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US Dollar – The Rodney Dangerfield of Currency

After S&P downgraded the debt outlook of the US, the stock market sneezed, drank some high liquidity kool-aid, and then regained a lot of its lost ground. The real interesting phenomenon of course, was in the bond market, where market participants all but ignored the warning from S&P and bought US treasuries for their ‘safety’.

While some people may think this might be due to the damaged credibility of the credit rating agency after the financial tsunami, or that the US’s house of finance is fundamentally strong, the real reason may actually be the strong faith in the bi-winning fed’s determination to destroy the dollar by keeping interests rates artificially low. The evidence is best seen through the currency market.

With all the problems in Euro due to its PIIGS members, the latest being the risk of Greece restructuring its debt, the Euro fell from 1.45/dollar to 1.42/dollar, but then reversed its course and marches steeply towards 1.45/dollar again. Another evidence is on USD/JPY. Japan, with a 200% debt/GDP ratio, and a devastating tsunami that will cause the BOJ to keep its interests rates low for a long period of time, reversed its course of its weakness against the dollar, causing USD to trade below its pre-tsunami level once again. While we don’t believe the JPY can continue its ascend, and that the repatriation of Yen might be at work here, it nonetheless reflects the relative strength of the dollar.

So when will the dollar strengthen again? Long-term wise, it will probably be after the bi-winning fed exits its QEn program, with the likely scenario that n being a double digit number. In the short-term, however, everyone should be tuning to bi-wining Fed Chairman’s April 27th briefing, where every word will be parsed, however un-convoluted his message may be. The markets, whether it be equity, treasury, or currency, are currently placing tremendous faith in the chairman’s continued determination to destroy the dollar in order to bring unparalleled prosperity to the US. While this can make a great trade for reversal if there’s any surprise, it is hard to argue that the Fed worshipers have the upper-hand given the bi-winning Fed’s history.

This article originally appears on benzinga.com

What If QE2 Ends On Schedule?

QE2, the program that the bi-winning Fed started last November to buy $600 billion of US Treasuries, is scheduled to end in late June. While the market is still priced for a continuing QE2 or a QE3 program, some people are not so certain. Among the doubters, the most influential person is likely Bill Gross, who runs the largest bond fund at PIMCO, as he dumped all the US Treasury portfolio. Recently, he seemed to have gone one step further in shorting US Treasuries as well.

If indeed there’s no QE3, and QE2 does come to an end, what will happen? We will not know for sure, of course, until it happens, but it’s at least prudent to prepare for it. In the best case, US economy sustains its growth, unemployment improves, inflation is truly tamed (not the way the Fed said, but what main street observes), and interests rate remains low. In that case, stock market will likely rise, and commodities’ prices will stabilize. However, even then the voracity of the market’s climb is debatable unless unemployment’s number improves significantly while commodities’ prices retreat.

On the other hand, if Mr. Gross is right, there can be significant downside to many risk assets:

Currencies:
US Dollar had become a carry-trade currency since the original QE started, and QE2 only intensified the desire for other high yielding currencies. If interest rates rise, or merely the expectation of rates will rise sooner that it does, look for a sell-off, at least temporarily, on high yielders. Euro is likely the most at risk in this case because of its PIIGS members. Expect USD to rise sharply against Yen as well, as Yen is back again as ‘the’ carry-trade currency.

Commodities:
While the bi-winning Fed took credit of revitalizing the stock market, the denial that QE 2 contributed to the surge in commodity prices is just ridiculous. Unless investors and speculators were prohibited from investing in commodities and must invest only in stocks, the oversupply of liquidity undoubtably contributed or spilled to the commodities market. Therefore, if liquidity is withdrawn, we can expect to see downside in precious metals and other commodities.

Stock Markets:
A Strengthened dollar is not welcoming news for companies with strong international sales, and higher interest rates will curtail borrowing for speculation. As investors unwind their USD carry-trades, stock market will most likely suffer. However, there are still various US government stimulus programs at work for this year, which could help to sustain the market in some sectors.

If and when the market accepts that QE2 will end on schedule with no near term follow up of QE3, unwinding of risky assets can begin well before QE2 really end. The end of QE2 will at the very least dampen animal spirits, if not to cause any mayhem in various risk asset markets. Nonetheless, we all know how the Fed wants to be bi-winning, so the prospect of QE3 should never be dismissed, which will help to re-inflate the market again when it happens. When time comes, we will explore what investors should prepare when QE3 hits.

This article originally appears on benzinga.com

Opportunity for US Car Companies?

