Hi Grkfx just a quick question about the Nikkei if you don’t mind…. I know you are bearish on it and I fully understand your reasons by reading the weekly habits. My question is regarding how you think the end of QE in the US would affect the Nikkei. Generally speaking, the S&P and the Nikkei have some positive correlation if you both see them as risk assets. Now if one assumes that QE does have a positive impact on risk assets, the end of QE in the US is a negative for the S&P but is it a negative for the Nikkei? In terms of correlation I would say yes a falling S&P could drag down the Nikkei. But since the BoJ is doing some wild QE and would be the only (assuming the ECB doesn’t) central bank left doing it, I wonder if we could see the Nikkei and the S&P decouple, I mean the Nikkei rising even as the S&P rises little or even falls as investors are left with one obvious choice? Of course I understand that stocks do not rise of fall only based on QE….
I am bearish on the Nikkei and bullish on the JPY, but this week that theme didn’t play out. My scenario was that Bank of Japan would only consider more QE maybe in the Fall of this year, due to some Kuroda comments a few months ago. I thought and still do believe there is a window of opportunity for disappointment. But those comments were a few months ago and the Nikkei seems to want to go higher as some players assume they may do extra QE faster in July or June.
The Fed winding down QE is not having much effect at all. The market was volatile last year around May, etc where equities fell and bonds fell. But the market has gotten used to the Fed unwinding QE, and believes that rates will stay low “well past.” The market eventually got the Fed’s message, even though there was some initial volatility last year.
QE’s effect is the psychological effect, and also from the bond yields. But the Fed has been tapering, and bonds have still gone up, so the impact of Fed QE is more muted. The market doesn’t care that much about it, and is focusing on other macro forces.
Ending QE by the Fed would be equities bearish, if bonds were dropping, thus causing interest rates to spike higher and if the market believed that the economy could not handle the higher rates (there have been years in time where the equity market can continue to rally despite interest rates going up). But bonds haven’t dropped since the beginning of the year, so the market doesn’t care that much about the tapering now, unless the Fed were to start tapering by 20bln per meeting, instead of 10bln.
The Nikkei did partially decouple with the S&P since the February 5, 2014 or so market retracement low. Nikkei is about flat, while S&P is still up +7% since that time. So long U.S. equities were the better trade so far, rather than long Japanese equities. That is what made me stay bullish on U.S., and bearish on Japan, though if the Nikkei drops due to disappointment in BoJ, that could potentially drag down the S&P as well.
Yes, BoJ QE is wild as you said. As a proportion of the economy, it is already double what the Fed is doing. BoJ is doing around 70 billion per month in a 6 trillion size economy, while Fed maxed out at 85bln in a 16 trillion economy. So that is definitely wild QE buying up 70% of the government debt every month.
The Nikkei is highly sensitive to what the JPY does because the market believes that a good portion of the rise in the Nikkei is due to the QE and JPY depreciation solely and not due to structural and fundamental improvement in the economy. In Japan they were suffering from lack of structural reforms and a stagnant population. Those are not things you can just solve in 6 months or a year. But the massive QE can certainly mask the structural problem, cause a rise in equities, and keep bond yields low, creating a wealth effect and trying to give the economy a kickstart while trying to get the structural reforms done. In the U.S., QE did fuel a large portion of the rally, but there was also fundamental improvement as the deleveraging process finished and the unemployment rate dropped and the market can rally a bit even as tapering happens.
I don’t have a clear cut answer to your question becomes the sensitivity shifts on a weekly basis or daily basis.
What I can say is the potential forces and scenarios that the market can be sensitive to:
1. If BoJ will do more QE
2. If they will, then what is the timing?
3. How much extra QE can they do, and in what form will it take? (in other words is it a measly mount, or is it a good sized increased according to market expectations)
4. Is China slowing down or not and is that going to affect Japanese economy? Is the sales tax hike in April going to seriously slow the Japanese economy?
5. How successful will the third arrow of Abenomics – the structural reforms be in helping to raise inflation and growth?
The other wild card is the ECB. If they do QE, it can potentially cause another big wave of equities around the world moving higher.
