Raymond Firetag is a former real estate mortgage broker who turned to trading less than one year ago. Here we talk about his learning curve, how he blew his first trading account learning the craft, and the changes he made to come back from those first tough months.

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Tim Bourquin is the co-Founder of the Online Trading Expo and the Forex Trading Expo, and CEO of TNC New Media, a tradeshow and online media company.  Register to attend the largest convention for foreign currency traders, the Forex Trading Expo, by clicking here.

For Tuesday, the 30- and 5-year bonds continue to signal for a resumed up-move which the neutral 10-year is at least not contradicting. Obviously, when the signal is wrong, it can be spectacularly wrong as we saw on Monday, so caution is advised. At the moment, these market are more volatile than the indices.

Either-Or Biases

The first set of biases includes six biases that individually signal either long or short on a daily basis, except for the rare tie. Each bias has a +1 value for long bias, and a -1 for short. The bottom line is the sum total, which can range from -6 to 6. Positive totals are bullish; negative are bearish. For bullish signals (opposite is bearish):

1. The 2-day average is below the 5-day average.
2. The close is above the 40-day average.
3. The highest close of the last 50 days occurs before the lowest close of the last 50 days.
4. The day’s trading range is smaller than the 10-day average range and the day’s close is higher than the previous day’s close OR the day’s range is larger than the 10-day average range and the close is lower than the previous day’s close.
5. The close is above the midpoint of the average 15-day range. (The 15-day high average plus the 15-day low average divided by 2.)
6. Fade the majority direction of the last three open-to-closes.



Infrequent Biases

The five infrequent biases are listed below. For bullish signals (opposite is bearish):

1. Four successively higher closes were followed by yesterday’s down close. Today’s action was irrelevant.
2. Five successively lower closes were followed by today’s up close.
3. CUP trade. For the last three trading days, the middle day had both the lowest low and the lowest close. In addition, the low on the middle day must also be lower than the lows from the previous three trading days before the middle day. (CAP is the reverse and bearish.)
4. The highest low minus the lowest low of the last three days is less than or equal to 20% of the highest high minus the lowest low of the last three days.
5. For the previous two days, the market closed lower than it opened.



Calendar Biases

The calendar biases in the indexes are listed below.



DISCLAIMER: It should not be assumed that the methods, techniques, or indicators presented in this column will be profitable or that they will not result in losses. Past results are not necessarily indicative of future results. Examples presented in this column are for educational purposes only. These set-ups are not solicitations of any order to buy or sell. The author, Tiger Shark Publishing LLC, and all affiliates assume no responsibility for your trading results. There is a high degree of risk in trading.

Art Collins is the author of Beating the Financial Futures Market: Combining Small Biases into Powerful Money Making Strategies. E-mail him at art@traderinsight.com.

A traders success, or ultimate failure, depends on one simple question: Do you have a written trading plan?

Most do not. In order to manage your emotions effectively when trading, you need to create a written plan that you can review regularly to stay focused on your goal of trading success. By writing down your plan, you put yourself in the top 3% of individuals who have written goals and plans, giving you an immediate edge on most traders. Make sure you have answered these questions.

1) How you will enter trades? The key to good entries is putting on trades where there is relatively low risk compared to much higher reward. You also should write down a clear catalyst for the expected stock move.

2) How will you exit trades? You should define an initial stop point for your trade, at the point where the trend is invalidated. You will also need a ‘trailing stop’ technique to protect your profits.

3) What type of orders will you use to enter and exit? When entering, I like to use limit orders, good for the day only, while exits are often market orders. Why? Because limit orders allow me to define my risk and reward clearly on the entry of a trade, while when I need to get out, market orders allows immediate exit compared to the risk of missing my exit with a limit order.

4) How much capital will you need to trade successfully? There are economies of scale as you increase the amount of capital you trade with. Costs related to commissions, quote systems and equipment begin to diminish as the percentage of capital invested goes up.

5) What percentage of your capital will you invest in each trade? The amount of capital I typically use is 10% per trade in my own accounts. I know traders who commit anywhere from 5% of their account per trade to 20% of their account per trade. You goal should be to keep portfolio risk per trade at less than 2% per trade (for example if you invest 20% of your portfolio in a trade, a 10% loss on that position would lead to a 2% loss on your portfolio).

6) How many positions will you focus on at once? I like to concentrate my portfolio in my best ideas, plus I like to stay focused on how each stock is acting. If my portfolio is too big (I’d say more than 7 stocks is too many to focus on), then I will lose focus and invariably miss an exit on a trade that I should have previously exited.

7) What will your Trading Journal look like? In my Trading Journal, I note daily observations, particularly related to my ability to execute my trading plan. I also commit to doing a post-trade analysis every month. I note what I did right and wrong, and seek to learn from mistakes to minimize future errors in similar circumstances, while also looking for winning patterns where I seek to repeat big successes.

8) What is your Position Review process? Have an end-of-day routine to close your day. Review your trades, and assess if you followed your plan. Keep a log of all your trades, and make comments on each position.

9) What is your Preparation process before trading? You need defined time to prepare for the next trading day to build up your trading confidence. I prepare after the close for the next day’s trading, which allows me to formulate a plan of action BEFORE I get into the heat of battle. This keeps my trading proactive instead of reactive.

10) What broker will you use? Most traders mistakenly think that commissions are the number one factor they can control. In reality, commissions are a small cost compared to the broker’s effectiveness at executing your trade. Your focus should be finding a broker who gets you speedy and fair execution of your orders.

Once you have defined these facets of your trading plan, you are in an excellent position to have a strategy to control your emotions when trading. Make sure to review your plan on a regular basis to create effective trading habits.

Price Headley is the founder and chief analyst of BigTrends.com.

What a beautiful day it is in Paris. It’s snowing. The streets are white. And the streetlights, shoplights, and automobile lights make everything glow. It would be a nice morning to sit in a café and drink a cup of coffee.

But we don’t have time for that. We’re back at our desk…there is another year to be reckoned with…and it promises to be a doozy. The trouble with this year so far is that it is missing the question marks. What lies ahead seems obvious…too obvious…

“World stocks rise on US rally, stimulus hopes,” comes the headline from CNN/Money.

The Dow flew up 258 points on Friday - stocks have been up in the last three trading sessions. Oil rose to $46. Gold fell to $879.

