Overdue corrections?

Friday's price action was the final turd in the punch bowl of about as ugly a week of price action as you'd ever want to see (or not, as the case may be.)  The broad market reaction was always going to be interesting, and the reticence of fixed income to sell off despite the stunning headline number was telling.   To be sure, the earnings data was a disappointment, but even there the y/y reading on the headline figure reached a new cycle high (though the current iteration of the data has only been around for a few years.)


Macro Man had written that he thought that good news would be taken as such by markets, but he was clearly w-r-o-n-g.  The apparent willingness of rates markets to immediately anchor on the one disappointing aspect of the employment figures was a bit worrisome, and so it turned out to be for equities, with a turn and another ugly close, thus extending the poor start to the year.

There's been enough technical damage done that it's worth looking at things through a somewhat longer-term lens, and there the picture is unsurprisingly not terribly pretty, either.   On the weekly chart the two-year range in the SPX remains unbroken, but the support is rather close.  Given the way that the range played out, it looks a lot like a potential head and shoulders formation, with the neckline just below 1900.  A break would target 1665 or so, which would represent a peak to trough decline of 22% (just nudging into bear market territory) and bringing the index valuation back to levels that a lot more people would find attractive.

Although it feels like forever since the SPX endured a proper correction, in reality it's not quite the case.  Macro Man ran a little study using his since-1930 dataset to determine how long it has normally taken for the SPX to decline 20% below its previous all-time closing high.  The record, by far, was the 1990's, which went the entire decade without a close-to-close 20% drawdown.   "Irrational exuberance", indeed.  In contrast, essentially the entire 1930's and 40's were spent in drawdown mode following the 1929 crash and Great Depression.  As for the current period, based on the historical record Macro Man would suggest that we are due, though not overdue, for a correction.


Of course, this fits nicely with the notion that the expansion is getting long in the tooth.   Of course, as Yellen said in her December Q&A, expansions don't die of old age- there has to be a catalyst.   As things stand, "a China slowdown" strikes Macro Man as a fairly dubious one, though "China coupled with an implosion of the domestic energy industry and a collapse in credit" is a bit more believable, though we are still some ways from the latter of these on a structural basis.

Speaking of China, the latest fixing puts both USD/CNY and the CFETS basket almost totally unchanged, with the latter remaining below any level seen last year.  Macro Man has found it very interesting indeed that the market has chosen to buy yen over the last couple of weeks, as low delta USD/JPY puts are one his very favourite bottom-of-drawer systemic hedges when they are offered for sale cheap, as was the case a few weeks ago when USD/JPY looked to be pushing higher.

That being said, that the IMM has already flipped long JPY tells you that the CTAs are getting stuck in; while they may well be a catalyst to push USD/JPY even lower in the coming sessions, by the same token they're always just a squeeze away from getting stopped.   To some extent at least, the initial easy money being long yen has been made as they have puked USD longs.

On a broader context, however, it is clearly worth asking whether Abenomics has run its course in some ways, at least vis-a-vis the yen.   One of Macro Man's favourite pairs to look at from a macro perspective is JPY/KRW.  The two countries are superficially quite similar as Asian export powerhouses with deep domestic markets, and indeed they are direct competitors in and across a broad swathe of markets.

That being said, the JPY is generally a safe haven, whereas the KRW is a pro-cyclical EM play.  (Granted, it's fairly low-beta for an EM, but it's still a lot higher beta than the yen.)   Best of all, because of the competition between the two in export markets, the cross rate is an object of scrutiny for policymakers, particularly in South Korea.

 If we look at the long-term chart, we can see that there are 3 different market regimes in the pair:

* Slow, steady declines in JPY/KRW lasting several years
* Very sharp rallies lasting a year or two
* Long periods of sideways chop just below the highs of the prior rallies



What we can observe is the transition phase between the first of these regimes and the second tends to be relatively quick.  In fact, the previous two long-term cycle bottoms in JPY/KRW exhibited similar price action: an initial rally lasting a month or two, followed by a couple months of correction lower, a bit of consolidation, then a rally higher.   When the highs of the initial rally are taken out, the move higher accelerates.

