
election year upon us.
Yen
(JPY)
– The trend in the $ vs. Yen is clearly down,
however, the one challenge facing all FX traders is the persistent intervention
by the BoJ. While these interventions have had little effect in the long run,
they do make for some rather unpredictable and volatile swings which typically
stop you out. It is rare that the BoJ comes in light, they come in as
BIG buyers of dollars and make their presence felt. Knowing this, it reinforces
a point I made earlier, you need to approach FX with a barbell approach, a core
position and a trading position. The price action in the Yen is a perfect
example.
– According to Goldman Sachs, “Since
the Plaza Accord of 1985, the Yen has averaged around 26 big figures a year
(2600 pips). The range in 2003 was slightly less, 107-122.” Expect a
reversion to the mean in 2004.
– The out-performance of the Nikkei could
trigger further inflows as global investors are still significantly underweight
Japanese stocks. The chart below indicates this.
–
Break-even expectations among Japanese exporters are in the vicinity of ¥110 per
Dollar, which suggests that the current levels of the Yen should not pose a
major problem for the export sector. The next Tankan Survey will include
the FX assumptions of the surveyed corporates. Anticipations of a stronger Yen,
but a strong overall reading would give the MoF/BoJ scope to slow their
intervention efforts. Source: Goldman
Sachs
So what about HVT? Good question. Just like
last year it is still alive and well, albeit on a less frequent basis. The
opening 90-minutes is where I am finding the most edge. Trade frequency is
down, 5-7 trades per day, but consistency remains solid. I cannot continue to
stress the importance of finding one or two stocks and sticking with them, tape
reading is paramount under present market conditions. The usual HVT stocks are
not the most tradable candidates presently, rather,
Home Builders and Mining Stocks
seem to be the most active.
By this point I am sure it is clear why I have
chosen to integrate FX into my daily regimen. With HVT taking up a smaller
percent of my trading day, and with volatility in FX picking up and the very
technical nature of that market, it is the perfect combination. As we start the
new year my column will reflect this new approach, there will be a focus on:
1. HVT
2. FX
To ignore the potential of FX would be foolish.
I will attempt to share with you my thoughts, observations with you. The amount
of material I read each day will provide ample material for the daily column.
So, fire up the monitors, keep your head down and
remain focused, there will likely be many curve balls thrown at us again this
year, the ones who stay the course will know how to deal with them, the dabblers
and drifters will simply fall by the wayside.
As always, feel free to send me your comments and
questions.
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Dave