Essential
Nature of Asset Pricing Now and Over Months
Price action among assets have over months revealed
euro and S&P to be positively correlated, while U.S. dollar moves opposite
and is negatively correlated with euro and S&P. Last two trading sessions, however,
are showing an odd break from these correlations.
Namely, as mentioned in last article, euro is in
decline while S&P is up, and the U.S. dollar is up. Normally, where S&P
goes up, one could expect euro to increase and dollar to decline. Stated
otherwise, S&P is breaking from correlations to show risk appetite or a
bullish sentiment. Euro and U.S. dollar are showing an opposite risk aversion
or bearish sentiment.
Looking at past information that moved market price
reveals fundamental influences on current asset class divergence today. Without
knowing where you’ve been, how can you tell where you will go tomorrow.
July
Market Activity Showed Considerable Disappointment, Except Exploratory ECB
Comments
Starting with the July to September period provides
a reason for S&P recovering from its low of 1310 level in July. Going into
September, S&P levels managed to reach 1470, which amounted to a multi-year
high.
July 24 starts this period’s tail by knowing U.S.
earnings season was in full bloom. This day marked a third day of 100+ point
declines on the Dow Jones Industrial Average, with July 24 down 104 points to
close at 12,617. U.S. dollar index was on a rip reaching 84.0, a high. Euro
sunk like lead and saw a level below 1.2000.
Reason for S&P and euro declines and a U.S.
dollar rise was Q2 earnings reports and renewed Greece problems magnifying
Spain’s problems. On July 24 United Parcel Service, a strong bellwether,
reported earnings and revenues that missed already reduced estimates and its
stock fell 4.6%. Richmond Fed Manufacturing Index showed contraction and
Reuters reported Greece would need another debt restructuring.
By July 25, things were looking up. Although Apple’s
earnings were a surprising upset, Caterpillar and Boeing reported strong
results. Still, sale of new houses reported a June gain of 350,000 when 369,000
was expected by economists. Also known was Spain’s borrowing level stood at an
unsustainable 7.75%, German business confidence looked weak and Britain’s
economy slumped for a third quarter.
Given these factors, equities closed mixed on July
25 with Dow up at 12,676, and S&P remained down, but only by a fraction.
Reason for July 25 avoiding a fourth day of deep
equity losses appears to have come from Europe. While Caterpillar and Boeing
looked good in Q2, ECB’s Edward Nowatny made a comment that bazooka power of
European Stabilization Mechanism should be justifiably bolstered.
Such comments appeared to light a candle in
darkness. ECB hadn’t yet announced their easing measures and Federal Reserve
was “watching the economy closely”.
July
26 Activity Affirmed ECB’s Exploratory Comments and Renewed Equities, Euro and
Took Stress off U.S. Dollar
July 26 sent a pitch to equity markets in the strike
zone. Instead of rebuffing Edward Nowatny’s aggressive comments, ECB President
Mario Draghi added to comments. Draghi made his politically charged comment
that he would do whatever necessary to protect the Euro Zone. Consequently,
Spanish yields retreated from threatening levels. Also helping were U.S.
jobless claims coming in less than expected, durable goods beat expectations and
where Exxon Mobile disappointed; 3M, Akamai Technology and Whole Foods Markets
looked good.
July 26 saw Dow up an unimaginable 212 points,
especially given previous trends on closings. Euro gapped up to just under 1.2280 from an abysmal 1.2100 space, U.S dollar took a steep loss into an
82.00 area from a near 84.00 area.
Nature
of German and ECB Negotiations to Accomplish a Lasting Market Confidence Through August
ECB statements and some good earnings reports,
against reduced earnings expectations, lit a firecracker under the back-side of
equities. But more gunpowder was needed to push equities to recent year highs witnessed in September.
Despite this gunpowder that would come, currencies stayed within range and correlations.
After July 26, on July 27, S&P made another
grand advance, up a sharp 1.9% and Dow up 1.5% or 187 points to cross the
13,000 level, an obviously protected level today.
ECB remarks kicked of discussions among all European
contributors, especially with Germany, which funds much of European activity.
Terms of ECB and German negotiation became defined
by setting policy expectations in public spaces through exploratory comments.
Markets affirmed the comments. ECB thereby gained a lead in negotiations,
through placing market expectation “follow-through” on difficult countries that
are deservedly difficult, due to imbalances.
Result was a real discussion of where to go, and by
how much. Breaking a juggernaut.
Germany parlayed its stressed movement into limiting
ECB. Where ECB expressed open buying of
bonds, the two agreed on Outright Market Transactions (OMT)….of buying bonds of
countries to support debt pricing…..but only if and when a country asks for
help….and thereby sacrifices fiscal sovereignty. It wasn’t until September that
German/ECB negotiations resulted in a real policy.
Before German/ECB negotiations resulted in a
September announcement, markets went into August with optimism, enhanced by Fed
minutes.
Fiscal players in U.S. currently aren’t displaying
similar alacrity in discussions as demonstrated by tough German and ECB
negotiations.
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