If we stack up the S&P500 against the Bonds/Bunds difference, it is difficult to see a clear relationship.
However, the relationship between the S&P500 and the Euro/US$ difference is striking.
In other words, if you can correctly anticipate the next currency move, your equities trading will do well.
The exchange rate move of the past two days was very swift, indicating that more than a few bank notes exchanged hands. How will the Fed will ever be able to increase US rates without pushing the US$ even higher and risking great damage to US corporate profits?
Gold, oil and copper are moving opposite to the US$.
What can we expect in the next two months? October is already +8%. Does this mean that November and December will also be good? Should we already factor in a December effect and buy any dip?
As a reminder, the December effect says that in general, December is a good month, but it is even better when the market has been positive for the year leading up to December.
This pattern has been even stronger since 2000 (computer trading, with start of decimalization.)
Fund managers get 20% of the profits of their funds but bear 0% of losses. This means that by the end of November, if a fund manager sees that he cannot hope to make a profit for the year, he will start dumping whatever looks bad and will focus on the following year. However, if the fund is already at least break even by the end of November, then the manager will take on more risks in order to increase his 20% cut.
The above figure shows that we would need to be close to breakeven by the end of November. The market is now up 1.6% since the start of the year. I believe the market cannot afford to lose more than 2% in November, otherwise December could be difficult.
A new question then becomes, what would be November as a function of the total returns for the previous 10 months?
If we look at the 1952-2014 period (without the two obvious crashes of 1987 and 2008,) we see a rather strange pattern:
- When profits up to October have been very negative (<-7%), November experiences a reversal to the mean
- When profits up to October have been very positive(>7%), November experiences a buying continuation (December is near)
- When profits are between -7% and +7% (yellow), then the returns for November are indecisive.
Today, we are clearly in this yellow zone.
However, if we look only at the data for that yellow zone, we can see that there is a positive correlation between the annual profits at the end of October and the November profits.
I now have two questions:
1. Can we extrapolate using data that is as old as 1952? Even if fund managers' attitude might be similar, today's markets are only liquidity driven.
2. October was supposed to be the worst month of the year. What happens to November when October gains 8%?
Below is another figure, which shows the evolution of the 6-year and the 10-year correlation between the October and the November profits. Note that the 2014 six-year correlation measures the QE driven market.
It is rather surprising to see the correlation moving from extremely positive in 2007 down to extremely negative in 2014 (Both 1987 and 2008 have been taken out of the data.)
The most recent six years are shown below.
Conclusions:
Since 2009, markets have never lost more than 1% in November. Since the markets are already up 1.6% this year, this indicates that fund managers will run this higher in December.
Hence: buy weakness!!
Weakness will come in the form of a Fed head talking about the possibility of a rate increase.
Strength will come when the US debt ceiling will be raised again.
My biggest fear for the coming months is related to the way the US shows how it uses the US$ hegemony to print its way into financing its military presence.
Russia's move in Syria to help Assad is weakening the US position and this could give ideas to North Korea. North Korea could take advantage of a surging confrontational issue between the US and China in order to get Chinese support to any strange idea that North Korea's dictatorship might have.
What would this imply for US equities?
Maybe at that time, trading equities will not be high in our list of priorities.
This is, however, projecting too far into the future.
The real earth shaking event will be AAPL's earnings on Tuesday.
I will be curious to see what AAPL's guidance for China will be.