There is no denying that Japan is a major contributor to the global economy. In 2010, Japan accounted for nearly 9% of the world’s economic output and Japanese exports totaled $767.8 billion. This included 60% of the world’s silicon wafers (the building block of computer chips), where the shutdown of two factories due to the earthquake cut the world supply by 25%, and 90% of the world’s supply of BT Resin (a substance used to make printed circuit boards). Clearly this has huge implications for companies worldwide who rely on the island country for these and other materials. For now, strong inventories of these materials along with the quick ramping up and opening of other factories have helped. In other industries there was a more immediate impact.

One example is the auto industry. The immediate impact can be seen in both the car companies in Japan (Toyota (TM) and Honda (HMC) being two of the major players) where many factories where damaged by the quake but also on companies worldwide that depended on materials, mostly electronic, made in Japan. In the long-term however I see this as an opportunity for US car companies (for example Ford (F), General Motors (GM), and Tesla (TSLA)) as well as other players such as Chinese and Korean car companies, to take back some of the market share that Japanese companies have taken over the last decade. The earthquake will force many Japanese companies to focus their efforts on rebuilding domestically, giving companies from other nations an opportunity to gain some traction in emerging markets such as China and India. Furthermore, Japanese companies exported nearly nine million vehicles worldwide in 2010 and with factories temporarily idled there is an opportunity for outside competitors to steal some of this.

Japan is a major player globally and thus the earthquake and tsunami has had, and will continue to have major impacts in a wide range of industries. I think the auto industry is an especially interesting example and that investors thinking about making a move in this industry should consider both the short-term and long-term impacts this tragedy will have.

YouTube to become your TV destination?

Google bought YouTube for $1.6 billion in 2006 and is currently working on some major changes to the website that has brought us everything from Baby Charlie to The History of Dance. The plan is to create and highlight sets of “channels” around different topics such as sports or arts. In essence, the website will try to create online what we think of today as traditional television channels.

The idea is to “get people to watch YouTube the same way they watch TV.” This means an increase in the amount of time a user spends on the site, which currently sits at roughly 15 minutes per day. Recent reports have put YouTube at the world’s No. 4 website in terms of unique monthly visitors; if they were able to keep those visitors on their site for longer and furthermore had “channels” that presumably certain types of consumers were watching they could start to attract ad dollars, including a portion of the $70 billion U.S. television-ad market.

Even with all its success however, YouTube is still not profitable. Will the addition of channels change this? Are there other websites offering a similar product but with a more profitable business model? What will YouTube’s shifted focus on channels and longer content mean for other players in the online streaming video industry as well as television companies and others in entertainment? These are all things an investor should consider when looking at players in this space.

Yen Is Back As The Carry-Trade Currency

After Japan’s tsunami disaster, Yen surged on the assumption that Japanese companies and individuals will repatriate their overseas investments back home, causing high demand of Yen, thus warrant a strengthening in the currency. This happened even in the face of Bank of Japan expanding its quantitative easing program to inject trillions of Yen into the banking system. However, the aggressiveness of traders took the idea too far and too fast, causing USD/JPY to trade from ~83 to ~76.4 in five days, and at the request of the Bank of Japan, G7 joined together to intervene, finally staunching the rise of Yen.

We never believed Yen, given that it had already strengthened so much after the financial crisis, could or should strengthen as much as it did last time after the 1995 Kobe quake. This time, with the additional nuclear crisis (which just dumped radioactive water into the ocean), wrecking absolute havoc on Japanese economy, many of its Northeastern agricultural, fishing, and tourism activities will take a long time to recover. Even with a national debt with 200% of its GDP, Japan probably has no choice but to continue or even expands its loose monetary policy.

With Sweet Crude Oil hovering $110/barrel, even though most people still do not expect the bi-winning Fed will tighten anytime soon, as witnessed on the continual weakening of the Dollar against most currencies, USD had strengthened significantly against Yen. As we stated in our last article, USD/JPY needed to push through 83.4 to really staunch the appreciation of Yen, and then push through 84.5 to get traders to cover their ‘long Yen’ bet. While we thought this would take a while to do from the 81 level, it actually took only about 2 weeks for this to happen.

While we will not know if G7 had a hand on this rapid depreciation of Yen from 81 to its current trading level above 85, but the recent hawkish chattering from some members of the Fed probably played a large role in this as well. While the bi-winning Fed may not actually do any tightening even when some of its members continue their hawkish chattering, it is probably a safe bet that Japan will be the last to raise interest rates. Yen, once again, has become the carry-trade currency again.

