Euro Optimism (And not just Dollar Pessimism)

According to a recent Merril Lynch (Bank of America) survey, Europe has officially returned to favor among investors. “A net 30% of global portfolio managers see euro-zone equities as undervalued relative to other regions, the highest reading since April 2001. A net 11% are overweight Europe, the first overweight allocation in nearly two years, said Baker.”

The numbers, meanwhile, reflect this perception. Over the last month, investors have poured a net (inflows minus outflows) $2.1 Billion into EU capital markets, an impressive sum when you consider that the figures for Japan and the US were both negative. Meanwhile, stock markets in the region are up by 50%+ since bottoming last March. When you account for currency fluctuations (i.e. Euro appreciation), stock market comparisons between the US and EU start to look pretty lopsided.

According to a WSJ report, there’s no mystery behind the European stock market rally: “Even though prices have risen sharply since March, valuations aren’t stretched. Average price-to-earnings ratios in Europe, on a trailing 12-month basis, are about 16, up from seven back in March, according to Citigroup…On a price-to-book ratio, stocks are trading about 15% below their long-term average, and dividend yields compared to government bond yields are historically still very attractive.”

At this point, you’re probably wondering, “Why the long preamble on European stocks?” Because, it’s easy to forget that there are inherently two sides to every currency pair. In the case of the USD/EUR (the most frequently traded pair in the world), most of the recent commentary has focused exclusively on Dollar-negatives, portraying the dynamic as a depreciation in the Dollar. In this context, it’s easy to forget that the Dollar’s depreciation implies an appreciation in the Euro. Duh?! But seriously, for every Dollar bear, it seems there is at least one Euro bull.

To be fair, those who don’t see much to be excited about in the Euro can be forgiven. After all, the European economy is technically still mired in recession, and isn’t projected to return to growth until 2011. While some of the intangible indicators are improving, others continue to stagnate. “Industrial output in the euro zone is 20% lower than its February 2008 peak, despite some recent improvements.” In addition, the appreciation in the Euro threatens to choke off exports and stifle the recovery before it has a chance to get off the ground.

Speaking of which, the European Central Bank (ECB) will probably hold of on raising rates because of the strong currency. A more valuable Euro keeps inflation in check (via cheap imports). Besides, higher interest rates would attract carry traders hungry for yield, and would make it even more difficult to keep the Euro in check. Many EU monetary officials (including ECB President Jean-Claude Trichet) have already made their concerns about the Euro’s appreciation clear. If they are able to succed in halting its rise, that could make investing in Europe a lot less exciting…

Central Banks Prop Up Dollar

By all accounts, the decline of the US Dollar has been measured, and without incident. This, despite the fact that most investors reckon the Dollar is doomed, both from a long-term and a short-term perspective. What, then, is preventing an all-out collapse?

Personally, I think the best answer is that Central Banks (and their sponsoring governments) don’t want the Dollar to collapse. In other words, a schism is forming between private investors and public government, whereby investors (on a net basis) are rooting against the Dollar, while Central Banks are rooting for it. That’s not to say that there is a global conspiracy involving Central Banks, designed to prop up the Dollar. Rather, it is that Central Banks are simply trying to protect their short-term financial interests, and long-term economic interests. By this, I mean simply that foreign Central Banks have everything to gain from a strong Dollar, and seemingly everything to lose from its collapse.

From an economic standpoint, foreign Central Banks also benefit from a strong Dollar, especially those whose economies are powered by exports. “A stronger local currency relative to the dollar attracts foreign investment and tempers domestic price pressures by keeping import prices in check, but also cuts into the competitiveness of the country’s export sector.” Given that inflation is currently a moot issue whereas economic growth remains tenuous, Central Banks have made it clear that they currently favor weak currencies. “If (their currencies have) too much strength and the U.S. recovery falters, it’s bad for emerging market growth,” and could even lead to a so-called “double-dip recession.”

In order to alleviate this possibility, many Central Banks have intervened directly in forex markets and depressed their currencies through the purchase of Dollars. During only one trading session earlier this month, “Asian central banks said to be intervening in currency markets overnight by buying dollars included South Korea, Hong Kong, Taiwan, Thailand, the Philippines and possibly, Indonesia, according to analysts.”

