‘Santa Claus’ gatherings, holiday trips to the market and trying to figure out how you’re going to fit everyone’s cars in your driveway this weekend are just a few of the concerns traders have face with the approach of Christmas. .
Still on the side of caution, however, we note that some new risks could present unexpected profit opportunities.
Starting across the ocean in Japan, the trickle-down effect of some recent activity has some interesting effects on stocks.
Here’s what we mean…
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What’s going on abroad
It might get a little confusing for a while, but bear with us.
The Bank of Japan (BOJ) made a major move on Tuesday by raising the cap on the yield on Japanese 10-year government bonds from 0.25% to 0.50%. (This is different from what the Fed does by raising the target for the overnight rate, but the effect is similar. Raising bond yields raises the cost of capital.)
The BOJ has decided to start normalizing monetary policy, but we don’t know what “normal” monetary policy is for the BOJ. Japan’s central bank has been the most aggressive in lowering rates and keeping them low among developed economies since the collapse of its own asset bubble in 1991.
To put that into perspective, the BOJ only raised rates twice since 1990 – in 2006 and 2007 just before the global financial crisis. Talk about bad timing…
To be fair, it would have to be said that the “normal” monetary policy of the BOJ is to stimulate with low rates. So, this week’s move came as a huge surprise and caught economists and traders off guard. As you can see in the following chart, the USD lost 4% against the Yen on Tuesday.
So what does this have to do with stocks?
As you know, when the Fed raises rates, the cost of borrowing goes up.
This is one of the reasons the homebuilding market in the United States is doing so badly. This is also true for the yen. Rising rates mean that yen loans are more expensive, especially if they were used for short-term financing.
Over the past few years, investors around the world have borrowed yen at very low rates in order to buy higher-yielding assets like US stocks. When the yen is cheaper, borrowing is even easier, and that benefits those other assets. In other words, a strong yen is bad for US stocks.
The correlation between a stronger yen and falling stock prices isn’t perfect, so don’t panic about this week’s surprise just yet.
However, the two assets are getting close enough that this is a trend we should watch closely. For example, the yen has been rising since the BOJ began supporting it on Oct. 21 and stocks have been unable to break trendline resistance over the same period – the S&P 500 has failed again after two attempts to break resistance over the past two weeks.
A Santa Claus Rally?
Has a rising yen and a hawkish Fed eliminated the possibility of a “Santa Claus” rally? We’ve had a lot of questions about that this week, and the answer is that Santa’s gathering isn’t a real thing; it’s just something that financial journalists talk about because it’s fun and attracts readers.
The Santa Claus rally is loosely defined as a probability that stock prices will rise the week before and/or the week after Christmas. However, a historical analysis of these weeks shows that the market is as likely to rise as any other two-week period during the year.
We think the real question traders should be asking is whether the market will find support before the end of the year (support, as you remembermeans a stable level below which a given security does not fall).
From a technical standpoint, we think the chances of a break at support are high. As you can see in the following chart, the S&P 500 broke short-term support near 3,900 last week following the Fed’s rate decision. However, the 3,800 range is still intact and we expect this level to hold in the near term.
In our view, the worst-case scenario is a return to previous lows near 3,600 on the S&P 500. Positive surprises from FedEx Corp. (FDX) and Nike Inc. (NKE) this week confirmed that consumer and business spending is still relatively strong. While we don’t think the market will make new highs, these reports increase the odds that support will hold, and we won’t see price at or below 3,600 for some time.
The week before Christmas and the week between Christmas and New Year are usually very quiet.
Volume tends to be the lowest of the year, and unless there’s a bigger surprise in store, we plan to look for opportunities to add some risk to the portfolio (and more revenue ) on declines to support.
As we saw with the latest jobs reports and Tuesday’s earnings report from NKE, consumption and hiring are still strong. It may take some time before a new uptrend emerges, but a bounce up to trendline resistance in early January seems likely.
John and Wade
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