What Asia-Pacific Currencies Tell Us about Stocks

What Asia-Pacific Currencies Tell Us about Stocks

Dear Slingshot Trader Subscribers, 

If investors around the world were to be compared to dinner guests, an attentive host would tell you, they are simply full up. They no longer have an appetite for risk, and no, they don’t even have room for a little after-dinner kiwi plate, thank you very much. Over the past week, the U.S. Dollar has strengthened against all major currencies except the Yen. Even high yielding champs like the New Zealand Dollar (also known as the “Kiwi”) and the Australian dollar (A.K.A. the “Aussie”) have weakened significantly since the decline started to pick up steam in May. The divergence is a strong indication that, globally, investors are seeking safety over risk.

Perhaps the most conclusive evidence can be found in the performance of the Aussie-Yen pair, one of the most popular carry trades in the financial markets. A carry trade is constructed by buying a high yielding asset and simultaneously shorting a low yielding asset. Depending on market conditions, this can be a very productive strategy, but when traders get nervous about risk, they tend to exit quickly.

Since the Australian Dollar pays the most interest (3.75%) and the Yen the least (0.1%), this currency pair represents the simplest way for banks and institutions to earn overnight interest income in the form of a carry trade. This pair makes an excellent gauge for institutional investor attitudes towards risk. Even better, the pair is highly correlated with the U.S. Stock market.

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Aussie-Yen (AUD/JPY) carry trade vs. S&P 500 Stock Index – Chart Courtesy of freestockcharts.com
 

The higher the price of this pair, the more institutions vote to expose their money to risk in return for the opportunity of earning interest. Lately both this pair and domestic markets have watched holdings recede from risk assets into cash, that is to say, U.S. Dollars. But notice how this week’s action features the AUD/JPY hitting a new low, and the SPX trying to cling to a feeble bounce. When these charts diverge, it is usually bearish for both. They experienced an even larger bearish divergence last March and April, and look how that turned out.

One could speculate that there is serious credit risk as a result of these signals, but it is more likely to be outdone by worries regarding Greece and rising yields in Spain. If these worries fade (a big “if”), risk-averse investors could change their minds and reverse the market’s course; however, that is not likely to happen quickly. We would expect to see improving market conditions show up in the AUD/JPY carry trade as well. So far, that is not the case, but it’s a good risk-barometer to watch.

Headwinds from Abroad, Headaches at Home

What this means is that we expect more downside or flat channel-bound trading. Even if stock market investors could show signs of demand, it would be met with resistance. The headwinds of international risk aversion are further compounded by internal weakness in the domestic markets, which is spurred on by headlines courtesy of JP Morgan’s trading division.

The notably weak financial sector isn’t helping buy prices any either. Perhaps because even though Goldman Sachs and Bank of America (erstwhile Merrill Lynch traders) are rumored to be on the receiving end of JPM’s losses, no one is actually expecting them to show outstanding profits any time soon.

Traders observing these conditions may not think there is much opportunity for bullish trades. While it is true that such opportunities might be difficult to find, it might be equally difficult to capitalize on bearish trades—at least for the upcoming week. We think the markets may be nearing a condition of being oversold, and that they could continue to trend flat with a little short-term support. It might be prudent to take profits if unusually strong moves occur in our favor.

For example, the head-and-shoulders pattern we described two weeks ago has completed its move to the price target we had specified for it. It is not surprising that the market mounted a one-day rally coming off of the 1,300 level.

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S&P 500 head-and-shoulders pattern – Chart Courtesy of freestockcharts.com
 

The ongoing question will be whether or not this level will hold, even if the debt and currency markets continue to roil and move towards safer havens. During these next few days, the better opportunities are likely to be in the weakest sectors, as we trade them in a way to take advantage of falling prices.

Quick-Strike Mentality Useful This Week

The market continues to look weak, and while it is probably going to remain so within our trading time frames, we need to be on guard for sudden reversals. News items this week may not be unusual such as Thursday’s unemployment claims report, or the revised University of Michigan Consumer Sentiment, which is expected to report the same numbers given last month.

But if the market reacts to the reports with unusually large moves, it will be a signal of continuing and growing fear in the markets. On the other hand, tepid reactions may foreshadow a market that finds support and quietly moves higher. Therefore, taking apparent profits from bearish trades, when they occur, will likely be a prudent strategy going into a three-day holiday weekend for the United States and much of Europe.

Here are some of the news events that we may trade in the next week or so. We’ll be discussing some of these in tonight’s webinar.

May 23 – Pandora (P) Quarterly earnings report – After Market Close

May 24– H.J. Heinz (HNZ) Quarterly earnings report – Before Market Open

May 24– Tiffany (TIF) Quarterly earnings report – Before Market Open

May 24 – BOJ Monthly Report

May 24 – U.S. Unemployment Claims

May 24 – Costco (COST) earnings – early during market open

May 25 – Revised UoM Consumer Sentiment / Inflation expectations

May 28 – U.S. Bank Holiday (Memorial Day)

TRADE REVIEW

When it’s time to open or close a trade, we’ll send you alerts via e-mail. You also can sign up to receive text messages regarding our trades. For more info about our SlingShot Trader portfolio, you can read trade alerts here and view our portfolios here.

Open Positions

These are the SlingShot Trader positions we opened during the past two weeks of trading that we have not yet closed.

Pandora (P) – On May 18 we recommended you to “buy to open” the June 10 puts for $1.40 or less. We still like this trade and recommend entries at our maximum price or less.

H.J. Heinz Company (HNZ) – On May 21 we recommended you to “buy to open” the June 55 puts for $1.65 or less. We still like this trade and recommend entries at our maximum price or less.

Tiffany & Co. (TIF) – On May 22 we recommended you to “buy to open” the June 65 calls for $1.45 or less. We still like this trade and recommend entries at our maximum price or less.

Positions Closed

These are the SlingShot Trader positions we closed during the past two weeks of trading.

Chico’s FAS Inc. (CHS) – On May 16 we recommended you to “sell to close” the June 14 puts. We closed the position for $0.26 for a loss of -61%.

Youku (YOKU) – On May 18 we recommended you to “sell to close” the June 22 puts for $2.51 per share for a gain of 38%.

Foot Locker, Inc. (FL) – On May 18 we recommended you to “sell to close” the June 28 Puts for $0.63 per share for a loss of -61%.

Best Buy (BBY) – On May 18 we recommended you to “sell to close” the June 18 puts for $1.31 per share for a gain of 38%.

Webinar Preview: Join Us Tonight at 6 p.m. ET

Every Wednesday at 6 p.m. ET, we host our live webinar, in which we’ll review this weekly newsletter, discuss coming events in more detail and walk through our Top Trades. We also encourage you to submit your questions live during the session. We want to do everything we can to help you become a successful options trader, which is why you’ll have live access to us for an hour every week.

And if you have any questions or comments you would like to send us in advance of the live session — or anytime during the week — you can write to us at johnandwade@slingshot-trader.com

If you can’t attend the session live, you can watch the archived version on our website in the “Live Weekly” section. It’ll typically be posted within about two hours of the end of the live session.

Sincerely,

 

John Jagerson and Wade Hansen
Editors
SlingShot Trader