InvestMacro FX

By MoneyMorning.com.au

Publisher’s note: Brand new Slipstream Trader market update video – just uploaded and free to watch on YouTube…

In this week’s overview Murray Dawes looks at a few different scenarios that could arise out of a momentary impasse in the US S&P500. He points out where there’s resistance in the chart… and highlights where there could be “some great sell signals” coming up. He also gives his view on what the coming European rescue package could mean for buyers and opportunists… To get Murray’s insight ahead of the crowd – for free – just go here

Stock market volatility has been a regular theme in Money Morning recently.

It’s a theme we’ll continue today. And if we’re honest, it’s a theme we’ll have to follow for many more years. More on that below.

Meanwhile…

“The volatility of the US share market in 2011 is a little above average but it is well within historic norms and nothing like that experienced by our forefathers during the 1930s.” – Simon Marais, managing director, Orbis Investment Management

He’s not wrong. Look at the following chart:

Click here to enlarge

Between the end of 1929 and mid-1930, the Dow Jones Industrial Average dropped 89.5%.

By comparison, from the peak in 2007 to the low in 2009, the Dow fell “just” 54.9%.

What does that tell you? The 2008 financial meltdown wasn’t as bad as we all thought? There wasn’t – and won’t be – a second Great Depression…?

Or… the worst is yet to come?

On Tuesday, Slipstream Trader, Murray Dawes wrote:

“The irrational fear of prices falling has politicians scared to death. They are willing to throw unlimited amounts of other people’s money at the problem to stave off the markets attempt to return to equilibrium. The unravelling of 30 years of credit creation can’t be swept under the carpet.”

And don’t forget, the sweeping under the carpet hasn’t just happened since 2008. The market bubble actually burst in 2000. That was when the credit bubble reached a peak… reflected in the crazy investments made during the dot-com boom.

But rather than allowing the bubble to completely burst, the U.S. Federal Reserve applied a makeshift patch. So instead of the market falling… and investors learning the lessons of what was then a 20-year credit boom, the market recovered and the bubble re-inflated.

You can see on the following chart the big rate cuts starting in 2000 as the Fed took the benchmark interest rate from 6.5% down to 1%:

Click here to enlarge

It’s no surprise that as interest rates headed lower asset prices stopped falling… and eventually headed higher.

With money so cheap and fixed interest earnings so low, investors had to take bigger risks. So the damage was done by the time the Fed started jacking up rates in 2004.

And things would only get worse…

You may recall this was the period when Alan Greenspan ran the Fed. Fed statements were full of semi-cryptic language. But as with any cryptic message, the more it’s used, the easier it is to decode it.

That was the case with the Fed statements. For instance, the following sentences appeared in every Fed statement between June 2004 and November 2005:

“With underlying inflation expected to be contained, the Committee believes that policy accommodation can be removed at a pace that is likely to be measured. Nonetheless, the Committee will respond to changes in economic prospects as needed to fulfill its obligation to maintain price stability.”

At each meeting the sentences appeared, the Fed raised the Fed Funds Rate by 0.25%. The Fed changed the language for the December 2005 statement to a new phrase it used for the next three meetings… also increasing rates 0.25% each time.

So it didn’t take a genius to figure that as long as this statement remained, interest rates would keep going up.

And they did.

What did that mean for the markets?

Well, it meant the Fed was showing its hand. And the market took full advantage of it. Smart traders at the investment banks could make the pretty sure bet that rates would go up.

It allowed them to safely hedge their interest rate exposure.

Simply put, by giving the game away on its intentions, the goal of raising rates to slow down investment failed. In fact, it arguably increased risk taking. Because in order to maximise profits on hedged position, the sooner traders made bets on rising interest rates, the bigger the profits.

After all, if you’re pretty certain rates will go up in 0.25% increments for the foreseeable future, why wait? You wouldn’t. You’d leverage up as soon as possible to get the biggest bang for your buck.

In short, banks and traders were front-running the Fed… something the banks were quick to pick-up on from 2009 through to this year. And in both cases the big investment banks racked up big profits.

But with front-running opportunities fading away, so is the easy money. This week Bloomberg News reports:

“Goldman Sachs Group Inc. (GS), whose shares have fallen 43 percent this year, may report its lowest quarterly profit since the 2008 financial crisis…

“Goldman Sachs… said in July that it will cut about 1,000 jobs after its second-quarter drop in trading revenue was bigger than analysts estimated.”

