STOCK MARKET FOR BEGINNER | Stock & Option Guide

THE JAPANESE YEN HAS BEEN EVEN STRONGER DURING JANUARY — THE YEN IS ALSO TURNING UP RELATIVE TO OTHER GLOBAL CURRENCIES IN UNWINDING OF CARRY TRADE AND MOVE TO SAFETY

YEN IS ALSO A SAFE HAVEN CURRENCY … Most currency focus has been on the rise in the U.S. Dollar since December. That has not only undermined the commodity rally, but is also siphoning money out of global stocks that had been trending in the opposite direction of the greenback. Chart 1 shows the PowerShares Bullish Dollar ETF (UUP)breaking out to a new four-month high today and nearing a test of its 200-day average. [The cash $USD, on which the UUP is based, has already exceeded its 200-day line]. The dollar isn’t the only currency to be rallying on safe haven status. So is the Japanese yen. Chart 2 plots the CurrencyShares Yen ETF (FXY) rallying against the dollar since the start of January. That’s when most global stocks and commodities started to weaken. That may be due to unwinding of “carry trades” in both currencies. The carry trade involves borrowing low yielding currencies (selling the dollar and yen short) and reinvesting the money in higher-yielding (and riskier) assets. When those riskier assets start to weaken (as they have during January), global traders sell those pricey assets and buy back dollars and yen. The bigger story may involve the upturn in the yen versus other currencies besides the dollar.

MOVE TO YEN SAFETY… Chart 3 plots the direction of the Euro (red line) andAustralian Dollar (blue line) against the Japanese yen over the last decade. It’s clear that the yen was a dreadful currency during that period of time. Most of the Euro and Aussie gains came after 2002 when global stocks and commodities started a major upturn (and the U.S. Dollar weakened). A lot of that global strength was financed by borrowing cheap yen. During 2008, however, global assets (including most currencies) collapsed against the yen as the yen carry trade was unwound. Fast forward to Chart 4. Starting in March 2009, higher-yielding assets like the XAD and XEU turned up against the yen as did stocks and commodities. That started to change during October, however. TheAussie/yen (blue line) peaked in October and again in January. The XAD was the strongest currency during 2009 (because of its close ties to commodities and China). It may be starting to roll over. The Euro/yen (red line) peaked in October and has fallen to the lowest level in a year. That may be due more to European weakness than yen strength. But it looks like global investors are turning to the yen (and dollar) as safe havens as the likelihood of a global correction grows.

YEN VERSUS DOLLAR… In case you’re wondering whether the yen or dollar is stronger, take a look at Chart 5. It plots the yen versus the dollar over two decades. After bottoming in 1998 (during the Asian currency crisis), the yen remained relatively flat against the dollar for nearly a decade. During 2008 (in the midst of the subprime mortgage crisis), the yen broke out to the highest level against dollar in thirteen years. The yen is still the stronger of the two.

BASIC MATERIALS INTO CONSUMER STAPLES AND HEALTCHARE SHOWS MOVE AWAY FROM RISK AND TOWARD SAFETY — TECHNOLOGY IS FALLING HARD TODAY AND IS PULLING REST OF MARKET LOWER — DAILY EMA LINES TURN NEGATIVE AND WEEKLIES WEAKEN — THAT’S INDICATIVE OF AN INTERMEDIATE CORRECTION OF AT LEAST 10%

MARKETS TURN RISK AVERSE… the recent rotation out of former market leaders and into defensive market sectors that are considered to be risk averse. It’s an important point that bears repeating. While it’s important to look at the technical condition of major market indexes (which are weakening), it’s also important to know what’s going down the fastest and what groups are holding up best. That also tells us something about the currrent market mood and deterioration in riskier assets. Chart 1 is intended to paint a visual picture of what’s going on. The four colored lines are plotted relative to the S&P 500 (the flat black line). In other words, they show the “relative” performance of the four lines. The two top lines show the January downturn in the relative performance of Emerging Market iShares (pink line) and basic material stocks (green line). That makes perfect sense since weakness in large emerging markets like China and Brazil have started to take a heavy toll on commodity markets and stocks tied to commodities. The two bottom lines show an upturn in the relative performance of healthcare and consumer staple ETFs, which are defensive in nature. That’s where money usually goes when investors sense a market downturn. Another group that usually loses favor during a downside correction is technology. That’s certainly the case today.

TECHNOLOGY FALLS HARD TODAY… Technology stocks are falling especially hard today and are pulling the rest of the market lower. The weakest index is the Nasdaq 100 which is dominated by large technology shares. Chart 2 shows the PowerShares QQQ Trust tumbling 3% and pushing it to the lowest level in two months. The chart shows the 50-day average (which was broken last week) now acting as resistance (which is the case which other market indexes as well). I’ve written several times in the past that the relative performance of the technology sector is a key barometer of market direction. The QQQQ/SPX ratio on top of Chart 2 had been rising since last March as technology led the market higher. The drop in the ratio during January shows that technology is now leading the market lower. That greatly increases the odds for a continuing correction.

DAILY EMA LINES TURN NEGATIVE … This is a good time to revisit the 13-34 EMA combination because the daily EMA lines have turned negative for the first time in six months. Chart 3 shows the 13-day EMA (blue line) crossing below the 34-day EMA (red line). That’s a short-term sell signal. The black line below Chart 3 plots the “difference” between the two EMAs. Although the line started dropping more than a week ago, it has just dropped below its zero lines (which is another way of spotting the negative EMA crossover). [To create the lower line, insert 13,34,1 into the MACD indicator. At other times, use the default 12,26, 9 numbers]. Chart 4 shows the “weekly” version of the 13-34 EMA combination. The good news is that the two weekly lines are still positive. The bad news is the the spread between the two (the black line) has started to drop for the first time since last March. That’s indicative of a likely downside correction of intermediate proportions which usually means a drop of at least 10%.

[John Murphy]