The expected rebound seems to be underway. Even dead cats bounce. And considering the height from which this one fell, it would not at all be surprising to see it bounce up 30% or even more…over the next three months.

Investors took a terrible beating in ‘08. It was the worst year in stock market history. They’ll figure that this year is bound to be better. And along will come many reasons to believe that things are looking up.

President-elect Obama is talking about relief on a Rooseveltian scale. He wants to spread unemployment and Medicare benefits around more freely, for example. But he knows he can’t just toss out a few dimes to bums on the street corners; he needs a stimulus plan that knocks peoples’ socks off.

“Economists from all across the political spectrum agree that if you don’t act swiftly and boldly we could see a deepening economic downturn,” he said recently.

We must be somewhere on the political spectrum. But he didn’t ask us. If he had, we would have explained that every penny spent on a bailout has to be taken out of the spending of the person who earned it. We’d add that there is no economic problem at all. The markets are doing what they’re supposed to do…clearing away the mistakes of the Bubble Epoch.

It’s a political problem, not an economic one. People don’t like to have to pay for their mistakes. So, they whine to politicians. And then the politicians make things worse…by trying to prevent the correction from taking place.

But, our “Head of State Hotline” has been silent, here at The Daily Reckoning headquarters. So we have to assume it was Barack Obama who was not calling - along with every other government leader on planet earth.

Mr. Obama figures he needs to do something spectacular…something that will give the impression of really turning things around. He calls his project the ‘American Recovery and Reinvestment Plan.’

Ahh…here are some question marks: What is it meant to recover? We don’t know…maybe the glory days of the Bubble Epoch. What is being reinvested? We can’t figure that out either. Typically, you reinvest a profit. But you have to have a profit to reinvest it. As near as we can tell, 2008 was a year of losses. You can’t reinvest losses.

Nevertheless, we know what American Recovery and Reinvestment Plan is…political claptrap. And now it’s expected to cost as much as $1 trillion. At least, that is what state governors are calling for. Congressional leaders say they want to stay below the “politically charged” one trillion dollar level. But they also say the bill won’t be ready for Obama’s signature until February. Congress needs time to pry open the pork barrel and spread it around - no question about that, either. By the time they’re finished, there’s almost sure to be $1 trillion work of grease in the package.

“US Debt Expected to Soar,” says the Washington Post, stating the obvious.

All this extra debt will do no good for the economy, but investors will probably feel like the good old days are back. And for a while, they will be.

*** It troubles us that so many people expect a bounce…followed by a further collapse. How can Mr. Market work his mischief if so many people see what he is up to? Where’s the surprise? Will the bounce not come at all? Or, will it come much more emphatically than people expect?

Perhaps markets will rally strongly all over the world. Chinese manufacturing will show signs of recovery. Housing in the United States will appear to have stabilized. Commodities will edge up. Investors may begin to believe they have another bull market on their hands - or at least a tradable rally. They won’t want to miss the opportunity to ‘get even.’ And then, as stock prices rise, investors will slip back into their old habits. They will turn to risky investments in order to boost their profits. Among other things, they are likely to invest in emerging markets, which will probably rise more than the U.S. market itself. Currencies such as the Brazilian real and the ruble will go up against the dollar.

As the rally recovers 40%…50%…maybe even 60% of last year’s losses, investors will be suckered into seeing it not as a bear market rally, but as a genuine new boom. They will think it is real…and durable. And they will forget to sell.

Mr. Market will have pulled another fast one.

*** “In a severe crisis, orthodoxy can prove a very bad strategy,” said Ben Bernanke last week.

We are as puzzled by this as by Obama’s American Recovery and Reinvestment Plan. Economics is not improv theatre. You can’t just make it up as you go along. You make a change in banking regulations or fiscal policies, for example, and it will take months or years before you know if it has worked. That’s why you need theories to guide you…you can’t wait to see how an economy reacts. In the absence of a theory about the way things work, you are just committing random acts of kinkiness.

Today’s news from Bloomberg also tells us that the “Fed has abandoned monetary policy.” We’re puzzled by that too. With rates at zero, what monetary policy did the Fed have left? Not much.

*** Poor Ireland. The Celtic Tiger has been de-clawed and spayed. House prices have fallen as much as 50%. Bank shares are down 90%. Unemployment - which had all but disappeared in the boom years - is headed back to 10%.

Bill Bonner is the President of Agora Publishing. For more on Bill Bonner, visit The Daily Reckoning.

Deflation is the new theme in the economy, as trading volume returns to the financial markets after the holidays. What do the professional traders of TraderInsight.com think?

Here’s the list of 7 stocks our professional traders will be watching this week:

Bed Bath & Beyond (BBBY), Family Dollar Stores (FDO), Supervalue (SVU), Constellation Brands (STZ), Acadia Realty Trust (AKR), Boston Properties (BXP), Avalon Bay Communities (AVB)

——————————————————————————–
2 Months for the Price of 1

Swing trade along with a hedge fund manager. The regular price of Tom Incorvia’s Stock Trading Service is only $99 per month, but when you pay for one month, you’ll receive the second month for free. Your membership will continue at the regular price of $99 per month until you cancel. Cancel at any time. This offer for a free month ends, Monday, January 5, 2009.

Join today.
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Adrian Manz, Stock Day Trader

Monday represents the first “real” trading day of 2009 and it looks as though the week will provide some volatile price action as many companies report earnings and economic announcements will be plentiful. This week’s earnings news promises volatility in retail, as Bed Bath & Beyond (BBBY), Family Dollar Stores (FDO), Supervalue (SVU) and Constellation Brands (STZ) are scheduled to report. Each will almost certainly provide solid trading opportunities, both before and after earnings are reported, with intraday 5-minute and overlapping 25-tick timeframes providing the trading opportunities I will be on the lookout for.

Also on deck early this week, the REITs look ready for a move lower. I will watch Acadia Realty Trust (AKR), Boston Properties (BXP) and Avalon Bay Communities (AVB) for a Switch Hitter reversal move lower on Monday and Tuesday.

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Tom Incorvia, Stock Swing Trader

All three of the broader averages posted strong gains last week, lifting them to levels not seen since November 2008. All but one of the 31 sectors were in the green. The leading sectors were the Metals and Mining, Energy, and Aerospace/Defense.