All this makes us wonder what will happen next. Central bankers have shown they won’t allow banks to fail. Yet with easy money opportunities gone and interest rates close to zero the banks only have one choice if they want to make money…

And that means taking bigger risks.

The bad news is it won’t mean the same kind of credit boom you saw from the 1980s to 2000, and again from 2003 to 2007. Today the consumer and businesses are already maxed out on credit…

And besides, what’s left for the market to front-run the Fed on?

As someone who writes a monthly newsletter giving stock market tips, we’d love to tell you the market is heading for another dream run. Trouble is we just don’t believe it.

Our bet is we’ve seen the best days of the latest stock market boom (from 2009). And that the next few years – at best – are more likely to mirror the period from the mid-1960s to late 1970s… lots of volatility but not much in the way of long-term buy-and-hold profits.

That sounds like a nightmare for investors.

Well, it doesn’t have to be…

Providing you have a conservative long-term investment portfolio (cash and dividend paying shares) and a riskier short-term portfolio (small-caps and blue-chip growth trading) you can shield your investments against some of the worst volatility…

And if you get it right with your active portfolio you could achieve what Goldman Sachs can’t – a profit.

Cheers.
Kris.

Related Articles

Why Chinese Monetary Planning Means More Volatility for You

Australia: The World’s Investing Casino

Why China’s Hidden Debt is Bad News for Aussie Stocks

The Great Indian Coal Rush

The Other Side of Short Selling

From the Archives…

What Debt Crisis?
2011-10-07 – Greg Canavan

Enjoy the Rally, It Won’t Last for Long
2011-10-06 – Greg Canavan

Why the Fed’s Actions Make Perfect Sense
2011-10-05 – Murray Dawes

Too Big to Bail
2011-10-04 – Murray Dawes

What Can We Expect Next From Commodities?
2011-10-03 – Dr. Alex Cowie

For editorial enquiries and feedback, email [email protected]

Can You Beat Goldman Sachs?

Prior to the last recession, there was a sharp increase in exchange rate volatility. Fast forward three years and, once again, we are witness to another obvious uptick in currency price instability. This time around, factors such as the Eurozone debt crisis and the resulting flight to the safety of the dollar have served as the catalyst triggering the volatility. For currency traders, lessons learned from past experience should be top of mind now and the primary goal should be preservation of account capital.

Forex Storm Watch Infographic

Foremost in this list of lessons is the need for a risk mitigation strategy. All trading activities should be guided by a plan that minimizes, as much as possible, the potential for over-sized losses. During times of increased volatility, the need for risk strategy is even more critical as losses can quickly become magnified to the point of compromising your entire trading account.

One of the first things to consider when updating your risk strategy is to re-evaluate your use of leverage. Lowering your leverage when volatility spikes can reduce losses, but it also lowers potential gains. Given that the main goal at this time should be capital preservation, most traders should see this as an acceptable trade-off.

On a related note, instances of greater volatility also elevates the risk of a margin call. As volatility increases, the speed with which your account can fall into margin trouble rises dramatically. To prevent a margin call, you must keep a close watch on your account’s margin status. You may also consider increasing the capital in your account to provide greater margin headroom to allow for wider price swings.

Determining price trends becomes even more challenging during bouts of higher volatility. For those trading in the OANDA market there are several tools available that can help gain a clearer picture of overall market sentiment. The OANDA OrderBook for example, shows all  current positions for each currency pair as well as all pending orders for each price level. With this information it is possible to determine possible rate trends and even potential support and resistance levels.

Keep in mind that as long as you have an open position, you are exposed to market price changes. If you cannot actively monitor your open positions, you are at risk of the market price moving against you. To limit losses to manageable amounts, it is imperative to include stop loss instructions for all open positions.

By Scott Boyd, forexblog.oanda.com/

The world’s foremost Elliott wave expert goes “behind the scenes” on the Federal Reserve

By Elliott Wave International

The ongoing economic problems have made the central bank’s decisions — interest rates, quantitative easing, monetary stimulus, etc. — a permanent fixture on six-o’clock news.

Yet many of us don’t truly understand the role of the Federal Reserve.

For answers, let’s turn to someone who has spent a considerable amount of time studying the Fed and its functions: EWI president Robert Prechter.

Today we begin a 3-part series that, we believe, will help you understand the Fed as well as Prechter does. (Excerpted from Prechter’s Conquer the Crash and the free Club EWI report, “Understanding the Federal Reserve System.”)

