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.