This week’s focus will definitely be on the release of the December Employment Report. The Street is looking for a loss of 500,000 jobs, which would follow the 533,000 job loss reported in November. The unemployment rate is expected to jump from 6.7% to 7% on any weak employment figures. Also, President-elect Obama will be meeting with congressional leaders from both sides of the isle to discuss economic stimulus plans.

The action in the markets last week was productive from a price action prospective. The question that remains to be answered is will there be any follow-through this week. If volume shows up in harmony with upside probing, that may signify a short- to intermediate-term bottom. Because of anemic volume last week, I will wait to see the reaction from the Street before I test the waters.

——————————————————————————–
2 Months for the Price of 1

Swing trade along with a hedge fund manager. The regular price of Tom Incorvia’s Stock Trading Service is only $99 per month, but when you pay for one month, you’ll receive the second month for free. Your membership will continue at the regular price of $99 per month until you cancel. Cancel at any time. This offer for a free month ends, Monday, January 5, 2009.

Join today.
——————————————————————————–

Art Collins, Index Futures Trader

The recent stock market rally is a result of both a technical oversold condition and a fundamental exuberance about the impending Obama election. Any veteran trader is likely to affirm the phenomenon of “buy the rumor, sell the fact,” and I can certainly add my own anecdotal two cents its effectiveness. That implies we should continue to see a market that is resistant to down-side pressure up until the election. We have an opportunity to gage this on Monday as the market is likely to show at least initial weakness over the current Mideast crisis. I’m figuring the close is likely to be higher than the opening, but even if that it proves incorrect, I expect persistent strength for the next two weeks.

The classic resolution of this would be a sharp down-move on inauguration day, January 20. Maybe it won’t be quite that perfect, but there are other reasons I’m imagining a monthly high just before the 20th. It’s pretty much the January story. Anticipation of a fresh start initially drives the market to uncomfortable heights and then reacts late in last third of the month. On the other hand, this does contradict my seasonal overview that says be short from the 7th through the 21st of any month and then long for the rest of the time. I’m betting on the special nature of January though, as well as the political fundamental setup. For the forthcoming week, I expect higher prices by Friday’s close.

Dave Mecklenburg is the Editor-in-Chief of TigerSharkTrading.com.

Friday’s sharp drop in bonds should reverse direction on Monday according to the CzarCharts. The currencies are also flashing buy signals.

Either-Or Biases

The first set of biases includes six biases that individually signal either long or short on a daily basis, except for the rare tie. Each bias has a +1 value for long bias, and a -1 for short. The bottom line is the sum total, which can range from -6 to 6. Positive totals are bullish; negative are bearish. For bullish signals (opposite is bearish):

1. The 2-day average is below the 5-day average.
2. The close is above the 40-day average.
3. The highest close of the last 50 days occurs before the lowest close of the last 50 days.
4. The day’s trading range is smaller than the 10-day average range and the day’s close is higher than the previous day’s close OR the day’s range is larger than the 10-day average range and the close is lower than the previous day’s close.
5. The close is above the midpoint of the average 15-day range. (The 15-day high average plus the 15-day low average divided by 2.)
6. Fade the majority direction of the last three open-to-closes.



Infrequent Biases

The five infrequent biases are listed below. For bullish signals (opposite is bearish):

1. Four successively higher closes were followed by yesterday’s down close. Today’s action was irrelevant.
2. Five successively lower closes were followed by today’s up close.
3. CUP trade. For the last three trading days, the middle day had both the lowest low and the lowest close. In addition, the low on the middle day must also be lower than the lows from the previous three trading days before the middle day. (CAP is the reverse and bearish.)
4. The highest low minus the lowest low of the last three days is less than or equal to 20% of the highest high minus the lowest low of the last three days.
5. For the previous two days, the market closed lower than it opened.



Calendar Biases

The calendar biases in the indexes are listed below.



DISCLAIMER: It should not be assumed that the methods, techniques, or indicators presented in this column will be profitable or that they will not result in losses. Past results are not necessarily indicative of future results. Examples presented in this column are for educational purposes only. These set-ups are not solicitations of any order to buy or sell. The author, Tiger Shark Publishing LLC, and all affiliates assume no responsibility for your trading results. There is a high degree of risk in trading.

Art Collins is the author of Beating the Financial Futures Market: Combining Small Biases into Powerful Money Making Strategies. E-mail him at art@traderinsight.com.

I meant to take yet another Friday away from my writing, but as I am researching for next week’s annual prediction issue, there is so much material that begs to be covered that I thought I would put out a short letter with 3 or 4 points as a preface to my prognostications of next week.

This week we look at a very interesting, if not altogether encouraging, piece of research on the length and severity of recessions that come during periods of financial crisis, which can apply to not just the US but all countries that are involved in the current crisis. But being forewarned is better than blindly stumbling through, so we will take some time to peruse it. Then we (briefly) look at the depth of the manufacturing numbers in the US, which leads us into the recent bout of earnings downgrades and some thoughts as to where that might suggest the market is going. That should be enough for this week.

The Aftermath of Financial Crises

What happens to an economy after a financial crisis? Since there are few who would deny that we have been in and are experiencing a financial crisis, it might be instructive to look at what has happened in previous crises in other countries. Fortunately, the work has been done for us by Professors Carmen Reinhart of the University of Maryland and Kenneth Rogoff of Harvard, in a recent paper entitled “The Aftermath of Financial Crises.”

There are very real differences between normal business-cycle recessions and a recession brought on by a financial crisis. The latter are much more severe. Sadly, we are in the latter type.

Reinhart and Rogoff had done an earlier paper on financial crises and their aftermath, just in developed countries, and now they have expanded their research to include developing countries as well. What they have found is that there is not that much difference in general between developed and developing economies after a crisis. (About which I will comment later, but first let’s look at their work.) Quoting:

“In our earlier analysis, we deliberately excluded emerging market countries from the comparison set, in order not to appear to engage in hyperbole. After all, the United States is a highly sophisticated global financial center. What can advanced economies possibly have in common with emerging markets when it comes to banking crises? In fact, as Reinhart and Rogoff (2008b) demonstrate, the antecedents and aftermath of banking crises in rich countries and emerging markets have a surprising amount in common.