Here is Part I; come back next week for Part II.

Money, Credit and the Federal Reserve Banking System
By Robert Prechter

An argument for deflation is not to be offered lightly because, given the nature of today’s money, certain aspects of money and credit creation cannot be forecast, only surmised. Before we can discuss these issues, we have to understand how money and credit come into being. This is a difficult chapter, but if you can assimilate what it says, you will have knowledge of the banking system that not one person in 10,000 has.

The Origin of Intangible Money

Originally, money was a tangible good freely chosen by society. For millennia, gold or silver provided this function, although sometimes other tangible goods (such as copper, brass and seashells) did. Originally, credit was the right to access that tangible money, whether by an ownership certificate or by borrowing.

Today, almost all money is intangible. It is not, nor does it even represent, a physical good. How it got that way is a long, complicated, disturbing story, which would take a full book to relate properly. It began about 300 years ago, when an English financier conceived the idea of a national central bank. Governments have often outlawed free-market determinations of what constitutes money and imposed their own versions upon society by law, but earlier schemes usually involved coinage. Under central banking, a government forces its citizens to accept its debt as the only form of legal tender. The Federal Reserve System assumed this monopoly role in the United States in 1913.

What Is a Dollar?

Originally, a dollar was defined as a certain amount of gold. Dollar bills and notes were promises to pay lawful money, which was gold. Anyone could present dollars to a bank and receive gold in exchange, and banks could get gold from the U.S. Treasury for dollar bills.

In 1933, President Roosevelt and Congress outlawed U.S. gold ownership and nullified and prohibited all domestic contracts denoted in gold, making Federal Reserve notes the legal tender of the land. In 1971, President Nixon halted gold payments from the U.S. Treasury to foreigners in exchange for dollars. Today, the Treasury will not give anyone anything tangible in exchange for a dollar. Even though Federal Reserve notes are defined as “obligations of the United States,” they are not obligations to do anything. Although a dollar is labeled a “note,” which means a debt contract, it is not a note for anything.

Congress claims that the dollar is “legally” 1/42.22 of an ounce of gold. Can you buy gold for $42.22 an ounce? No. This definition is bogus, and everyone knows it. If you bring a dollar to the U.S. Treasury, you will not collect any tangible good, much less 1/42.22 of an ounce of gold. You will be sent home.

Some authorities were quietly amazed that when the government progressively removed the tangible backing for the dollar, the currency continued to function. If you bring a dollar to the marketplace, you can still buy goods with it because the government says (by “fiat”) that it is money and because its long history of use has lulled people into accepting it as such. The volume of goods you can buy with it fluctuates according to the total volume of dollars — in both cash and credit — and their holders’ level of confidence that those values will remain intact.

Exactly what a dollar is and what backs it are difficult questions to answer because no official entity will provide a satisfying answer. It has no simultaneous actuality and definition. It may be defined as 1/42.22 of an ounce of gold, but it is not actually that. Whatever it actually is (if anything) may not be definable. To the extent that its physical backing, if any, may be officially definable in actuality, no one is talking.

Read the rest of this eye-opening report online now, free!

Understanding the Fed: How to protect yourself from the common and misleading myths about the U.S. Federal ReserveIt’s time to pull back the curtain on the Federal Reserve system. In this revealing 34-page ebook, you’ll learn how the Federal Reserve controls the money supply, you’ll pin-point a few critical points in Federal Reserve history, and you’ll uncover several important myths and misconceptions, like who owns the Federal Reserve Bank.Representing more than 10 years of research by financial analyst Robert Prechter, this free report goes beyond Federal Reserve history and it’s government mandate and digs into the Fed’s real motivations for being the United States’ “lender of last resort.” Take this important step toward understanding the Federal Reserve system — Download this FREE 34-page ebook now >>

Walter Energy on the Block

by Justin Dove, Investment U Research
Thursday, October 13, 2011

It was just last week that David Fessler talked about the positive outlook for coal and that Walter Energy (NYSE: WLT) was one of the most likely companies to benefit.

On Thursday, rumors spread that Alabama-based Walter Energy was a takeover target of mining giants Anglo American plc (OTC: AAUKY.PK), BHP Billiton (NYSE: BHP) and possibly Vale S.A. (NYSE: VALE).

Bloomberg reported that “demand from steelmakers in China and flood-related supply disruptions in Australia have driven prices for the raw material to record highs.”