Meanwhile, Central Banks in industrialized countries are using increasingly strong rhetoric to try to talk down their currencies. The Banks of Canada and England have achieved modest success in the last few weeks in convincing investors that overvalued currencies would be met with decisive action. The Royal Bank of Switzerland has intervened several times, while the European Central Bank has expressed concerns about “volatility” (code for the rapid appreciation in the Euro) in forex markets. It’s still not clear where the Bank of Japan stands. The newly appointed Finance Minister has already flip-flopped several times, settling finally on a course of action that would prevent the Yen from rising too high and threatening the nascent recovery.

Consider also foreign Central Banks’ collective holdings of US Treasury securities, which increased by nearly $800 Billion over the last year, a large portion of which was accounted for by the Banks of China and Japan. According to the most recent Federal Reserve data, they are collectively adding to their stockpile at a pace of $10 Billion per week. As the WSJ explains, “The inflows highlight the challenges facing nations with large dollar holdings, particularly developing countries. A weaker dollar is, in theory, bad for their investments as it eats into returns when translated back into local currencies.”

In other words, continued foreign Central Bank investment in US Treasury securities is perhaps rooted less in investment strategy, then in the simple desire to prevent their current holdings from depreciating. At the same time, those banks that intervene directly in forex markets often have little choice other than to hold their forex reserves in US Treasuries.

You can see from this that the idea of an alternative reserve currency would actually run counter to the interests of many of these Central Banks. With the exception of a few (i.e. Iran, and to a lesser extent, China) that would like to see the Dollar fail for political reasons, the vast majority of banks have a vested interest in the Dollar remaining where it is. Otherwise, they would witness the value of their Dollar-denominated assets collapse, as well as a collapse in exports to the US.

It looks like, then, there will be a showdown at some point between the Central Banks and investors. If you accept the notion of efficient markets, then it should be obvious who will win in the long-term. On the other hand, you can’t underestimate the determination of some of these banks.

How will Foreign Investment Tax Affect the Real?

On October 20, the executive office of the government of Brazil enacted an emergency measure, calling for a 2% tax on on all foreign capital inflows. And with one foul swoop, this year’s 35% rise in the Real had come to an end, right?

The tax certainly took investors by surprise, with the Brazilian stock market falling by 3% and the Real falling by 2%, the largest margins for both in several months. The tax is comprehensive and applies to essentially to all foreign capital deployed in Brazilian capital markets, whether fixed income, equities, or currencies. While the tax doesn’t apply to those currently invested in Brazil, the possibility that it would cause potential investors to stay away was enough to cause a sell-off.

The ostensible reason for the tax levy is to prevent a further rise in the Real. By most measures, the currency’s rise has been excessive, more than erasing the losses incurred during the credit crisis. The concern is that a more expensive currency will derail the Brazilian economic recovery before it has a chance to firmly get off the ground. “Brazil’s currency needs to weaken as much as 19 percent for sustainable economic growth, said Nelson Barbosa, the Brazilian Finance Ministry’s top policy adviser.”

According to cynics, however, the tax is a backhanded effort to raise revenue to fund a growing budget deficit. The government continues to spend money (perhaps to offset the negative impact on exports brought on by the Real’s rise) as part of its stimulus plan, but is increasingly tapping the bond markets to do so. The tax is expected to bring in an impressive $2.3 Billion over the next year, which could go part of the way towards fixing the government’s fiscal problems.

The real question, of course, is how the Real will fare going forward. The initial reaction, as I said, was ‘The Party’s over…‘ But investors with a longer-term horizon aren’t fretting. “In the medium term, the measure will have a limited impact. The fundamentals point to a stronger real, with commodities rising and the dollar weakening globally,” asserted one economist. While investors aren’t happy about paying an arbitrary 2% fee to the government, such pales in comparison to the 10%+ returns that investors still aim to reap from investing in Brazil over the long-term.

Ignoring the possible bubbles forming in Brazilian capital markets (admittedly, a dubious suggestion), Brazil still looks like a good bet, especially on a comparative basis. Interest rate futures point to a benchmark interest rate of 10.3% at this time next year, compared to ~1% in the US. Even after accounting for inflation and the 2% tax levy, the yield spread between Brazil and the US remains impressive. For that reason, the Real has already stalled in its expected fall against the US Dollar, standing only 1.7% below where it was on the day the tax was declared.

