The Big Picture: Oct 12, 2015

With the bond market closed today and volume expected to be minimal, I’m taking the opportunity to update a number of secondary charts.  We’ll start with an overview of the big picture.

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In December 2013, the S&P 500, along with other key indices, had reached important technical resistance: a huge Butterfly Pattern at 1823, set up by the decline from 2007 to 2009.  Rather than reverse, though, it was forced higher by the yen carry trade.  The yen was aggressively monkey-hammered, USDJPY spiked right through resistance, and stocks did the same.

2013-12-23-SPX-wkly-butterflyIt was the second big success for the yen carry trade since the BoJ put a floor under USDJPY in 2011.  But, the celebration was short-lived.  Central planners were growing increasingly uneasy about the repercussions of the yen’s continual devaluation.

Bashing the yen made stocks more valuable and helped exporters, but it made everything Japan imported more expensive — especially oil, which is priced in US Dollars.  Energy prices, conveniently excluded from Japan’s CPI calculations, had soared 27% since Fukushima.

Yen Carry Trade PictureHigher energy prices not only hurt Japanese consumers and businesses, they complicated the argument for expanded QQE — which was necessary (the party line, at least) in order to cause much-needed inflation.

Seven months after USDJPY got the S&P 500 over the 1823 hump, stocks were starting to struggle again.  USDJPY had been going sideways, and investors were starting to wonder if the carry trade had run its course.  TPTB needed USDJPY to actually break out.

The only way to accommodate this without killing off Japanese consumers and businesses alike was to crash oil prices (or, at least stop propping them up.)  And, that’s exactly what happened.

2015-10-11-CL v USDJPY 1835As the chart above shows, USDJPY’s breakout from that protracted consolidation occurred at exactly the same time that CL started crashing.

And, everyone would have lived happily ever after… except for the fact that the carry trade relies on the yen continuing to devalue.  Sideways doesn’t cut it.

Last December, USDJPY reached the critical .618 Fib retracement of its losses from 147 to 75, and has since gone essentially nowhere.  Without the guarantee of the yen carry trade to propel it higher, SPX topped out in May and has been dropping ever since.2015-10-11-USDJPY v SPX 1835Bottom line, it’s time for another boost.  If you find yourself thinking “wait a minute; this has to end eventually,” congratulations!  You are smarter than all the central bankers in the world put together.  They’re addicted to the “benefits” of the yen carry trade: higher stock prices.  And, like any addict, they can’t see beyond the need for one more fix.

But, keeping the carry trade going means oil has to decline even further — which presents other problems.  The fracking industry, for instance, is hanging by a thread.  Worse yet (from their standpoint, not mine), the banks financing all that activity are feeling the pain of all those borrowers going belly up.

While TPTB might not care much about frackers, they do care about bankers (or, at least a couple of them would be in jail by now.)  So, they’re at an interesting juncture with no great choices:

  1. keep bashing the yen, which would keep stocks rising but make Japan’s 5th recession since 2009 official as oil and food prices spike.
  2. keep bashing the yen, but crash oil prices too — which would kill off at least a few banks and more than a few oil industry players.
  3. give up on Abenomics and the yen carry trade, which would give some measure of relief to Japanese consumers and businesses (other than exporters) — but crash the stock market.

The one factor I haven’t mentioned is that between the BoJ and the GPIF, the Japanese government owns about $700 billion in stocks.  That’s almost 15% of its GDP.  And, given that Japan is leveraged to the tune of 240%, their stock holdings should be considered heavily margined.  I wrote about this two months ago in Japan’s Equity Trap.

2015-10-12-USDJPY v SPX LTAnyone who’s ever been heavily-leveraged and upside-down on a huge bet knows what desperation is all about.  And, though you’d never guess from their speeches and press releases, Abe and Kuroda must be feeling pretty desperate right about now.

The BoJ has another monetary policy meeting coming up on October 30.  All investors will remember last October 31, when the last big expansion of QQE (with help from Jim Bullard) rescued stock markets from the biggest decline since 2011.

Will we see a repeat performance? I think so. Central bankers have consistently deferred to the institutions which caused the financial crisis in the first place.  I can’t see that changing anytime soon.

Sure, they’ve painted themselves into a corner with respect to oil prices.  But, when was the last time a central banker stood up and admitted that QE was a huge mistake — a zero sum game which shifted rather than created wealth and which should be unwound regardless of the impact on the stock market?

Stay tuned.



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