Walter Energy shares spiked in early September to just over $90 per share after the London Times reported that Anglo American was offering $120 per share – about 60 percent more than shares were trading mid-day on Thursday.

If the three companies are engaging in a bidding war, it could mean even more of a premium for Walter. The Times added that Anglo American could potentially boost its offer to $150 per share if needed – more than a 100-percent premium to the mid-day value on Thursday.

Walter Energy: A Solid Buy-Low Opportunity

Spokespeople for Anglo American and BHP declined comment to Bloomberg, but Walter would offer a solid buy-low opportunity for the mining companies.

As you can see in the graph above, Walter’s stock was hammered down to the 70s after reaching a high of $143.76 in April. The drop, much to do with macroeconomic concerns, came despite raising its second-quarter profit by $0.20 per share.

The Bottom Line for Walter Energy

At its current levels, Walter looks like a bargain for potential acquirers and investors alike. The coal industry as a whole has a positive forward outlook as outlined by David Fessler.

Even with the recent spike due to rumors, Walter itself appears cheap, with a P/E around 10 and an EPS of $7.44. Considering the 52-week high is $143.76, the stock may have plenty of room for improvement before it becomes too expensive for investors.

Good investing,

Justin Dove

Article by Investment U

Oct. 13 (Bloomberg) — John Greenwood, chief economist at Invesco Asset Management and architect of Hong Kong’s fixed-exchange-rate system, talks about the outlook for the local currency’s peg to the U.S. dollar. Greenwood also discusses China’s yuan policy and Europe’s debt problems. He spoke yesterday with Bloomberg’s Robyn Meredith. (Source: Bloomberg)

By Mike Conlon, ForexNews.com on Oct 13, 2011

Yesterday’s release of the FOMC meeting minutes was a complete dud and market hopes that the Fed was close to QE3 went unrealized.  Part of that hope came from Bernanke’s speech to the Joint Economic Committee earlier this month, but it seems as though that mention of further easing was intended to keep the markets from falling off a cliff.

Yet they are no closer to QE3 then previously thought, so the “free money trade” will have to wait for another day or for the economy to worsen dramatically, which is not out of the realm of possibility if the EU fails to meet their deadline on the debt crisis resolution.  The clock is ticking.

News out of Europe this morning showed that German CPI was slightly higher than expected though not enough of a gain to cause the ECB concern.  What was more of a concern though was the ECB’s monthly report for October which was largely negative.  Citing “moderate to lower growth”, reduced outlooks, and the like, the ECB essentially confirmed what we already know.

What was more concerting to the market though was a report out of China that showed that their gains in exports declined more than expected, showing a gain of only 17.4% vs. an expected 20.5%.  While they will cry that the strengthening Yuan is hurting them, no one else will shed a tear as their trade surplus came in at $14.5B, which contrasted with the US trade deficit of 45.6B makes them look silly.  The Senate passed the Bill to impose tariffs on China if they don’t move to revalue their currency, which could ignite a trade war and is likely not going to help the global economy recover.  I’ve discussed an alternate solution to tariffs in this morning’s video.

However there was some good news for those with risk appetite, as Australia added 20.4K jobs to their economy vs. an expected 10K, which helped push their unemployment rate down to 5.2% from the expected and previous 5.3%.  While the Aussie has pulled back on general risk aversion, the slight decline may reverse throughout the day.

Additionally, the Bank of Japan released the minutes from their rate policy meeting which called for additional monetary easing to attempt to weaken the Yen.  Citing problems in Europe to global economic stability, prolonged Yen strength will harm exports though recent economic data in Japan has been better than expected.

Here in the US, initial jobless claims figures came in as expected, with 404K newly unemployed.  400K has been the “norm” which is unfortunate as we are not adding enough jobs to move the needle.  Perhaps the passage of the Free Trade Agreements that have been sitting around for over 4 years will help, but structural reform is more likely needed.

Since the President’s “jobs” bill was rejected by the Senate, we are likely going to have to wait for the debt “super committee” to attempt to reduce our deficit and provide confidence to the markets.  This is a big task and much like the Euro commission that is charged with finding the resolution to the Euro debt crisis, essentially puts us in a holding pattern until then.

So I’m going to focus on corporate earnings here in the US, which if the majority come in better than expected, could revive risk appetite in the markets.  The general mood surrounding the markets seems to positive, though that could be derailed by the Europe failing to resolve by their self-imposed dead-line, or more of the same Washington DC gridlock.

