4) Currencies
USDSGD
It is well known that the Monetary Authority of Singapore (MAS) intervenes
on our currency from time to time, to keep
it within the unspecified trading bands that it sets. While the MAS has
held off depreciating the Singdollar outright policy-wise, a slowing local
economy coupled with shifting global fundamentals could see it change its
stance and guide the Singdollar lower.
The local economic backdrop is rather bleak. Singapore’s economy grew at a sluggish 1.8%
in 2016, according to preliminary readings, the lowest growth rate since 2009. This lackluster economic environment
looks set to continue, as economists
predict 2017 growth to be between 1% and 3%. With US interest rates and
yields set to rise in 2017, the US Dollar has been on a tear against its
developed country counterparts in recent months.
Against the Singdollar, the
USD jumped from 1.3940 SGD to 1.4440 SGD within this period.
Such a sharp move in recent memory is only rivaled by the late 2014
surge in the USD. The fact that such a sharp drop in the SGD was allowed to
happen does hint at a lack of outright
intervention by the MAS. While the MAS could have intended to depreciate
the SGD, market
movements in recent months could have already fulfilled this intent.
Sharp resistance was met in recent weeks as the USDSGD pair approached 1.45, not unlike how the USDJPY pair behaved as it
approached the critical 100 level in early-2016. This could be government intervention.
While much of the weakness in the Singapore dollar may already have been
priced in, a further decline in the SGD later in 2017 should not be ruled out. Technically,
the long term direction of USDSGD is up,
implying a weaker SGD, as indicated by the series
of higher highs and higher lows in 2015 and 2016. 2017 could see a higher
low forming, should the pair correct from currently stretched levels at 1.44 and consolidate before moving off again.
The fact that the Singdollar is unlikely to appreciate strongly, while its
weakness is an obvious conclusion for now, makes
a long USDSGD trade attractive. With the risks skewed asymmetrically to the upside for USDSGD, long
positions can be taken when the pair falls to more appetizing levels, such as
the resistance-turned-support 1.3940 level. However,
retracements are likely only to correct the pair to 1.4200.
A reasonable long term price target could be 1.4800,
and subsequently 1.5000.
The key risks to this long position would be a drastic shift in MAS
policy, a reversal in the direction of the US dollar or a stronger than
expected Singapore economy.
USDSGD Prediction
Verdict: Bullish
Predicted End-2017 Level: 1.4800
Worst-case-scenario Level: 1.3600
Immediate Resistance Levels: 1.4370 (127.2% Fib extension), 1.4540 (138.2% Fib extension), 1.4600
(psychological level)
Immediate Support Levels: 1.4200 (2010 highs and psychological level),
1.3940 (early-2015 peak, recent resistance-turned-support)
EURUSD
With the pair finally breaking below the 2015 decade-low at 1.0460 in
late 2016, there has been much chatter
about the pair reaching parity (1 EUR = 1
USD). The euro has never been at parity
since the last time in late 2002. This important level will be extremely
closely watched by the financial world.
Technically, the euro has broken out of a box formation (sorry I didn't include
a zoomed-in chart for this period) formed since early 2015, where it was stuck
in a range between 1.05 and 1.15. A trendline (green diagonal line) can be drawn
connecting the series of lower lows since 2008. With woes in the Eurozone (the
latest being Italian banks) affecting confidence in the single currency, parity with the USD does look plausible for
the EUR at this juncture.
With the eurozone beleaguered by a litany of economic woes – continued
sluggish economic growth, negative interest rates and quantitative easing
failing to deliver solid results, weakness in the Italian banking sector etc,
as well as geopolitical uncertainties – French and German elections, the actual
act of Brexit set to happen in 2017, the threat of populist governments moving
to leave the Euro, immigration and refugee problems and so on, it is hard to
make an optimistic bullish case for the single currency. (Phew, that was a very
long sentence!)
While EURUSD parity seems nearly inevitable at this point, I do not think the road there will be a
straight line. For one thing, widespread
expectations do not necessarily translate into immediate market movements.
There are far too many short positions
on the euro at present to support a straight line trajectory toward parity.
Not to mention probably huge open interest for options written against that
level. With so many players betting on a move to parity, the market will therefore move to “shake out
the weak hands” first.
Therefore, I would not be surprised to see a rebound to 1.08 first before the
golden level of 1.00 eventually comes, spurred
by short covering on this crowded trade.
The sudden surge in EURUSD on 30th Dec 16, the last trading day of
the year, gives us an insight. The fact that the euro rocketed more than 100 pips (1 cent) in less than 10 minutes
under thin liquidity conditions seems to hint of numerous stop loss orders on short EURUSD positions being hit,
fuelling the spike that was probably started by computer algorithms. In a
one-sided market with so many short positions, achieving parity would not be so
simple.