While this may well be a coincidence, Macro Man finds it very interesting indeed that a similar chart profile has played out over the past year or so: initial rally, followed by pullback/consolidation, followed by a new rally phase.   While we have yet to breach the high of the initial rally, we are very close indeed; if the pattern holds, the pair should accelerate thereafter.

While all of Asia is clearly being affected by the Chinese slowdown, one might reasonably posit that Korea is more deeply affected than Japan, given the Chinese antipathy for the latter.   Sure enough, y/y export growth in Japan has been above that of South Korea for a couple of years now (though that of course might have something to do with the FX rate!)



Still, as high upside bets go, long dated low delta upside (strikes of 12+) in JPY/KRW look pretty tasty given the pair's current valuation and tendency to explode higher.  Indeed, given current price action in equities, finding anything that might explode higher (as opposed to just explode) looks pretty good right now. 



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31 comments

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Anonymous
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January 11, 2016 at 7:24 AM ×

Opex. Time for another rally? Same as Nov and Dec.

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Nico G
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January 11, 2016 at 7:26 AM ×

Bowie - what an awful start of the week

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Anonymous
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January 11, 2016 at 7:38 AM ×

@Nico -- the Bowie news is disturbing. I just found a video from his Ziggy Stardust tour in 2004, when he was basically my age. Looked good/vital. 2004 doesn't seem so long ago.....

- Whammer

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Nico G
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January 11, 2016 at 8:52 AM ×

true that Whammer - perhaps you didn't do as many drugs as he did.. and you have better vital

i bought Estoxx auction this morning - it's rippin'

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Anonymous
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January 11, 2016 at 9:06 AM ×

Fair play Nico - tried to get on it but bounce was so fast. Thought we might get a small pullback into Cash. Big Opex rally as I mentioned.

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Nico G
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January 11, 2016 at 9:16 AM ×

it is one of those Monday gaps which started so deep below, that cash traders had to jump on momentum an hour later. How much we retrace from that 10% downpour is one big ?

about one billion people have planned to trim longs on any rally they'd see

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Anonymous
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January 11, 2016 at 9:19 AM ×

Dax did 6/700 point rallies from Monday lows opex week in Nov and Dec following similar opens. 300 already.

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Nico G
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January 11, 2016 at 9:29 AM ×

such 10250 target would retrace 50% of the unhappy new year Untergang

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Anonymous
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January 11, 2016 at 9:31 AM ×

Thanks MM
What do you mean by "IMM has flipped long JPY"?
Not aware of positioning indicators in FX!

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Henner
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January 11, 2016 at 12:01 PM ×

Anon, what do you mean by opex here? i'm not getting it really

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washedup
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January 11, 2016 at 12:30 PM ×

MM - pretty intrigued by the KRW/JPY idea, although I must confess I have never played that one before - makes good fundamental sense - I have long believed that this notion of a chinese currency war sucking the JPY into a vortex even as their is general disdain for risky assets, is somewhat overblown, in as much as the entire japanese manufacturing chain has diversified globally. Kind of like the US nat gas industry doing a full chase my tail building LNG import facilities in time for the shale revolution in 2008!
How do you think EURJPY would act in the event that JPYKRW did a moonshot? I am tempted to conclude it may weaken somewhat but would like to hear your (or anyone else's) opinion.

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Macro Man
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January 11, 2016 at 12:40 PM ×

@ Anon 9.31, the CFTC does FX futures position reporting, which is useful as a proxy for CTAs.

@ Henner, it's short for option expiration

@ washedup, Yeah, I'd think it would probably go down, as JPY tends to be higher vol than euro during periods of explosive JPY strength. I would say however that if a position squeeze was part of the driver, it could go up initially as EUR positions seem much bigger than JPY.