“… Broadly speaking, financial crises are protracted affairs. More often than not, the aftermath of severe financial crises share three characteristics. First, asset market collapses are deep and prolonged. Real housing price declines average 35 percent stretched out over six years, while equity price collapses average 55 percent over a downturn of about three and a half years. Second, the aftermath of banking crises is associated with profound declines in output and employment. The unemployment rate rises an average of 7 percentage points over the down phase of the cycle, which lasts on average over four years. Output falls (from peak to trough) an average of over 9 percent, although the duration of the downturn, averaging roughly two years, is considerably shorter than for unemployment. Third, the real value of government debt tends to explode, rising an average of 86 percent in the major post-World War II episodes.

Interestingly, the main cause of debt explosions is not the widely cited costs of bailing out and recapitalizing the banking system. Admittedly, bailout costs are difficult to measure, and there is considerable divergence among estimates from competing studies.

But even upper-bound estimates pale next to actual measured rises in public debt. In fact, the big drivers of debt increases are the inevitable collapse in tax revenues that governments suffer in the wake of deep and prolonged output contractions, as well as often ambitious countercyclical fiscal policies aimed at mitigating the downturn.”

As long-time readers know, I believe you must be very careful when using average numbers of past performance of investments or economic data. While they can be useful in helping to determine direction, using them as an absolute predictor of future patterns can be quite misleading. As an example, it would be misleading to say that unemployment in the US or England will rise to 11% because average unemployment is up 7% over the recent trend numbers in good times. The actual level will in all likelihood turn out to be higher or lower, depending on a number of factors.

That being said, the numbers do suggest that unemployment will be much higher than we see in a typical recession and will last longer. How much higher and how much longer we won’t know for some time. Let’s look at a few graphs which tell the story about housing prices and equity markets after a financial crisis.



The next graph shows that equity price declines are much steeper, but shorter in duration.



Interestingly, on unemployment they note:

“… that when it comes to banking crises, the emerging markets, particularly those in Asia, seem to do better in terms of unemployment than do the advanced economies. While there are well-known data issues in comparing unemployment rates across countries, the relatively poor performance in advanced countries suggests the possibility that greater (downward) wage flexibility in emerging markets may help cushion employment during periods of severe economic distress. The gaps in the social safety net in emerging market economies, when compared to industrial ones, presumably also make workers more anxious to avoid becoming unemployed.”

So much for the Detroit bailout.

The 9.3% drop in GDP they noted as the average drop illustrates the problem of using averages as predictors. The really horrible drops were mainly due to the Asian crisis of 1997 and the Argentinean debacle of 2001. Throw those out and my guess is that it looks like an average drop of 5%, which is still a very serious recession indeed.

I will let you read their conclusion, as it is short and instructive. You can read the entire paper at http://ws1.ad.economics.harvard.edu/faculty/rogoff/files/Aftermath.pdf. It is short (for an economics paper) and quite readable. Now, their conclusion [emphasis mine]:

“An examination of the aftermath of severe financial crises shows deep and lasting effects on asset prices, output and employment. Unemployment rises and housing price declines extend out for five and six years, respectively. On the encouraging side, output declines last only two years on average. Even recessions sparked by financial crises do eventually end, albeit almost invariably accompanied by massive increases in government debt.

“How relevant are historical benchmarks for assessing the trajectory of the current global financial crisis? On the one hand, the authorities today have arguably more flexible monetary policy frameworks, thanks particularly to a less rigid global exchange rate regime. Some central banks have already shown an aggressiveness to act that was notably absent in the 1930s, or in the latter-day Japanese experience. On the other hand, one would be wise not to push too far the conceit that we are smarter than our predecessors. A few years back many people would have said that improvements in financial engineering had done much to tame the business cycle and limit the risk of financial contagion.

“Since the onset of the current crisis, asset prices have tumbled in the United States and elsewhere along the tracks lain down by historical precedent. The analysis of the post-crisis outcomes in this paper for unemployment, output and government debt provide sobering benchmark numbers for how the crisis will continue to unfold. Indeed, these historical comparisons were based on episodes that, with the notable exception of the Great Depression in the United States, were individual or regional in nature. The global nature of the crisis will make it far more difficult for many countries to grow their way out through higher exports, or to smooth the consumption effects through foreign borrowing. In such circumstances, the recent lull in sovereign defaults is likely to come to an end. As Reinhart and Rogoff (2008b) highlight, defaults in emerging market economies tend to rise sharply when many countries are simultaneously experiencing domestic banking crises.”

ISM: Anywhere You Look It Is Bad

The Institute for Supply Management (ISM) has been giving us data on US manufacturing for 50 years (formerly as the NAPM). Many other countries now have similar numbers, often published by a “PMI” or Purchasing Management Institute. The data is presented in a similar fashion. If an item is growing it is above 50, and if it is contracting it is below 50. Depending on how good or bad the data is, the index can be well above or well below 50. While a level of say, 57, as opposed to 62 or 52, for the manufacturing index does not reveal all that much, there are two things that are very useful in the surveys. First, is the number above or below 50? Quite simply, are we growing or contracting? Second, what is the trend over the past 3-6 months?

And looking at those two factors, it is ugly all over the world. In some places, very ugly indeed. Russia is at 33.8, down 20% from November. India is down to 44, and the trend is downward. Hong Kong is down for six months in a row, to 39. Australia is at 33.7. (Thanks to Dennis Gartman for the world tour.) We will look next week at China, whose numbers show a sharp decline in export growth.

We got the US ISM numbers today, and they were just awful. The overall index is down to 32.4, down over 25% in the last three months. This is the lowest level since 1980, in what was a severe recession. The ISM survey points to one of the deepest contractions in industrial output in the post-World War II era, this quarter. The forward-looking details were weak and point toward further declines in the ISM manufacturing index. Businesses are cutting orders, inventories, and workers because of tight credit conditions, declining final demand, and shattered confidence. Manufacturers reported in December that their customers’ inventories were too high, a bad omen for future production.

But when you look at the components, it gets even more sobering. New Orders are down over 50% from six months ago, to 22.7. This is the lowest number since they began keeping records in 1949. Production is down to 25.5. New Export Orders were way down (35.5), as was Order Backlog (23).

“Another standout in the December report was the decline in the prices-paid index [down to 18! -JM] which fell to its lowest level since 1949. The abrupt decline in energy and other commodity prices is driving the index lower. Lower input costs may entice manufacturers to pass on the savings via reducing their prices. If businesses broadly across industries cut prices to preserve some sales, it will heighten the threat of deflation.” (www.economy.com)

This is all suggestive of an economy in serious decline. The GDP for the 4th quarter should be down somewhere between 4-5%. It is likely we are going to see even more earnings downgrades in the next few months, and as I outline below, we have probably not yet hit bottom. As long as the ISM numbers look like the ones we just analyzed, things are likely to be getting more difficult. And that goes for the world in general, not just the US economy.