It’s unclear how determined the Brazilian government is towards pushing down the Real. The comments by its finance minister suggest that the consensus is that it is not slightly – but extremely overvalued. Thus, it’s likely that the government will enact other aggressive measures to prevent it at least from rising further. It continues to buy Dollars on the spot market, and is trying to make it easier for Brazilians to take money out of Brazil. It is not yet ready to tamper with its floating currency, but by its own admission, the “government was studying additional measures to regulate the heavy inflow of foreign investments and its impact on the country’s currency.”

There are also implications for other (emerging market) currencies. As I wrote earlier this week (”Central Banks Prop Up Dollar“) a number of Central Banks have already intervened or are currently mulling intervention in forex markets, to push down their currencies. You can be sure that other governments will be studying the situation in Brazil closely, with the possibility of implementing such policies themselves.

Forex Implications of China-US Economic Codependency

The Economist recently published a special report on China and America (”Round and round it goes“). As the title suggests, the article described the increasing interdependency between the economies of the US and China. In a nutshell, China maintains an undervalued currency, in order to stimulate exports. The resulting overseas (American) demand puts upward pressure on the RMB, which China defuses by buying US Treasury securities. This results in artificially low US interest rates, causing American consumers to import more, putting even more pressure on the RMB, which is further defused by buying more US Treasuries. And the cycle continues ad nauseum.

The article focused primarily on the political side of this precarious relationship, at the expense of the financial implications. It got me thinking about the forex forces at work, and how a disruption in the cycle could have tremendous ramifications for currency markets. It’s clear that in its current form, this system keeps the Yuan artificially low, but does that means that the Dollar is also being kept artificially high.

Given the depreciation of the Dollar over the last six months, this seems almost hard to believe. Over the same time period, though, China (as well as many other Central Banks) have vastly increased their Treasury holdings. This would seem to imply that indeed, the Dollar’s fall has been slowed to some extent by the actions of China. It’s kind of a paradox; as US consumers recover their appetite for Chinese goods, the Dollar should decline. But as China responds by plowing all of those Dollars back into the US, then the net effect is zero.

As the Economist article intimated, there are a couple of developments that would seem to upset this equilibrium. The first would be if the Central Bank of China began diversifying its forex reserves into other currencies. By definition, however, it would be impossible for China to continue pegging the RMB to the Dollar without simultaneously buying Dollars. Thus, the day that China stops recycling its export proceeds into the US, the RMB would start to appreciate, almost instantaneously. In addition, the sudden surcease in US Treasury bond purchases would cause interest rates to rise. Both higher rates and a more expensive currency would presumably result in lower demand for Chinese exports, and hence eliminate some of the need to recycle its trade surplus back into the US. In this way, we can see that China’s Treasury purchases are actually self-fulfilling. The sooner it stops purchasing them, the sooner it will no longer need to purchase them.

I’m tempted to elaborate further on this point, but it seems that I’ve already taken it to its logical conclusion. China must recognize the dilemma that it faces, which is why it refuses to break from the status quo. If it allows the Yuan to appreciate, it will naturally face a decline in exports AND the relative value of its US Treasury holdings will decline in RMB terms. Both would be painful in the short-run. However, by refusing to concede the un-sustainability of its forex/economic policy, China is merely forestalling the inevitable. With every passing day, the adjustment will only become more painful.

Emerging Markets Bubble Continues to Inflate, but for How Long?

Yesterday, emerging markets (proxied by the MSCI Emerging Markets Index) recorded their biggest fall since July, ending a week of solid gains. Still, this one-day slide of 1.4% pales in comparison to the nearly 100% gain that the index has achieved since bottoming last March. In other words, while investors might be starting to pull back, the direction of asset prices is still upward.

As for what’s causing this across-the-board appreciation, that was the subject of my previous post (Inverse Correlation between Dollar and Everything Else…Still), in which I merely stated the obvious; that the Fed’s year-long program of negative real interest rates and quantitative easing (i.e. wholesale money printing) has unleashed a flood of cash into global capital markets. Since we’re not just talking about the Dollar, here, it makes sense to point out that the Fed’s easy money policies have been copied by Central Banks in most other industrialized countries, including the UK, Canada, Switzerland, Sweden, and to a lesser extent, the EU.