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Leftback
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January 11, 2016 at 1:21 PM ×

JPYKRW analysis very persuasive. Like it. USDJPY set to trade in a range here, between 116-118?

Overnight action in China a remake of the same slasher movie. US rates may drift higher into the long bond auctions this week. Waiting for capitulation in Spoos before leaving the Hammock. A decent chance that today's little bounce brings out sellers.

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Bruce in Tennessee
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January 11, 2016 at 1:28 PM ×

http://www.bloomberg.com/news/articles/2016-01-11/hong-kong-yuan-interbank-rate-rises-by-record-to-all-time-high

"The city’s benchmark rates for loans ranging from one day to a year all set new highs, with the overnight and one-week surging by the most since the Treasury Markets Association started compiling the fixings in June 2013. The overnight Hong Kong Interbank Offered Rate surged 939 basis points to 13.4 percent on Monday, while the one-week rate jumped 417 basis points to 11.23 percent. The previous highs were 9.45 percent and 10.1 percent, respectively.

“Yuan liquidity is extremely tight in Hong Kong,” said Becky Liu, senior rates strategist at Standard Chartered Plc in the city. “There was some suspected intervention by the People’s Bank of China last week, and the liquidity impact is starting to show today.”


....The L word...

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Anonymous
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January 11, 2016 at 1:34 PM ×

Henner - opex is monthly options expiry, third Friday of the month for equity indices. As opposed to the big quarterly events encompassing futures, options etc.

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washedup
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January 11, 2016 at 1:35 PM ×

The HIBOR explosion has little implication from an institutional funding standpoint in Asia, but just underscores how mainstream the china weakening (specifically continuing devaluation) trade now has become - thats not to say its the wrong idea in the long or even the medium term, but I have never seen this situation happen without some pretty big squeezes to knock some punters off.
This ain't USDJPY guys - liquidity is there till it isn't.

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Polemic
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January 11, 2016 at 1:36 PM ×

"Price is news" and has been for a week now. I am starting ti get the end of the world emails from my learned friends who last wrote such missives at the beginning of September.

I was going to wait until 19th Jan but with sentiment so heavy and that NZ open stop-fest in the likes of ZAR and following rebound in all risk stuff I have started to buy equities.

The highest beta to buy for a bounce in everything would be Russia.

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washedup
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January 11, 2016 at 1:43 PM ×

Pol - couldn't agree more - if the doomsayers get any shriller I am going to have to get noise canceling headphones for all the dogs in my neighborhood...
Interesting you would pick Russia - if oil has a mini rally there is certainly some room on that one.

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Skippy
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January 11, 2016 at 2:25 PM ×

MM, SGDJPY, as you are probably well aware, is a similar trade and chart structure to KRW/JPY. Less from the perspective of manufacturing and exports, more as a play on the levered carry trade, banking system. Although the Koreans are also specialists in that area. The increase in bank credit to GDP In Singapore has been stunning in since the crisis and both credit and real estate prices are positively correlated to the currency as policy is pro rather than counter cyclical. Real loan growth peaked at a higher level than pre Asian crisis in 2013. To top it off the Singapore Banks have been at the pointy end of trade finance into China and lending to the commodity sector in the region.

All of that said, I am sympathetic to Pol's counter trend rally and point that price has become news.

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Leftback
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January 11, 2016 at 6:26 PM ×

Another lovely day for equity longs and energy investors. The beatings will continue until morale deteriorates to the point of towel chucking... perhaps we will see a dip below $30/bbl before a face-ripper emerges in crude and drives Polemic's counter-trend rally? At $31.19/bbl west texas we may not have very long to wait. The recent oil/10y rates correlation has broken down today and US energy/HY credit isn't terrible, may be telling us that we are getting close to the end of the current selling frenzy.