The inverse correlation between the S&P 500 and  the US dollar is still pretty high, so the risk trades are still intact and could be driven by stocks rather than perceived global economic risk in the near-term.

Regards,

Mike Conlon,

Senior Forex Mentor

www.forexnews.com

Oct. 13 (Bloomberg) — Kit Juckes, head of foreign-exchange research at Societe Generale SA, talks about currency markets. He speaks with Linzie Janis and David Tweed on Bloomberg Television’s “Countdown.”

Oct. 13 (Bloomberg) — Shaun Cochran, head of Korea research at CLSA Asia-Pacific Markets, talks about the outlook for Bank of Korea monetary policy. Cochran, speaking from Seoul, also discusses the free-trade deal between South Korea and the U.S., and the outlook for South Korean stocks. He speaks with Rishaad Salamat on Bloomberg Television’s “On the Move Asia.” (Source: Bloomberg)

Don’t Run Scared, Just Reduce Risk

by Jason Jenkins, Investment U Research
Thursday, October 13, 2011

Now is not the time to follow the crowd.

It’s times like these when strategy wins out over mentality. We’ve seen what the herd mentality can do to overall markets historically and over the past few years in particular.

The herd tells you that every piece of positive information out of Germany and France should cause a rally. And then a day or two later, Greece still doesn’t hit its austerity measures and the Slovakian government votes not to expand a 440-billion euro bailout fund, throwing a monkey wrench into the EU’s crusade to contain its sovereign debt crisis.

Everyone yells, “Sell!” and money is funneled into Treasuries with a return of less than two percent. Save yourself the heart attack of this rollercoaster ride. This is a time when trusted strategies can deliver peace of mind.

Reducing Investment Risk With Dividends

No one has a clear view of how this market is going to work out so drastic reallocation every other day isn’t going to work. What you should be looking to do now is reduce risk – gaining the best possible return for the lowest amount of risk.

If you are focusing on large, dividend-paying multinational corporations, you can get the best of both worlds. As I wrote last week, many multinational stocks are benefiting from record-level profit margins, lower cost of debt, and long-term global demand from emerging economies.

For example, take a look at these three dividend bellwethers:

• AT&T (NYSE: T)

• Nestle (PINK: NSRGY)

• PepsiCo (NYSE: PEP)

AT&T is still a leading telecom and wireless company that has raised dividends for 27 straight years no matter what the economic climate. Its current yield is near six percent. That’s about double the yield on 30-year Treasuries and three times that of the S&P 500.

Nestle has raised dividends for 15 consecutive years. It has a current yield of 3.8 percent. Also, expect Nestle’s earnings to get a substantial boost by the Swiss National Bank’s policies to make the Swiss franc competitive against the euro and other international currencies.

PepsiCo is definitely taking advantage of global demand from emerging economies racking up annual revenue growth of about 24 percent in those same markets. Pepsi has raised dividends 39 years in a row and its stock yields 3.4 percent.

More Diversified Dividend Options

We’ve also written before about exchange traded funds, which offer a little more diversity in this space. For example, keep an eye on PowerShares Dividend Achievers Portfolio (NYSE: PFM). This ETF is based on the Broad Dividend Achiever Index (Index). The Index is designed to identify a diversified group of dividend paying companies that have increased their annual dividend for 10 or more consecutive years.

Also, the Vanguard High Dividend Yield ETF (NYSE: VYM) attempts to track the performance of the FTSE High Dividend Yield Index. This measures the investment return of common stocks of companies characterized by high dividend yields over a period of time.

Remember, dividend-paying stocks are not going to promise to set the world on fire with returns, but the right companies or ETF can deliver stability in a rocky landscape.

Good investing,

Jason Jenkins

Article by Investment U

Two years after playing host to the United Nations COP 15 Climate summit, Copenhagen has once again called world leaders to the Danish capital to discuss the “State of Green” 2011.

In those two years, the discourse on solving global climate problems has shifted from reducing carbon emissions to now stimulating international green growth.  A necessity in lieu of the ongoing concerns about the global economy, say politicians and business leaders alike. That has spurred leaders like UN Secretary General Ban Ki-Moon to say that his primary goal in coming years is assuring sustainable global growth.

Reporter: Brian Woodward
Camera/Edit: Jesper Jakobsen

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Video courtesy of en.jyskebank.tv