Now that USD/JPY is trading above 85, the next stop is 85.98. If USD/JPY trades past this, we believe traders who previously betted on Yen appreciation not only will cover their positions, but may even reverse their positions and start shorting Yen. In this case, there is a good chance it can trade towards 90, as stated by Eisuke Sakakibara, formerly Japan’s top currency official. For traders who are not afraid of using leverage, this could turn out to be ‘the’ trade of 2011. For traders who are not afraid of using leverage, this could turn out to be ‘the’ trade of 2011. For investors who trade only equities, one can use the iPath JPY/USD Exchange Rate ETN (NYSE: JYN) for this trade, but remember that this ETN mimics JPY/USD instead of USD/JPY. So to bet on the depreciation of Yen, one will have to short rather than long on JYN.

This article originally appears on benzinga.com

The Fed is Bi-Winning!

Federal Reserve Chairman Bernanke gave a speech on Monday (Apr 4, 2011) at a conference hosted by the Atlantic Fed, of which he said:

“I think the increase [on inflation] will be transitory, that it will pass, and we will go back to a level of inflation that is consistent with our price stability mandate.”

He also said:

“We have to monitor inflation and inflation expectations extremely closely because if my assumptions prove not to be correct, then we would certainly have to respond to that and ensure that we maintain price stability.”

This got people thinking that the Fed might have changed its loose monetary policy, but then quotes from his interview on ABC after his speech really gave away his thinking. Some notable quotes from the interview are shown below:

Q: Some people have questioned the Fed’s reasoning behind leaving food and fuel cost out of inflation monitoring.  Why do you think they should be left out?
A: You can’t process me with a normal brain. If you borrowed my brain for five seconds, you’d be like, ‘Dude! Can’t handle it, unplug this bastard!’ “It fires in a way that’s maybe not from, uh… this terrestrial realm.

Q: The financial tsunami had adversely affected many Americans and citizens of many countries.  How has the event affected you personally?
A: I’m tired of pretending I’m not a total bitchin’ rock star from Mars.

Q: Other than quantitative easing, what other tools does the Fed have in achieving its dual mandate of promoting maximum employment and price stability?
A: I was banging seven-gram rocks, because that’s how I roll. I have one speed, I have one gear: Go.

Q: Thomas Jefferson once said that ‘Banking institutions are more dangerous to our liberties than standing armies. If the American people ever allow private banks to control the issue of their currency, the banks and corporations that will grow up around will deprive the people of all property until their children wake-up homeless on the continent their fathers conquered.’ What do you think about that?
A: I’m not Thomas Jefferson. He was a pussy.

Q: Some people believe that Americans are addicted to debt, and some say that you are the drug dealer to them. Is that true?
A: The only thing I’m addicted to right now is winning.

Q: Ron Paul criticized you that you failed the dual mandate of the Fed, that you failed to create real jobs or to control price. What do you think?
A: Wow what does that mean? I’m bi-winning. I win here and I win there. Now what?

Mea Culpa! We mixed up the Charlie Sheen’s interview with Chairman Bernanke’s. Be sure to read the true quotes on chairman Bernanke here.

When Inflation Wreck Havoc on Earnings

Earnings season is coming up again, with Alcoa (NYSE: AA) kicking it off on April 11. It will then be followed by J.P. Morgan (NYSE: JPM) on April 13, with many more to come.

While inflation was of no concern in the last earnings season, it looks to be quite different this coming earnings season. Even though the Fed said there was no inflation, some companies seemed to think differently. For starters, Nike (NYSE: NKE), before most companies were openly concerned about inflation, cited rising commodities cost, labor, and transportation cost as risks to its future earnings in its December 2010 earnings report. In that sense, Nike did not disappoint investors, as it dashed investors’ hope again in its latest earnings report on March 17 citing higher costs, pushing its stocks down ~9% after the report. Besides Nike, Carnival Corp (NYSE: CCL), the cruise operator, also cited rising fuel prices and itinerary changes due to turmoil in Middle East and North Africa on March 11 as the reasons to cut its earnings outlook.

The Fed would like investors to believe that all is well on the inflation front, but it’s getting harder and harder for investors to stomach that. The market may be bouncing well even though Middle East’s turmoil or Japan’s nuclear crisis are far from over, but investors need to be vigilant on this upcoming earnings season for companies, particularly those not in high growth modes or not having high margins that are sensitive to food or oil prices. To protect themselves, investors should consider buying put options, or even lessening their exposures before their invested companies report earnings.

This article originally appears on benzinga.com

G7 Can Do More For Yen

One of the casualties of the Japan earthquake and tsunami was Yen, Japan’s currency. Rather than tanking because of the extra liquidity Bank of Japan provided for the market, Yen surged against all other currencies instead. In this case, traders followed the same playbook for the 1995 Kobe quake, betting that Japanese companies and individuals need to repatriate capital back to Japan for the rebuilding effort. While this thesis is debatable, traders was not concerned about the argument of its validity, and Yen rose significantly in the days following the quake, as USD/JPY traded down to 76.4, nearly an 8% strengthening in 5 business days.