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Nico G
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January 11, 2016 at 7:31 PM ×

constructive price action in Europe - for what it's worth

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Leftback
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January 11, 2016 at 8:32 PM ×

Daily candles for SPX and VIX here resemble those at the end of the secondary September sell-off, not the more serious panic in August, and if the parallel holds then tomorrows candle in SPX may be a doji and a reversal is close at hand.

We are thinking about dipping a few toes in the water here.

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abee crombie
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January 11, 2016 at 9:17 PM ×

Good interview with the dean of US Economics, Ed Hyman this weekend. He see's US economic growth trending along this year. Be sure to check out the interview, its a good one with Blackrocks $50B global allocation manager Dennis Statman taking hte opposite view.

I'm finding some pretty decent individual value in single names here. Dont have to be very shrewd anymore. Just have to be brave to stick your neck out. But hard to buy anything when oil goes down every single day. I also worry that it seem to be concesus that oil will bottom by Q2.

I hope we get a flush below 1700 in the Spoo's that would be a great LT buying opportunity. Until then we are in purgatory where cheap stuff keeps getting cheaper and the fundi's slowly churn. I'd think Interest rates will be the leading indicator for a rally here.

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Leftback
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January 11, 2016 at 9:20 PM ×

We expect to see a fairly substantial bounce now into the SPX 1960 range, perhaps even as far as 1980-1990 by the end of the week as we head into options expiration. We have left the Hammock and have gone almost full body Kevlar suit and we are now long Spoos and Stoxx, at least for the time being. Let's try to explain our reasoning.

The SPX pierced the lower Bollinger band for four days in a row and those types of conditions don't usually persist without a sharp snapback at some point. Oil and energy stocks also seem to be oversold but we don't have the intestinal fortitude yet. Here and there today we nibbled on a few European energy names and a couple of Aussie banks, for the dividends. One of the more interesting things to happen today was the way AUDUSD turned around.

Have a good night and we'll see if the PBOC pulls any rabbits out of the hat or if the carnage continues for Dr Copper. We were not brave or foolhardy enough to buy FCX or BHP but there was an element of capitulation in those names today.

Good luck to all punters into the end of the second week of trading of 2016...

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Polemic
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January 11, 2016 at 9:54 PM ×

welcome to the kevlar gang LB

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Anonymous
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January 11, 2016 at 11:21 PM ×

RBS advises clients 'sell everything' as deflationary crisis nears... their last similar call was 2008. So with a statistical sample of one, and this being a bank, I think we can safely say: "strong buy".

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Carry Trader
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January 12, 2016 at 12:12 AM ×

LB,

Just hope the aussie banks are for a trade. We get wheezy thinking of potential headwinds it might face if the property market turns. Current earnings are based on bad debt charges near record lows.

Our preference has always been RIO over BHP. No energy exposure and on par being lowest iron ore and copper cost assets. Lesson we learned from 2008 was if your going with commodities, lowest cost producer is a must and balance sheet is king. RIO has both.

Agree on AUD/USD. Got stopped what we hoped was a bounce prior to year ends and it has been a slow grind down. Although taking comfort that the weak sentiment on china is not flowing to massive sell off leads us to believe the bottom is near.

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Anonymous
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January 12, 2016 at 1:31 AM ×

FCX -- wow what a bloodbath that has been... Haven't looked at the balance sheet to see if there is any hope.

-- Whammer

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Anonymous
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January 12, 2016 at 2:06 AM ×

Some pretty impressive moves in USDCNH.

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abee crombie
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January 12, 2016 at 2:46 AM ×

To the anon who posted about WPX last week. Thanks for the insights. Any thoughts on Crc bonds? So far they are the best thing I can think of for an asymmetric long oil beta trade.

Since the Kevlar seems to be out and we are sharing names, U.S. Housing stocks are getting crushed but my feeling is that it's probably one of the safest secular markets out there. I don't like home builders but building materials look very interesting especially as we are forecasted to go into a supply shortage of cement next year.

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