At times when expectations are so one-sided, a big rally in EURUSD after
some unexpected news or developments would certainly catch everyone off guard. It does pay to consider the contrarian side
of the matter. (Just remember Brexit and Trump)
Then again, the euro may fall beneath the 1.000
level, only to rally off again in the following weeks, should Eurozone data
trump expectations. A key risk to the short euro trade would be the European
Central Bank (ECB) tapering its asset purchase program earlier than the market
expects.
EURUSD Prediction
Verdict: Moderately Bearish
Predicted End-2017 Level: 1.0000
Worst-case-scenario Level: 1.1300
Immediate Resistance Levels: 1.0460 (market likely to converge around
this level), 1.0600 (psychological)
Immediate Support Levels: 1.0460, 1.0150 (23.6% Fib level), 1.0000
(psychological)
5) Bonds
Probably the least disputable asset class in terms of direction would be
bonds. Although I am wary of black swan events that could derail the upward
trajectory in bond yields, I go with the consensus view that the US 10 year yield could touch 3.00% in 2017, while yields continue to rise
across the entire yield curve.
What is worthy of debate then, is whether the US yield curve steepens or
flattens in 2017.
Following the victory of Donald Trump on 8th Nov, the US yield curve has somewhat steepened,
[Comparing the blue line (recent) and the green line (before elections), we see
that the difference between them widens as we move along the x-axis
(maturity).] and that yields have generally increased across the board. The
following chart shows a good proxy for the gradient of the yield curve, the
yield spread between the 2 year and 10 year Treasury Notes. [Both of which are
bonds, despite being called “notes”] As seen, the spread has jumped
dramatically since Trump’s victory, implying that the yield curve has steepened quickly.
This does not come as a total surprise, as President-elect Trump has
promised large fiscal spending to boost
the economy. The influx of
government spending in an economy widely viewed to be already at full
employment and with no excess capacity is likely to cause inflation, and
therefore bond yields have increased to price in increased inflation
expectations. Since inflation expectations affects the longer end (bonds of
longer maturity) of the curve more than the shorter end, the shift in the yield curve is not parallel and the curve steepens
in this case.
While the yield curve may be steepening on inflation expectations, the
effect of interest rate hikes by the Fed cannot be neglected. Successive and
rapid rate increases are likely to raise
the short end (bonds of shorter maturity) of the yield curve to a greater
extent than the long end, causing
the yield curve to flatten. Conversely, a slower paced series of rate hikes
gives the market more time to adjust. In this case, the curve would likely see
a more parallel shift upward, flattening to a lesser extent.
Combine Trump’s big fiscal spending plans with the three forecast rate
hikes for 2017, and a very conflicting
outlook is painted. Since the markets tend to go ahead of themselves and
price in changes way in advance of them even happening, the rapid ascend in bond yields so far could
have been overdone. On the other hand, not many have considered the
possibility that the US economy may not have hit full employment yet, and there
is still spare capacity to accommodate higher aggregate expenditures, resulting
in lower levels of inflation than expected.
Predicting the Fed’s moves are
easier said than done, but what if the Fed holds off raising rates until
mid year, followed by 3 hikes in rapid succession? Couple that with lackluster
inflation and the result could well be a flatter yield curve.
There are too many “what ifs” at this juncture that clouds one’s crystal
ball, but if I were to make a bold
prediction, I’d go against the consensus of a steepening yield curve.
6) The Fed
 |
| Obtained from the Federal Reserve website |
The Fed has been promising rate hikes since 2014, but so far has only
delivered two – once in December 2015, and the other in December 2016. Yawn,
Wall Street has probably found a new obsession to fret over in 2017.
While I believe that interest rate hike expectations are now less likely
to impact the stock market, its effect on fixed-income markets is still going
to be profound. Trying to predict exactly when and how many rate hikes will
take place has become the staple of market pundits. I have 3 scenarios in mind
about how the Fed could move in 2017:
1) 2 hikes in 2017, first in June, another in the 4th
quarter
2) 3 hikes in 2017, one in the first quarter, then June,
then year end
3) 3 hikes in 2017, first in June, then September, then December
The first is the most “popular” scenario by far, and one agreed upon by
the experts. Currently, the Feds Funds
Futures imply a more than 50% chance of a rate hike in June, which would
bring rates to between 0.75-1.00%. Before June,
the probability of a hike does not exceed 50%, according to the futures.
Hang on, doesn’t this prediction sound a little familiar? That’s because
it’s exactly the same as the market expected back in
early 2016. Back then, there was much talk of two hikes (as opposed to
the purported four) in 2016, once in June and once in December. However, the
unexpected arrival of Brexit derailed those plans.