Follow Up Question:
Ok thanks for your long answer Grkfx, my reasoning was that as Japan is left out being the only nation doing QE (as long as the ECB doesn’t) that could kind of “force” investors around the world to look at the Nikkei for opportunities… But I guess they may simply borrow Yen to invest it in other markets around the world like they’ve done before if they judge Japan’s fundamentals as too poor…
So if the ECB announces some QE all of the Euro cross would get hit pretty badly just like the Yen cross were last year but what would happen to U/Y? Up on risk appetite but down on E/Y selling as well as Yen buying since it no longer is the absolute funding currency? Wow next week might be full of opportunities…
I see you write this line in your habits: Overall, this is the year where stock pickers shine as individual stocks will have better reward/risk characteristics than a plain, vanilla long S&P position.
Do you mind at some point sharing how you analyse individual stocks? I ask because the task seems overwhelming to me as with stocks there seems to be so much to analyse for each individual stocks. For example I have a friend found of Tesla, its the only stock he follows but that one alone uses up all of his free time, he knows everything that is to be known about it…
I think that the market Japanese equities are already priced for the current Japan QE. They are looking to what could happen in the future to cause it to rise or fall. I do not think that if Japan was the only country doing QE, it would benefit Japanese equities. The reason being that the reason they did QE in the first place was the give the economy a kickstart to give some time and higher chance for structural reforms to pass and be implemented. QE isn’t a long term strategy. After QE, the market starts to look for how strong the economy is growing, what corporate earnings are, etc, the “fundamentals of the economy.” Yes, yields can stay low in Japan, but if most of the money is already long Japan expecting the current pace of QE, the current low yields, the current JPY depreciation, then the macro market participants will eventually want to see other reasons to go further long Japan. Other reasons could include more JPY depreciation, more BoJ QE, Japan pension fund buying more equities, third arrow of Abenomics a stunning success, etc.
Yes, there is the other potential scenario where the risk appetite and search for higher yields caused people to sell the JPY, beyond the JPY specific catalysts or improvement in U.S. economy / U.K., economy, etc.
It depends how much QE the ECB does and how it is structured. For now it seems that is just speculation as no decision is imminent.
If someone wants to short EUR, then it is best pared with the anticipation for which currency will be the strongest. No sense trying to short EUR/JPY if the BoJ will do more QE, and ECB cuts rates, as that would be conflicting scenarios and macro forces. I try to avoid whipsaws when I can. Maybe perhaps short EUR/NZD or EUR/GBP or EUR/USD may be better.
Last year was an easy year for many playing the stock market. If they just had a straight long S&P index position, they made around 30% or so, with moderate to low volatility along the way. This year it is a bit difficult as the S&P isn’t up so much, and there is more potential for stock picking to generate higher returns. There were both a lot of opportunities to the long and short side of the equity market for the first three months of the year. I would expect this large opportunity set to continue as company and sector specific fundamentals show up in the volatility. In other words, there have been and will continue to be easier volatility in select individual equities rather than a plain long S&P position. If you are going to take on equity risk, you should be rewarded with potential profits. If you are long S&P, then I am not sure how much it can go up. But if you are long the right equities, the company and sector specific scenarios can shine and cause volatility in your favor. That is my mindset.
I just finished an intensive over three months of analyzing equities and drastically increasing the size of the long/short equity trading book. Developed scenario sheets for around 100 different stocks, sorted the stocks by different sectors and analyzed hundreds of charts per day for potential opportunities, then drilling down to the company specific scenarios and what the market sensitivity was. I learned a lot, and even made a few % return on my equity trading, but I think I piled on a bit too much pressure for myself. It is a hell of a lot easier just analyzing currencies and the futures and commodities markets. I think I missed some opportunities in currencies and futures because the equity trading was consuming so much of my time and energy. So I have begun liquidating my equity positions over the past two weeks or so. I have drastically reduced the size of my long/short equity positions, from say 30, down to less than 10. I may just hold a few core stocks long that I think can go up over the course of the year where I do not have to watch them ten times a day, then focus the rest of my time on currencies and futures trading. I think that is the best mix for my style of trading. I learned that just because my expectations analysis, information flow, scenario philosophy, market sensitivity strategies, etc all works for equities just as well as other markets, that doesn’t necessarily mean I should stretch myself too thin to try to do it all.