As for why emerging market assets and currencies seem to be outpacing appreciation in other asset classes, that’s also not difficult to explain. First of all, by some measures, emerging market stocks have hardly outperformed other assets. Oil, for example, has risen by 131% in less than a year, to say nothing of other commodities. Still, by other measures, growth has been remarkable. Most emerging market stock indexes and currencies have fully erased (or come close to erasing) the losses recorded during the peak of the credit crisis. Bonds, meanwhile, have gone one step further. Yields are collapsing, and prices have exploded – by 25% in the last year, sending the JP Morgan Emerging Market Bond Index to a new record.

Is it safe to call this a bubble? Intuition would suggest so; given that all assets are rising across the board, without regard to particular fundamentals, it would seem that only a herd/bubble mentality could offer an explanation. Some analysts, in fact, have given up completely on fundamental analysis, instead using fund inflows (i.e. investor demand) to predict whether some emerging market assets will continue rising. As Nouriel Roubini (the NYU economist that famously predicted the credit crisis) summarizes: “Traders are borrowing at negative 20 per cent rates to invest on a highly leveraged basis on a mass of risky global assets that are rising in price due to excess liquidity and a massive carry trade.” P/E ratios are nearly twice as high in some emerging markets, compared to stocks in the S&P 500.

On the other side of the equation are the bulls and the efficient market theorists.”By historical price-to-earnings ratios — the ratio of stock prices to per-share profits —these levels can be justified, if the economic recovery continues. With massive layoffs, business costs have been cut sharply. “The hope is that when consumers and companies start spending, the added sales will drop quickly to the bottom line [profits].” Other proponents argue that the rise in asset prices is exactly what the Fed wants, since it implies that the markets are once again characterized by stability and liquidity.

Regardless of whether growth materializes, however, that doesn’t change the fact that the free ride can’t and won’t last forever. At some point, Central Banks will be forced to raise interest rates and start withdrawing Trillions of Dollars from global capital market. This will cause the Dollar to rise, and investors to rapidly unwind their carry trade positions. Warns Roubini, “A stampede will occur as closing long leveraged risky asset positions across all asset classes funded by dollar shorts triggers a co-ordinated collapse of all those risky assets – equities, commodities, emerging market asset classes and credit instruments.”

If the tech-bubble and real-estate bubble taught us anything, it is that there is no free lunch in the markets. It is not possible for all investors in all assets classes to simultaneously win. At least, in the long-term. In the short-term, meanwhile – it pains me to say this – let the party continue. My only warning is this: when the music stops, don’t be the one caught with your pants down…

Forex Training: What to Look for in a Forex Training Program

Should new Forex traders take Forex trading courses or join a Forex training program? Definitely yes; by now you have probably heard that only 5% of traders achieve consistent profitable results when trading the Forex market. The main reason for this is the lack of education. Don't get me wrong here, taking a Forex training program or a Forex trading course won't guarantee profitable results, nothing can, but choosing the right Forex training program or Forex trading course will definitely put the odds in your favor.

Before spending any amount of money on any Forex trading course or Forex training program there are some important aspects you need to take in consideration. There are many training programs available, but not every one of them suits the needs of every trader.

The first thing you should be looking in a Forex training program is the content of the material. Unfortunately, most courses or training programs focus or spend most of the time on basic concepts. Though these basic concepts are important, spending most of the course on them won't help the trader to make consistent results.

The following subjects are what I consider the most important aspects of trading and every training program or trading course should address:

Forex trading basics.

Review basic concepts such as: margin, type of orders, a little background, bid/ask, rollover, etc. You need to make sure you understand every single concept to perfection.

Main drawbacks of Forex traders.

Being aware of the common mistakes made by Forex traders and knowing how to handle them will prevent new traders from making those mistakes.

Technical and fundamental analysis.

These are the two main approaches adopted by Forex traders. Knowing how to properly apply each concept will definitely put the odds in your favor.

The three pillars of Forex trading. I consider that these three subjects have the most impact on every trader trading account.

Forex trading system development.

Having the right system is a must if you want to have consistent profitable results. Having a system that doesn't fit you will cause a series of problems that will make your trading account vanish away (second guessing the system, not following your system, etc.)

Money management.

