Updated: Nov 8, 2018
Authors: Phoenix Li Macro/FX/Multi-Asset Strategies Analyst, Justin Lam Equities Analyst, Chris Jin Co-VP Education/Research, Jason Sohal Co-VP Education/Research
Equities Market Update – Justin Lam
After a sharp drop on Monday, the equity markets recovered and ended the week higher. The markets are off to a much better start in November than the previous month. Optimism over trade was among the drivers of market gains. President Donald Trump suggested, on Fox News and later on Twitter, that progress was being made on a trade deal with China. The materials sector led the gains in the S&P 500, where all sectors but utilities posted increases. Consumer discretionary and financials were among the top performing sectors of the week, putting an end to a month-long streak of declines in cyclical sectors.
Corporate America on track for earnings records
Most companies on the S&P 500 have reported third quarter results, and corporate profits are on track to be at their highest since 2010. S&P 500 earnings are on pace to rise 26.3% for the third quarter of 2018. However, concerns are mounting as earnings growth is expected to experience a significant slowdown after its recent peak. The fourth quarter is estimated to see a 17.5% increase in earnings. Profits from a one-off tax cut are wearing off, inflationary pressure could accelerate the Fed’s rate hikes, and business costs are rising—all of which are reasons for investors remaining cautious of a long-term market outlook.
Tariffs and the market
Materials costs have started to cut down on corporate profitability, as companies are now realizing the impacts of U.S. tariffs. The significantly increased costs of materials represented on the graph present a major increase in variable production costs, which has contributed largely to the year-to-date decline of the S&P 500 industrials sector. The tariffs on steel are particularly impactful, as steel is a major input for the auto industry—a considerable part of the American economy.
Ford estimated a $1B cost to the company from tariffs, as it prepared to lay off workers amidst a restructuring plan to cut costs and remain competitive in the auto industry. IHS Markit estimates that the tariffs could add up to $5700 to the price tag of a new vehicle.
Meanwhile, Americans are accumulating debt quickly. The average American currently owes 26% of annual income to lenders, which is greater than the consumer debt levels during the mid-2000s when credit availability spiked up. The peak of consumer debt reduces the ability of companies to pass on increased costs to customers, a large reason for the significant year-to-date decline in auto companies such as Ford.
Short-Term Event-Driven FX Trading – Phoenix
This week’s FX research will be an introduction to short-term event-driven FX trading. Thank you to Cory Yan, who works closely with short-term currency traders for his contributions and insights.
The Nature of FX Trading
Technical traders are drawn to the FX market given the unpredictable nature of short-term currency movements. Short-term currency movements are largely affected by outcomes of political events, government announcements, and sometimes even Trump’s tweets. When an investor is looking at short-term currency trading, economic fundamentals are not always their primary concern. Instead they focus on speculating on major event outcomes and utilizing candle charts with sophisticated market sentiment indicators as their guide. With appropriate leverage, one can make good amount of money in just one day.
An Insight into the Italian Credit Crisis using Greece as a Case Study
A recent interesting example is the negative effect Italian debt has had on the Euro currency. Italy has a 2.3 trillion-Euro national debt that dwarfs even Greece. Although talks are ongoing, Italy has shown little interest in really solving the problem. In fact, most of the debt is owed by Italian institutions and individuals, meaning that a default would hit hardest on the consumer and business level of the economy. Unlike Greece, Italy is both too big to fail and too big to bail.
Given this situation let us consider the perspective of a short-term currency trader. To trade on the Italian debt crisis, it is a good idea to review the other credit crisis in the Eurozone - the Greece Debt Crisis of 2010 and what happened to the Euro from the perspective of a short-term trader. Below are charts of the EUR/USD throughout that period.
Timeline for Greek Debt:
2010 April/May: Fears of possible default
2011 July: EU agrees for a bailout of 109bn
2011 Oct: EU agree to 50% debt write off
2012 Feb: Protests against 130bn bailout in exchange of austerity
2012 May/June: Change in Greek political party against austerity
2013 Dec: Greece passed a 2014 budget that predicted 6 years of recession. First step toward getting out of bailout
2015 Aug: Third round of bailout at 86bn
A long-term investor makes money from the growth of the companies, while a short-term trader makes money from the movements of the markets. What happened of Euro’s short-term movements has more to do with market sentiment than actual fundamentals. In the beginning of the crisis, fear gripped the markets. As a result, all political and economic actions were considered negative to the Euro, where events happened at the beginning was causing larger reactions from the market. However, when investors “got used to” the uncertainty, the volatility that resulted from each piece of news became less extreme. At the end, as more uncertainty was already priced in, the market began to take every action as good news. Those charts only depict the Greece Debt Crisis. Please note that at the same time, the EU was also undergoing QE which impacted the Euro as well.
By looking back on the Greece Debt Crisis, I hope it gives you an idea on how short-term event-driven FX trading works. The ongoing drama in Italy is interesting to watch with many potential short-term trading opportunities. Also, from a multi-asset perspective, as general equity markets turn bearish (US equity currently has a mixed signal), instead of shorting stocks, which is very costly for retail investors and sophisticated research needed, a good alternative is to play “zero-sum” games. (In a bear market, the overall expected return of the market is negative, while the expected return for any zero-sum game is zero.) As the most intuitive “zero-sum” game, FX trading is definitely a good place for a young trader to hone its trading instinct and hopefully, make some money.
The above information does not constitute the provision of investment, legal or tax advice. Any views expressed reflect the current views of the authors, which do not necessarily correspond to the opinions of University of Waterloo Finance Association (“UWFA”). Opinions expressed may change without notice. Opinions expressed may differ from views set out in other documents, including research, published by UWFA. The above information is provided for informational purposes only and without any obligation, whether contractual or otherwise. No warranty or representation is made as to the correctness, completeness and accuracy of the information given or the assessments made.