As for some insights on how to analyze equities, I will quickly share what I can in this email:
- You can do virtually the same exact news, information flow, market sensitivity analysis, etc that you do for currencies on individual stocks as well with just minor adjustments to take into account that equities do not trade 24 hours a day. (important to remember)
- I would create a list of 20 – 60 “Active stock” list. There are thousands of equities, but in most situations, if you are a tactical trader / swing trader, you only should be focused on the leading, active stocks of the moment. This can dwindle the list down to between say 20 – 60 stocks. You also have to make a decision on if you will do intraday trading on stocks or go for swing trades / longer term trades. There are certain stocks that are great for day trades that also have an active option market. If you like to intraday trade, then your active stock list would consist of stocks that typically have a fair amount of option volume, and certain intraday volatility characteristics. If you prefer swing trades, then some of the stocks that are good for day trading are also good for swing trading. In other cases, there are stocks that are great for swing trading, but do not have an active option market, but you do not care. So it would depend on your needs. And you would make minor adjustments to this list every week or so, reviewing the key news of the week, which stocks were sensitive to which news, etc. You could add some stocks to the list or remove some stocks. There are stock scanners out there that scan the thousands of stocks to find the criteria you are looking for whether technical or fundamental. Finviz.com is one such website. What are some stocks that are on my active list? Stocks such as FB, TWTR, AAPL, NFLX, TSLA, BAC,MSFT, YHOO, AMZN, GOOG, P, GM.
- For the active stocks that you trade, develop scenario sheets – Bullish and bearish forces. You do not have to know every tiny little detail about a company, and you most certainly do not have to spend 8 hours on a single stock all day long, unless you only trade that stock for a living and that is what you have chosen to do. When a trader makes the decision to trade multiple instruments, they do not have to know every tiny detail. They just need to know the 1-5 key scenarios that could move the price up and the 1-5 key scenarios that could move the price down. In some cases, if you learn the 5 scenarios that move the stock up, you just reverse them to get the 5 scenarios that would move the stock up. Ex – If PC sales rising would cause a stock price to go up as one scenario, then you just reverse it and say if PC sales decline, the stock would go down. So focus on the active stocks of the moment, as well as the key scenarios that would move the stock up or down.
- You can use market sensitivity to compare how the stock is reacting to: Movements in the general market (S&P, Nasdaq, etc), movements in the industry / sector, movements in sister stocks, and how the stock is responding to its own company specific information. As a simple example, I was long FB stock from around $55 level, primarily due to how the stock was reacting when FB issued more shares in a secondary offering. I saw how the price didn’t go down much when they issued new shares, and I was bullish on the outlook for mobile growth, instagram, etc, so that bullish market sensitivity led me to go long. I sold out around $68 or so, primarily because I felt the stock was rolling over, but also because there was one day when the broad market staged a big intraday rally, but FB didn’t go up or went down. So that was a potential bearish sensitivity signal that I should get out and I did.
- When comparing industry groups and stocks, ask good questions. Such as: Why is this industry in favor now, and another industry is out of favor? Why is this stock in this industry making new highs, while another stock in the same industry just broke support? Why and How are important questions to ask some of the time. Why did one stock in an industry group drop 3x more than another stock today? Etc. Why is one stock breaking out to fresh four month highs, while another stock is breaking out to fresh four month lows on the same day?
In sum total, you have a great arsenal of tools in the Mastery Course – with the philosophy of information flow, expectations, scenario sheets, market sensitivity, etc.
If you require further knowledge and would like to do further reading, there are some potential good books on the subject such as:
How To Trade in Stocks
Jesse Livermore’s Methods of Trading in Stocks
How to Make Money in Stocks
Trade Like A Stock Market Wizard
Stock Market Wizards
How I made $2 million in the Stock market