In six months, from Nov 16/12 to May 22/13, Japanese stock indices soared ~100% and the Yen fell ~25%…in sync with massive “quantitative easing” in Japan.  The tsunami of Japanese liquidity contributed to hugely bullish Market Psychology around the world…US and European stock indices soared…many to new All Time Highs…junk bond yields fell…gold lost ~$400…everybody took on more leverage…margin debt on the NYSE hit all-time highs…BUT…on May 22/13 Market Psychology “turned on a dime”…the Nikkei fell >20%, the Yen rallied >10% and the market dared to ask, “What happens if Abe’s Grand Plan fails?”  Well, if that’s the case, then the May 22/13 Key Turn Date could signal the end of four years of Central Bank inspired rallies in financial assets…with some BIG CHANGES coming across the board.

Big Picture:

For the past few years, in answer to the question, “What are we trading?” I’ve been saying that anticipation of Central Bank activity is “The” dominant factor driving Market Psychology…that seems more true now than ever as the recent tsunami of Japanese liquidity has helped to drive major American and European stock indices to All Time Highs.

Past 6 months:

Early last fall Market Psychology turned mildly bearish after the “buzz” from the Fed’s latest Q program wore off around the Sept 14/12 Key Turn Date…the US stock market drifted lower until the Nov 16/12 Key Turn Date…when the market realized that Abe was going to win the Japanese elections and begin implementing his extraordinary policies…hoping to end two decades of deflation in Japan…hoping to cause asset inflation and a weaker Yen…hoping to create inflationary expectations throughout the Japanese economy. In poker lingo, Abe went “All In.”

For six months it looked like Abe was a winner. His popularity with the electorate remained strong…Japanese stock indices soared and the Yen tumbled . The Japanese credit tsunami boosted bullish Market Psychology around the world…US and European stock indices rallied (the S+P gained ~25%)…yields on junk bonds and peripheral country bonds fell…gold was shunned and fell ~$400…the use of leverage soared…margin debt on the NYSE hit all-time highs.

Past 3 weeks:

But bullish Market Psychology got WAY overdone by mid-May 2013…Bernanke provided the “spark” to ignite a correction on May 22 when he hinted at a possible future reduction in the Fed’s easy money policies…and suddenly we had a Key Turn Date…since then the Nikkei is down >20%, the Yen has rallied >10% and the S+P was down >5% at last week’s lows.

During the six month rally phase and during the current bear phase Japan has been the LEAD PLAYER for Market Psychology. Now that Market Psychology has turned negative it dares to ask the question, “What happens if Abe’s Grand Plan fails?” My answer is that Japan has been the market’s best friend for the last 6 months…if Abe’s Grand Plan is perceived to be failing then Japan could become the market’s worst enemy.

If bearish Market Psychology persists then leverage will be reduced…margin clerks will become a force. We have seen Emerging Markets get hit…capital is seeking safety…leaving the Periphery and returning to the Center…if bearish Market Psychology persists we may see “It never rains but it pours” bear market…i.e., problems in Europe may come to the fore…problems in China may come to the fore…problems in the Mid-East may come to the fore…and these problems will collectively weigh on the market.

My short term trading:

Shortly after the May 22/13 top was made (I had been anticipating a top, but waited for a confirmation) I began to write short-dated OTM puts on the Yen…betting that the Yen would stop falling. I also wrote short-dated OTM calls on the S+P…betting that it would stop rising. I added to these positions over the next couple of weeks…also added outright shorts on the S+P…these positions have now mostly expired or have been closed out.  I also wrote short-dated calls on the Euro…betting that it would stop rising…but I lost money on that trade as the Euro has been surprisingly strong. (I had also written OTM Crude calls, then after crude fell, I wrote OTM Crude puts to create a strangle…those options all expired OTM.)

I’m pretty much flat at the moment…(I’m still short some way OTM calls on the S+P that expire this week) but here are some of the short term trading ideas I’m considering:  FX: The USD is oversold, the rally in the Yen and the Euro is overdone, the CAD has rallied a couple of cents but remains within a multi-month downtrend. Stocks: The “correction” in the S+P will continue…I will look to get short if a “buy the dip” rally fails…we might have seen that Thursday/Friday.  Bonds: are oversold…if they don’t make a new low on a “buy the dip” stock rally then I might buy them.  Gold: probably hasn’t bottomed yet…it could sell off more in a deleveraging theme…BUT…gold tumbled ~$400 or 23% during the six month Japanese inspired global stock market rally…stocks were preferred and gold was shunned…and gold suffered…but if Market Psychology is turning negative on stocks then gold could come into favor…see the “Charts” section below for my idea about buying gold Vs. stocks.   Crude: oversupply will weigh on prices but escalating Mid-East tensions could take prices higher…possibly sharply higher. Risk Management:  Be aware that these trade ideas  in FX, Stocks, Bonds and Gold are opposite sides of the same trading theme….

Longer Term Themes:

I think the “Age of Deleveraging” (thank you Gary Shilling) is continuing…I think the USD is headed higher…stocks are headed lower…interest rates are headed higher (but best-quality bonds may rally if stocks fall)…gold is likely headed lower near term if Market Psychology remains bearish and leverage is reduced…but I’m seriously looking at buying gold against the S+P (see charts below.)  From an overall investment point-of-view I think it’s a good time to be defensive…to take some money off the table now that the  “exuberance” generated by the Japanese liquidity tsunami has run its course. I can easily imagine that the 6 month run to new All Time Highs in several American and European stock indices was the “Last Leg” of a four year rally driven by successive rounds of stimulative Central Bank policies…if that’s the case, then the May 22/13 Key Turn Date would signal a MAJOR turn in financial assets…and some BIG CHANGES coming across the board. With my skeptical trader’s mentality I’m happy to have >90% of my net worth in cash…35%in USD and 65% in CAD.

Charts:

We had a Weekly Key Reversal Down in the Nikkei 4 weeks ago…followed by 3 more weekly lower closes…the Nikkei is down ~22% from its May 22 KTD highs, after rallying ~100% from its mid-November lows. A bounce seems inevitable, but I’m betting we’ve seen the high.

We had a Weekly Key Reversal Up in the Yen on the May 22 KTD… followed by 3 more weekly higher closes…hedge funds that bought the Nikkei must have sold the Yen to cover their currency risk…now they have to buy back the Yen.

We had a VERY RARE and powerful Monthly Key Reversal Down in the Bond market in May…on the monthly chart this is a strong signal that the “buy the dip” April rally failed and lower prices (higher yields) lie ahead…but the bonds may catch a bid if stocks fall.

The US dollar has closed lower for 4 consecutive weeks…mostly due to Euro strength…I’ll be looking for signs that the sell-off is over to establish long US Dollar (or short Euro) positions.

Crude had a Weekly Key Reversal Up the week-before-last and last week’s close was the best since September last year. The market looks like it wants to go higher on Mid-East tensions…if those appear to ease then the “over supply” factor should weigh on prices.

Gold made its all-time high in USD terms in September 2011…but it also made a 23 year high in terms of the S+P…since then the ratio has declined ~50% (as gold fell and the S+P rallied) and it “may” be signaling a reversal around the May 22 KTD.  I can easily imagine a scenario over the next few months where gold falls less than the S+P, or rallies in terms of the S+P…so I’m looking at constructing a trade where I buy gold and sell the S+P.

Futures and futures options are the best way to trade currencies, metals, stock indices and many other financial and commodity markets. Call 604 664 2842 to talk with a futures broker.