Another Round of Earnings Disappointments

So, how did the US market respond to this data? The Dow was up 258 (almost 3%) and the NASDAQ up a sprightly 3.5%. Nothing to worry about.

However, earnings, as you might expect, are not doing all that well. For the last year I have been highlighting how earnings estimates are dropping for the S&P 500, as analysts try and catch up with the reality on the ground. They are still behind the curve.

Let’s look at their estimates for earnings in 2008. They started at $92 in early 2007 and are now down to $48. This chart is not something to inspire confidence in stock analysts.



On a trailing one-year basis, that puts the Price to Earnings Ratio (P/E) at over 19 as of today’s close at 925, which does not make the market cheap. But last year’s earnings are history. What about 2009? Again, the analysts are in a race to find the bottom.



The current projections are for $42.26 for 2009. That makes the forward P/E 22. That doesn’t look like value at all, when the historical average is closer to 15.

Bulls would argue that the market is forward-looking and that all the bad news has been priced into the market. I would counter that the market has so far done a bad job of pricing in bad news, given the fall of the markets last year in the face of a recession. As I repeat incessantly, the US stock market falls an average of 43% during recessions. The stock market was not discounting a recession last January or even in May, even after a very serious financial crisis.

But how bad can it get? Analysts must surely by now have lowered their estimates to more realistic numbers. Shouldn’t we start to price in the recovery from here? Well, no, not if you look at the last recession.

In 2001, as-reported earnings were $24.67. Operating earnings in 2002 were $27.57. Does anyone think the current recession will be milder than the last one? Or shorter?

And it gets worse. Core earnings, which take into account pension and other under-reported liabilities, were less than $16 in 2001, and so P/E on a core earnings basis topped out at 71, and on an as-reported basis were as high as 46!

Of course, after that the stock market went on a tear, almost doubling over the next five years. And today the market seems to be suggesting that many people are afraid to miss out on the fun of the next bull market run.

A Bear Closes His Short Fund

I had a long conversation with Bill Fleckenstein today. Bill runs a short-only hedge fund and has done so for many years. He is one of the more outspoken and well-known bears. And he told me that he is closing his short fund. Shutting it down and sending all the money back.

“Right now, my list of stocks that I want to be long is longer than the list I want to short.” In the current environment he wants the ability to go long as well as short. For those of you who are long the market, that is probably as good an indicator as any that we are closer to the bottom than we are from the future top!

Interestingly, we agreed on a possible scenario for the first half of the year. We both see a very tradable rally going into spring. Then, when we get even more earnings disappointments at the end of the first quarter and warnings at the end of the second quarter, we could see another test of the November 20 lows. Earnings disappointments are the catalyst for protracted bear markets. But the wild card is the coming economic stimulus package. We have never been in a situation like this.

While I am negative on the stock market (and markets around the world) in general, there are some stocks which are now at reasonable values. When you can find a stock with a P/E ratio lower than its dividend, and with that dividend reasonably well protected, I can’t argue with a long-term investor buying that stock. 6% dividends can cover a lot of market sins at these levels. (Don’t ask for stock recommendations: I don’t analyze stocks. My business is analyzing the economy and money managers. A man has to know his limitations.)

The market seems to be thinking the economy will be coming out of recession in the third quarter of 2009, hence the rally. I think that is optimistic. As the research above suggests, this could be a longer and deeper recession than anyone younger than 50 can possibly remember.

Next week, we will get into the actual forecast for 2009.

John Mauldin is president of Millennium Wave Advisors, LLC, a registered investment advisor. Contact John at John@FrontlineThoughts.com.

Disclaimer
John Mauldin is president of Millennium Wave Advisors, LLC, a registered investment advisor. All material presented herein is believed to be reliable but we cannot attest to its accuracy. Investment recommendations may change and readers are urged to check with their investment counselors before making any investment decisions.

How Did the Dollar Trade in 2008?

It has been an exceptionally active year in the foreign exchange market as currency volatilities hit record highs. In the first half of the year, everyone was worried about how much further the dollar would fall but in the second half of the year the concern became how much further the dollar would rise. After hitting a record low against the Euro in the second quarter, in the beginning of the fourth quarter, the US dollar actually surged to a 2 year high. From trough to peak, the dollar index rose more than 23 percent in 2008.

3 Themes for 2009

The US economy and the dollar’s fate in the years ahead could be determined by what happens in 2009. We are focusing on 3 big themes that will impact the US dollar and each of these themes encompasses a lot.

1. Will there be a U or L Shaped Recovery?

The US is in recession and the slowdown is expected to deepen in 2009. Before a recovery is even possible, the economy has to work through more weakness and negative surprises. Non-farm payrolls declined by 533k in November, sending the unemployment rate to a 15 year high of 6.7 percent. With many US corporations forced to tighten their belts, the unemployment rate could rise as high as 8 percent in 2009. We expect this to happen because over the past 50 years on average, recessions have boosted the unemployment rate by 2.8 percent. When the current recession started in December, the unemployment rate was 5.0 percent. If you tack on 2.8 percent to that level that would put the unemployment rate at least 7.8 percent.

Non-farm payrolls could double dip, just as it has in past recessions. In this case, we would expect a rebound followed by another sharp loss that rivals November’s job cuts. A rise in unemployment spreads into incomes, spending and then usually leads to more layoffs. We need to see this toxic cycle end before we can see a recovery. Consumer spending has already been very weak and the trade deficit is widening as the dollar strengthens. As the 2 primary inputs into GDP, we expect fourth quarter growth to be very weak. The strength of the US dollar in Q3 and for most of Q4 will also take a big bite out of corporate earnings, leading to disappointments for the stock market. This is why we expect more weakness in the US dollar and the US economy in the first quarter of 2009. However towards the middle of the second quarter, we may begin to see the US economy stabilize as it starts to reap the benefits of Quantitative Easing and President Barack Obama’s fiscal stimulus plan. New Administrations usually hit the ground running and as such we fully expect the rest of the TARP funds to be tapped shortly after his inauguration. The shape of the US recovery will have a big impact on the price action of the US dollar but there is no question that the path to a stronger dollar will be through a weaker one.