This year, geopolitical risks seem comparatively more tamed, or has the
short-sighted market discounted those risks for now? As the French and German
elections approach, Mr Market could suddenly awaken in panic and fret over a black swan result,
the exact opposite behavior of a complacent market
going into the British Referendum. Would the Fed choose to hike interest
rates in the face of geopolitical uncertainties then?
Later in the year, would inflation begin to creep up following huge
fiscal spending, assuming they are passed? What if inflation doesn’t rise as
expected? Or what if the Fed sees a lot of inflation on the way, and tightens
rapidly in a “front running” effort? Or even more unexpectedly, what if the
“fiscal-hawks” in Congress block Trump’s fiscal plans?
Also, the Fed has a
reputation to maintain, and their credibility
is at stake here. Despite calling for the first rate hike to be in 2015,
and expecting four hikes in 2016, the Fed has not upheld any of those promises.
Nobody is going
to take the Fed seriously anymore if they do not act on their words.
More recently, Fed officials have mentioned that they are faced with
uncertainties with regard to how fiscal policies in future may influence their
decision to hike interest rates. Members also expressed concern over the strength of the US dollar, which has
been jeopardizing the profits of US
multinational companies as they repatriate them back to the US. In fact,
some argue that the appreciation of the USD accompanied by rising bond yields
have already done the Fed’s job for them, as these conditions are
very similar to an interest rate increase.
There are way too many unknowns
at this juncture to draw a solid conclusion and hence we have to make a
logical guess based on what we have now. I
foresee only two interest rate hikes in 2017, very likely once mid-year and the
other year-end. With President-elect Trump promising huge fiscal spending
and lower taxes at the same time, the only way this can be achieved is through
huge borrowing. And in order for huge borrowing to be
sustained without jeopardizing the solvency of the government, interest rates
have to be kept lower for longer.
Much of the US recovery since the Great Recession is funded by cheap
debt – cheap debt that is keeping inefficient “zombie” companies afloat rather
than letting them fail. Should interest rates rise rapidly, it would cause a
knee jerk effect on the delicate recovery and threaten a slowdown once again.
7) "Market Mayhems"
There have been numerous outbreaks of sheer panic in the financial
markets since 2015. Some extremely terrible things would happen (oh no
Brexit!), or market players suddenly lose their cool over trivial matters, and
the financial
markets would tip over into chaos and disarray.
A look at the CBOE Volatility Index (VIX), which measures the 30-day
implied volatility of options on the S&P500 index (a simplified explanation),
captures these instances of “market mayhem” over the past two years. The VIX is
often used as a proxy measuring the fear of investors. The higher the VIX, the
more terrified investors are.
These spikes correspond to events
that shook the financial markets badly one way or another. Notice that we
have periods of “low to moderate” VIX in between these spikes. Notice how the
index returns to “normalcy” in the months after a big spike. Also note the
frequency of the spikes, which occur once every 5 months or so. Beginning to
see a pattern?
Everytime bad things happen and it upsets the market, the reaction is likely to be sharp and
swift, with stock markets plunging in an instant and hot money scurrying to
the safe haven assets. However, perhaps after those who had panicked have
calmed down, they begin to regret their impulsiveness and flock to buy into the market again, sending it rocketing back to the level it was previously and then even higher.
I’m beginning to see this as a “buy the dip!” phenomenon, however nonsensical it
may seem, illustrated in the chart below using the Dow Jones Industrial Average
as an example.
Investors who “bought
the dip” each time gleefully made buckets of money, while those who had
panicked and sold out kick themselves in dismay. It does seem then, that “buying the dip” and then selling the
recovery later is a viable trading strategy (not investing) for now, in the
midst of a 7 year old bull market that seems to be invulnerable. Longer term investors can use such dips as
attractive entry points, to buy quality stocks on the cheap.
Far from declaring that the market will always rise, I have to concede that this strategy has
its fair share of risk. Looking back over a longer horizon, these “big
dips” have become a far more frequent event. The big question now is: When does a big dip become The Dip –
the beginning of the next bear market, the drop that the market doesn’t bounce
back from quickly? Nobody knows. Regardless, do bear in mind that with the US
market trading at historically expensive valuations (high P/E ratios) now, the risk of a
substantial correction cannot be neglected.
The Final Word
I have come to the end of my (extremely) long investment thesis for 2017,
and for those of you who have been reading since the first paragraph of part
one, you have my heartfelt gratitude.
Naturally, I do not expect everyone to agree with my views and opposing views
are definitely equally valid as well. Nobody can predict the future with 100%
accuracy and therefore only time will tell if any of our predictions come true.
Until then, it is better for one to form his/her own views and take a stand, to
make sense of this chaotic mess that we call the financial markets.
Once again, a very happy New Year to all readers!
Just my two cents.
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