Currency Trade Flashing a Warning Signal
As this liquidity driven rally has continued to push higher with a dash of hope and a heap of 'financial engineering', I am continually looking for signs to the contrary to prepare for reality instead of the fantasy that is continuously served up by our government and the financial press.
The latest story making the rounds is that things really weren't as bad as we thought they were last fall, and the entire selloff was irrational behavior. Now that things are getting back to 'normal', the worst is behind as and there is no where to go but up. If 'normal' is soaring unemployment, GDP numbers that can only be improved with ridiculous government spending programs, and a cash strapped, debt laden consumer, then I guess we truly have 'made it'. Yea verily, prosperity must be just around the corner.
I usually don't get caught up in these types of debates because there are many out there much smarter than me who can predict our economic future, so I will move on to what I do, and that is reading money flows in the market.
In the chart below, I have plotted a spread between FXM (Mexican Peso - a riskier currency) and FXF (Swiss Franc - a more stable, defensive currency). When the black line is rising, money is flowing into the peso more than the franc, which is a sign that traders are embracing risk. When the black line is falling, more money is flowing into the franc and away from the peso, which says that traders are moving away from risk. I have also plotted the MSCI World Index (MSWORLD) as the red dashed line to show world equity performance in relation to the currency spread.
Notice back in November/December 2008 (on the left side of the chart) how MSWORLD rallied while traders were moving away from risk in the currency markets. That party lasted about six weeks before the move away from risk caught up to equities. MSWORLD subsequently dropped 28% to its March low.
Following the volatility surrounding the March low, the spread and MSWORLD got back in synch in early July and moved higher together. Since early August, however, the spread and MSWORLD have been diverging badly, demonstrating that risk is once again being taken off the table. This is saying that the world wide liquidity driven rally may be near its end.
When equities rise while traders are moving away from risk, there is not enough fuel in the tank to support prices at very extended levels. This is one more warning sign that must be heeded.
The latest story making the rounds is that things really weren't as bad as we thought they were last fall, and the entire selloff was irrational behavior. Now that things are getting back to 'normal', the worst is behind as and there is no where to go but up. If 'normal' is soaring unemployment, GDP numbers that can only be improved with ridiculous government spending programs, and a cash strapped, debt laden consumer, then I guess we truly have 'made it'. Yea verily, prosperity must be just around the corner.
I usually don't get caught up in these types of debates because there are many out there much smarter than me who can predict our economic future, so I will move on to what I do, and that is reading money flows in the market.
In the chart below, I have plotted a spread between FXM (Mexican Peso - a riskier currency) and FXF (Swiss Franc - a more stable, defensive currency). When the black line is rising, money is flowing into the peso more than the franc, which is a sign that traders are embracing risk. When the black line is falling, more money is flowing into the franc and away from the peso, which says that traders are moving away from risk. I have also plotted the MSCI World Index (MSWORLD) as the red dashed line to show world equity performance in relation to the currency spread.
Notice back in November/December 2008 (on the left side of the chart) how MSWORLD rallied while traders were moving away from risk in the currency markets. That party lasted about six weeks before the move away from risk caught up to equities. MSWORLD subsequently dropped 28% to its March low.
Following the volatility surrounding the March low, the spread and MSWORLD got back in synch in early July and moved higher together. Since early August, however, the spread and MSWORLD have been diverging badly, demonstrating that risk is once again being taken off the table. This is saying that the world wide liquidity driven rally may be near its end.
When equities rise while traders are moving away from risk, there is not enough fuel in the tank to support prices at very extended levels. This is one more warning sign that must be heeded.
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