The following chart illustrates how non-farm payrolls double-dipped during the 2001 recession.



Although we expect the US economy to start its slow recovery in the second half of 2009, GDP growth next year will still be negative. Retail sales and non-farm payrolls will be particularly ugly in the first quarter, but we are optimistic that monetary policy and fiscal stimulus will begin to help the economy. The record decline in mortgage rates should also help to stabilize the housing market in 2009. Something between a L and U shaped recovery is likely.

2. What Matters More to the Dollar - Safety or Yield?

The dollar’s rally in the second half of 2008 has been largely driven by risk aversion, deleveraging and repatriation. In other words, despite the next to nothing yield offered by dollar denominated investments, a flight safety into US dollars and government bonds has kept the greenback from collapsing against other currencies like the British pound, Canadian and Australian dollars. The concern for safety was so high that investors were willing to take negative yields just to park their money with the US government. A bubble is brewing in the Treasury market and any improvement in risk appetite will take the market’s focus away from safety and back to return on money at which time ultra low interest rates could become a detriment for the US dollar. The dollar’s performance against other currencies would be contingent upon growth in the rest of the world. For example, if the UK economy is in the process of recovering, demand for yield and the prospect of return could send the GBP/USD higher, but if there is a prolonged recession in the Eurozone, then the Euro may no longer be the flavor of the month.

3. Compression in Interest Rates and Volatility

Volatility in the currency market also hit a record high in 2008 but in 2009 we expect the volatility to compress as interest rates around the world converge. Much of the volatility this past year has been spurred by speculation about how much various central banks would cut interest rates. As they run out of room to ease, we may stop seeing monetary policy surprises which can eventually lead to stabilization for carry trades. Don’t expect this to happen in the first quarter however as many central banks are still expected to cut interest rates. The Fed’s rate cuts have long been a big driver of market volatility and now that risk is off the table. When the monetary and fiscal stimulus start to impact the US economy, the market may actually start talking about a rate hike in the US. Interest rates cannot remain at zero forever, especially if inflation starts creeping higher in the second half of the year.

Is there a Risk of Deflation?

Deflation is much more of a problem for the US economy than inflation. Since oil prices are more than 75 percent off their highs. As a result, we have seen either flat or negative consumer price growth every month between August and November. The December numbers have yet to be release, but there is no reason to expect CPI to turn positive. Since the beginning of the year annualized consumer price growth has fallen from 2.1 to 1.1 percent. The US economy has not officially hit deflationary conditions, but with commodity prices continuing to fall and consumer demand slumping, deflation will become a greater risk than inflation in the first half of 2009. However this may change in the second half as Quantitative Easing, fiscal stimulus and hopefully a weaker currency boosts inflation.

Time for Quantitative Easing

US interest rates have fallen 400bp from 4.25 percent to 0.25 percent in 2008. For most people, interest rates at 0.25 percent are as unattractive as zero interest rates. With US rates pretty much at zero, the Federal Reserve has informally adopted its own version of Quantitative Easing. Some people may even argue that the Fed has been pursuing this strategy for months now. In conjunction with the Treasury department, the Fed has doubled their balance sheet in the past 3 months to more than $2 trillion. They have done this by purchasing direct equity investments in banks, easing standards on commercial paper purchases, made efforts to relieve institutions of their toxic asset-backed securities and are now considering buying Treasury bonds and agency debt. By buying these assets, they are adding money into the financial system. Like the Yen, Quantitative Easing exposes the US dollar to significant downside risks because the Federal Reserve is basically printing money and using that money to flood the market with liquidity, eroding the value of the dollar in the process. However it is a step that the central bank needs to take to stabilize the US economy and to prevent a deflationary spiral. The central bank will not be worried about a weak currency and will in fact welcome one because they know that a weaker currency is like an interest rate cut in many ways because it helps to support and stimulate the economy.

Technical Outlook for the Dollar Index

As indicated in the following chart, the US dollar rallied significantly in the second half of the year. Between June and November, the dollar index rose more than 25 percent. However the rally hit a brick wall in the month of December, when it plunged 12 percent. Since then it has recovered modestly, but it is hovering below stiff resistance. Not only is there the 38.2 percent Fibonacci retracement above current levels, but that also coincides with the 100-day Simple Moving Average. If the dollar index breaks above 81.70, there is scope for a much sharper gain, but the combination of a head and shoulders pattern in formation, Fibonacci and Moving Average resistance suggests that the odds are skewed towards more losses than gains in the beginning of 2009.



Euro 2009 Forecast

How Did the Euro Trade in 2008?

Exactly one year ago, the Euro was trading at approximately 1.47 against the US dollar, 5 percent higher than current levels. In 2008, this type of move is considered mild especially when compared to the Euro’s 20 percent rally against the British pound and New Zealand dollar and 27 percent decline against the Japanese Yen. However the mild year over year change in the EUR/USD masks a tremendous amount of volatility during the year. In the first half of 2008, the EUR/USD soared to a record high above 1.60. After that, it fell 22 percent to a 2 year low but recovered more than half of those losses in the month of December.

Eurozone’s to Underperform in 2009, Expect a Prolonged Recession

It is no secret that 2009 will be a tough year for many countries, but things will be particularly difficult in the Eurozone. Every major central bank has cut interest aggressively, driving their currencies significantly lower in 2008. The ECB on the other hand has been reluctant to follow suit, leaving the Euro only marginally lower for the year. Although the Eurozone is in a recession, growth has not been nearly as weak as the US. Annualized GDP growth in the Eurozone during the third quarter was +0.6 percent, compared to -0.5 percent in the US. The Eurozone’s outperformance in 2008 however could be short-lived as the central bank forecasts a 1 percent contraction in growth next year. As an export dependent region, the strength of the Euro will make a recovery difficult. German companies have already scaled back production as global demand eases. Looking ahead, unemployment is expected to rise, slowing consumer spending and forcing the ECB to continue to cut interest rates. If German unemployment hits 9 percent, we could easily see Eurozone rates hit 1 percent.