This is considered by many successful traders to be the most important single aspect of trading. Money management helps to increase your profits geometrically and at the same time limit your losses (i.e. a good risk reward ratio of about 2:1 will make you money in a Forex trading system that is right only 38% of the time.)

Trading psychology.

Being aware and knowing hot to handle the psychological barriers that affect every trader decision will put the odds in your favor.

Other important aspects every training program should include are:

Developing habits for success (such as discipline patience, taking responsibility of every action, commitment, etc.,) understanding and taking our trading as a business, risk and trade management.

Another important aspect you should take into consideration when choosing a Forex training program is the mechanics of it, getting to know how the training program works.

A good course will have the following:

A live conference room, where you can apply everything learned under live market conditions.

One-on-one feedback, every trader has different needs and requires special attention. For instance a trader wanting to improve the system and requires individual feedback from the instructor about it.

Online trading course, a course that could be accessible through internet. A plus is a course where you are able to access the course at the convenient time for you, so you don't have to change your lifestyle.

A forum, where members can talk just about everything related to the Forex market and the Forex training program.

Trading the Forex market is no easy task. It requires a lot of hard work. Making the right decision will definitely put the odds in your favor. Take your time when doing your diligence because it is a big and important step in a trader's trading career.

Relative Strength Analysis In Forex Trading

First what is Forex: The FOREX or Foreign Exchange market is the largest financial market in the world, with an volume of more than $1.5 trillion daily, dealing in currencies. Unlike other financial markets, the Forex market has no physical location, no central exchange. It operates through an electronic network of banks, corporations and individuals trading one currency for another.

Analysis means: Research used to assist in predicting the direction of the markets based on technical data relating to price movements of the market, or on fundamental data such as corporate earnings.

The relative strength analysis is a technical report that allows investors and brokers to make informed decisions about trading on the Forex. The Forex, also known as the FX or foreign exchange market is the most liquid of all markets in the world. Over two trillion dollars changes hands everyday through the foreign exchange market. There are many factors that affect both the stock market and the foreign exchange market.

When investors and brokers look at the relative strength analysis, they are getting a picture of how the trends in the Forex should go. This analysis allows brokers to see current trends in the foreign exchange market and allows them to know if they are interested in buying or selling currency at any given time. This can help an investor or financial institution make educated decisions on which markets are gaining and which ones are losing.

There are many factors that affect the exchange rate in the Forex. These factors can include political events, governmental policies, inflation, and current trends in the importing and exporting business, consumer opinions and even natural disasters all over the world. The relative strength analysis looks at all of these factors. The past trends in the Forex are also taken into consideration, but are not the only thing that is looked at when forecasting this type of market.

The relative strength analysis compares all foreign currency and the exchange rates every day. The report will then be sorted by their strength rating and ranked according the previous week's rating. This report relies on at least 45 weeks of data so that sustained growth can be seen with ease. Using this analysis promises to be one of the most valuable tools of forecast the trends in the Forex. In addition, it can show the rating of stocks and rate them into which ones are the strongest. The stock market has a direct relation to the foreign exchange market because it reflects current trends in buying and selling, which will increase or decrease the value of currency.

The current trend in predicting the trends in the Forex is to use not only the relative strength analysis, but to also look at other factors such as the stock market barometers and economic factors. When investors and brokers look into all of these factors when forecasting the Forex, it makes for a highly reliable means of predicting trends. This can be the vital difference between making money and losing money on the foreign exchange market.

When using the relative strength analysis in relation to the foreign currency exchange, it is possible to tell which markets are performing well and which ones are not. The key is finding the markets and currency that are moving up on the ranking scale. It is important to remember that like stocks, the Forex is affected by a variety of factors. The relative strength analysis can help investors find which ones are good investments. This report is based mostly on a stock's closing price and the relative strength analysis is based on gains and losses. The report can calculate the markets report for any period in time.There are several benefits to using the relative strength analysis when attempting to forecast the Forex. When an investor looks at the relative strength of a certain stock, it affects the foreign exchange rate. One with a strong relative strength is ideal, but the value on these will not be low. Investors can look at a stock that is increasing in values and used the relative strength to measure whether or not this particular stock is moving up because it has a history of increasing or if it has a sustained high value. Stocks with a good relative strength over a constant, steady time period are good performers in the Forex market.