As an export oriented country, Yen’s rapid ascent unnerved Bank of Japan. As Honda Motor (NYSE: HMC) estimated, each rise in one yen against the US dollar will cause 17 billion yen in lost earnings for the company. On Mar 17, G7 pledged to intervene to stop the rise of yen, and USD/JPY quickly reversed its course to trade back to 81.26. It then traded as high as 82.00 the following day. This illustrated that most of Yen’s move was more speculations by traders than true repatriation of capital.

While USD/JPY is now hovering between 80.5 and 81, judging from the inability of Yen to push past 82.00, we don’t think speculators have gone away on their playbook trade. In order to get the job done, and alleviate the need to intervene again, G7 will need to do better than this. Currently the Yen strengthening trend is still intact, and for G7 to really scare off the speculators, they need to cause technical damage to the trend. In this case, only a push of USD/JPY to 83.4, the previous rate where it was trading before the quake happened, will cause traders to doubt themselves. To really get traders to ponder changing course, though, will be to push USD/JPY pass 84.5.

In general, people do not have much faith in international coalitions, when different countries having their own policies and concerns towards a coalition’s action. This is illustrated in the enforcement no-fly-zone enforcement by the United Nations security council, when now the Arab League is wavering its support, and the US trying hard to hand off its duties, not to mention the absence of the BRIC countries in any form of support. Therefore, if G7 does not heighten its resolve to deal with Yen’s strengthening problem, it may soon find itself trapped in a situation getting harder and harder to deal with.

This article originally appears on benzinga.com

Mini Flash-Crash in Forexland

Much has been talked about the ‘Flash Crash‘, a dramatic event that plunged the Dow Jones Industrial Average by over 900 points, and then recovered, in a short period of time. After a lot of investigation, the SEC produced a report on October 1, 2010. In the report, SEC attributed the event to a large E-Mini S&P Futures sales order by a single large investor, many believed to be Waddell and Reed Financial, Inc. (NYSE: WDR), which then unleashed a torrent of sales orders that quickly swamped the stock market.

While all attention is on the equity market regarding flash crashes, we witnessed a mini flash crash in USD/YEN forexland last friday (Feb 4, 2010). To give a perspective on why this is a flash crash event, one needs to know that Forex (Foreign Exchange) market is perhaps the largest trading market of all kind. In recent years, the average daily turnover of forex trading is estimated to be ~ $4 trillion. Even in this era where trillion is just another monetary unit, this is still a huge amount that dwarfs other capital markets. Of this, ~$1.5 trillion is in spot exchange, and Euro/Dollar comprises ~$420 billion, while Dollar/Yen comprises ~$210 billion. In short, the Forex market is a highly liquid market, with participants from all over the world ranging from central banks, major banks, mutual funds, hedge funds, retail brokers and investors.

On Feb 4, 2010 around 8:30am EST, when both New York and London markets are trading, perhaps it was a large buy order on yen, or perhaps a large related futures order, USD/YEN plunged from ~81.60 to ~81.30, i.e. > 30 pips in forex lingo, and then recovered, all within 1 single minute. This may not seem like much to an equity trader, but this is a huge swing in forex for such a short amount of time, considering that a lot of forex trading are done through leverage of 100:1. To further illustrate the disappearance of liquidity within that period, we had a small outstanding position with a stop order during that time, and it took a full second and three tranches (one lower than the order) for that stop order to be completed, whereas in a normal situation it may take ~1 micro second to complete the order in one shot.

USD/JPY Flash Crash

For such a highly liquid market to experience a mini flash crash in such a short time frame, it makes people wonder what can really be done to prevent this from happening. While the SEC is taking different measures such as expanding circuit breakers, increase transparency of ‘dark pool’, etc., we are not sure how effective these measures will be to eradicate flash-crashes. There are also many markets out of jurisdiction of the SEC, which can and will affect the equity market in times of high uncertainty. In short, we believe flash-crashes, along with high frequency trading, are here to stay.

For an investor to protect himself against any flash crashes, one must reconsider the use of stop orders. In the case of a flash crash, it’s better not to have stop orders because it’s going to bounce right back in a relatively short period of time. However, in the middle of a flash crash, it’s extremely difficult to determine whether a flash crash is happening, or that a severe correction is under way. It is also against the trading rules of many people. An investor should therefore consider using tighter stops if they are worried about a flash crash. In the event of a flash crash, only a computer with proper monitoring of the action will have the chance to detect the pattern, and we believe such a service will come soon for portfolio managers and investors.

This article originally appears on benzinga.com