ECB Could Become One of the Most Aggressive Central Banks in 2009

Next to the Bank of Japan, the ECB has been the least aggressive central bank in 2008, having cut interest rates by only 150bp to 2.5 percent (counting the 25bp rate hike, their total easing is 175bp YTD). Compared to the 400bp rate cut from the Federal Reserve and the 350bp rate cut from the Bank of England, the ECB’s nimble move singlehandedly prevented the Euro from collapsing alongside the British pound, New Zealand and Australian dollars. However in face of slowing growth, it will be difficult for the ECB to hold onto their conservative monetary policy stance – they are expected to cut interest rates by 100bp in 2009. The ECB was behind the curve in 2008 and the biggest risk for the Euro in 2009 is whether the central bank’s sluggish policies catch up to them. In December, the EUR/USD soared on speculation that the ECB may refrain from cutting interest rates in January. At a time when everyone who still has room to cut interest rates are cutting them, a pause by the ECB could spur a EUR/USD rally above 1.45. However, with that in mind the ECB first hinted about pausing when the EUR/USD was trading at 1.25. The 13 percent rally in the currency pair since then increases the chance of a rate cut because a stronger currency hurts the economy. But a pause does not mean an end to the easing cycle. Beyond January, we still believe that significantly slower growth will force the ECB to cut interest rates by another 100bp. More importantly, the ECB will be cutting interest rates at a time when the Federal Reserve and the Bank of England are done easing. If the Eurozone underperforms the US economy in the second half of the year and the ECB is still cutting interest rates, a prolonged recession and prolonged easing could lead to a major reversal in the EUR/USD in 2009. Only if the economy proves to be resilient or if another major shock hits the US economy can we see a new high in the Euro.

Inflation Could Remain above ECB’s Target in 2009

One of the primary reasons why the ECB has been reluctant to ease rates aggressively in 2008 is inflation. The central bank has a 2 percent inflation target and consumer prices remained above the target throughout the year. In fact, the ECB became so alarmed in July when annualized CPI soared to a high of 4 percent that they raised interest rates by 25bp. Although the fall in oil prices has driven inflation lower by the largest amount in 20 years, CPI is still expected to remain above the ECB’s target in 2009.

Be Careful of a Run on the Dollar

Another major risk next year is a run on the US dollar. The global slowdown has forced many central banks around the world to become internally focused. This means that any excess money will be spent on spurring growth domestically instead of funding the US deficit. With next to zero yield, a deteriorating balance sheet and the risk of a weaker dollar eroding the notional value of any US investments, there are almost no reasons for foreign investors to load up on US debt. Having been burned badly by investments in Fannie and Freddie Mac, sovereign wealth funds like China have become skeptical of buying more US paper. According to an editorial in the state owned newspaper, China Daily, “China’s increased purchase of U.S. Treasury securities should not be interpreted as an endorsement of the assumption that the U.S. can borrow its way out of the current financial crisis.” If dollar demand continues to wane, it is another factor that could drive the dollar lower in the first half of 2009.

Political Risk

There will be 2 elections in Europe in next year– the election for the new Chancellor of Germany and elections for European Parliament. In Germany, Chancellor Angela Merkel is expected to take on her foreign minister Frank Walter Steinmeier. With an economy in turmoil, it is difficult to tell who will win but if it is another close election like one in 2005, we could see the Euro come under selling pressure. When both Merkel and Schroeder declared a victory in September 2005, the EUR/USD plunged as political uncertainty hit the currency. The European Parliament elections in June will be the largest transnational democratic election in history with over 700 members set to be voted in by 515 million EU citizens. For the currency market, the only implication is the possibility of legislative activity coming to a standstill in the spring as the European Parliament prepares for the election.

Technical Outlook for the EUR/USD

It is probably not a coincidence that the rally in the EUR/USD in December stopped right at the 50-week Simple Moving Average, which is hovering above the 61.8 percent Fibonacci retracement of the 1.60 to 1.23 bear wave. According to our Bollinger Bands, the EUR/USD is now within the Range Trading Zone. As long as it holds above 1.3760, the 38.2% Fibonacci support level, we could see a rally back towards 1.42. However, a break of 1.4685 is needed for the currency pair to have any chance of retesting its record highs. On the downside, a break of 1.30 would resurrect the downtrend.



British Pound 2009 Forecast

How Did the British Pound Trade in 2008?

The British pound was one of the worst performing currencies in 2008. It fell to a 6 year low against the US dollar and record low against the Euro in addition to selling off against every other G10 currency. The overwhelming weakness in the currency is a direct reflection of the impact that the credit crisis had on the UK economy. In the month of December, many currencies recovered against the US dollar, but unfortunately the British pound was not one of them. Although the pound could continue to weaken in the first quarter, the government’s aggressive fiscal and monetary stimulus should help the country recover towards the end of 2009.

Official Recession in 2009

Without two consecutive quarters of negative GDP growth, the UK economy is not technically in a recession but that should change in the first quarter of 2009, when the 2008 Q4 GDP numbers are released. Growth has been slowing materially and the weakness is reflected in the British pound. GDP growth fell by 0.6 percent in the third quarter, the largest decline in 18 years. The housing market and the financial sector have been the engine of growth in UK for the past few years and both blew up in 2008. Unfortunately the worst is probably not over for the 2 key components of the UK economy, particularly following the Bernie Madoff’s Ponzi scheme. In addition to losses suffered from the subprime mortgage crisis, many large hedge funds and European banks invested with Madoff’s. In 2009, they will be forced to write down those losses and deal with what could be pretty severe consequences for the financial sector as a whole. With the financial and housing market sectors expected to remain weak in the first half of 2009 and layoffs predicted to rise, GDP growth could fall as much as 2 percent next year. Although we believe that the country could be one of the first to recovery from the global economic downturn, this will not before more pain is felt in the UK economy. The severity of the UK recession will be largely dependent upon how quickly the credit markets are restored in 2009.

Inflation to Fall Back to 2%

Even though falling oil prices has driven inflation lower in the UK, the annualized pace of consumer price growth is still well above the central bank’s 2 percent target and even higher than their 3 percent upper limit. The latest data is for the month of October and according to that report, consumer prices rose 4.1 percent yoy. Despite the high level of inflation, the central bank has pretty much abandoned the inflation target and shifted their focus back to growth because they believe that the slowdown in the economy will naturally drive inflation lower. They believe inflation could fall back to 2 percent as early as the first quarter.

More Rate Cuts in First Half of 2009

Next to the Federal Reserve, the Bank of England has been the most aggressive central bank in 2008, having cut interest rates by 350bp to 2 percent, the lowest level in 57 years. Despite the massive interest rate cuts, tax cuts and other fiscal stimulus, the Bank of England remains committed to doing all that it takes to prevent a recession from sparking deflation. Central Bank Governor King believes that the economy will contract in 2009 and given his pledge UK interest rates could fall by another 100bp in the first half of the year. Although zero interest rates are not expected in the UK, interest rates will fall below 2 percent and until the Bank of England is done easing, the British pound may remain weak.

EUR/GBP at Parity

The sell-off of the British pound in the first few months of the year could drive EUR/GBP to parity. If that happens, it would be the first time ever that one Euro would be worth more than one British pound. This could not come at a better time than 2009, when the Euro celebrates its 10-year anniversary. In this past decade, the currency has risen from ashes to become more valuable than the 2 primary reserve currencies in the world. Although many Britons may be alarmed at the weakness of their exchange rate, the Bank of England will probably not step in to stop it from falling. Instead, the BoE will revel in the stimulative effects of a weak currency. There are already reports of Europeans from the Eurozone flocking to the UK for their holidays. The weakness of the British pound against both the US dollar and the Euro are key ingredients for an economic recovery.

Keep an Eye Out for a Recovery

Although the UK economy still faces many risks in 2009, there is hope. Consumer spending has been pretty resilient with November retail sales rising for the first time in 3 months. If the global economy begins to recover, we expect the UK economy to outperform its peers thanks to the Bank of England’s proactiveness. The currency has sold off significantly, providing additional stimulus for the battered economy. Even if there is no full-blown recovery, the UK economy is much further long in their slowdown than the Eurozone. Therefore if we see sharply weaker growth in the Eurozone economy in 2009, expectations for more aggressive ECB interest rate cuts may be all that the British pound needs to recover against the Euro. As for the US dollar, the recovery could come sooner if the quantitative easing forces the greenback lower. When the UK economy begins to recover, so will its currency.

Technical Outlook for the GBP/USD

The British pound experienced a drastic sell-off throughout the year as the price tumbled to a level not seen since 2002. The pair lost roughly 5000 pips as the BOE reduced the interest rates far more aggressively than other central banks. Currently, the pair is well below the 200-week and 50-week SMA reflecting in the change of the trend from an upward to a downward bias. Nevertheless, the pair seems to be oversold for the time being, needing a major retracement if it will continue to depreciate further. The pair still remains in the sell zone that is established using the Bollinger Bands, and until the price closes above the 1st Standard Deviation we could experience a further downtrend. Although the pair is destined to retrace at some point during the following year, the price still remains within reach of breaking further establishing a prolonged downward trend. Near term resistance is at 1.5723, the December high. The currency pair could hold above 1.45, but if it breaks that level, the next meaningful support is not until 1.40, which served support from 2000 to 2001.



Japanese Yen 2009 Forecast

How Did the Japanese Yen Trade in 2008?

The global economic turmoil and the subsequent unwinding of carry trades made the Japanese Yen, the best performing currency of 2008. The Yen rose more than 35 percent against the British pound, Australian and New Zealand dollars and hit a 13-year high against the US dollar. Unlike some of the other currencies, which may have seen wild swings throughout 2008, the Yen consistently strength throughout the year. Unfortunately the remarkable rally in the Yen will also be a big reason why Japan could underperform, its peers next year.

Japan Could be the Worst Performing Country in 2009

Of all the countries in the developed world, Japan will probably have the toughest time in 2009 because of the strength of its currency. As an export dependent nation, Japan typically runs a trade surplus but this year we have seen the country report trade deficits, which is extremely rare. Toyota, the world’s largest carmaker is the highest profile casualty of Yen strength. The automaker reported their first lost in 70 years as sales plummeted and the Yen soared. The toxic combination of a weak economy and a 16 percent rise in the yen against the US dollar has been disastrous for the automaker. Although Toyota is probably the most high profile, they are certainly not the only major Japanese corporation to be hit by the double whammy of a slowing global economy and a strong currency. Business sentiment across the country has already fallen to a 7 year low as exports decline by a record amount. Unless the Yen’s strength is suddenly reversed, we expect Japanese corporations to report more losses in the months to come. As of the third quarter of 2008, Japan is in a recession with growth shrinking by an annualized pace of 1.8 percent. Next year, GDP growth is expected to fall by 2.5 to 4 percent as weak domestic and international demand hits the economy. However it is important for currency traders to realize that the Japanese Yen does not always trade off economic fundamentals. The outlook for Japan has been bleak for months now, yet the currency is rallying because risk appetite has been the dominant driver of the currency’s price action. If the market is very nervous about the global economy, the Yen could still rise even if Japan’s economy continues to deteriorate.

Inflation: Consumer Prices Could Turn Negative in 2009

Like the rest of the world, inflation is slowing in Japan, but consumer prices still remain in positive territory. Nationwide, the latest data we have is from the month of November. During that month, annualized CPI growth slowed from 1.7 to 1.0 percent. However the combination of a strong currency and the continual decline in commodity prices could drive consumer prices into negative territory next year. A strong currency moderates inflationary pressures while a weak currency boosts it.

No More Room to Cut Interest Rates

With interest rates already at 0.5 percent in January 2008, we were surprised to see two obscurely sized rate cuts by the Bank of Japan that took interest rates down to 0.1 percent, within a whisker of zero. Although the BoJ Governor denies it, the rate cuts combined with plans to buy commercial paper and increase purchases of government debt essentially returns the country to quantitative easing. The only reason why the BoJ did not take interest rates to zero is because they do not want kill the repo market or give the public the perception that they have run out of ammunition. Looking ahead, we have probably seen the last of BoJ rate cuts and the central bank will need to rely on fiscal policy and a further expansion of the balance sheet to stabilize the economy.

Will Carry Trades Recover?

Between 2001 and 2006, one of the most lucrative strategies in the currency market was carry trades. However anyone long carry in 2008 was burned badly - GBP/JPY for example fell 41 percent to a 13 year low while NZD/JPY fell 39 percent to a 7 year low. Record volatility, massive deleveraging and global interest rate cuts created a toxic combination for carry trades. In order for carry trades to recover, central banks need to stop cutting interest rates, volatility needs to decline significantly and the global economy needs to recover enough for investors to be willing to start taking on risk. This could happen in 2009 but not until the second half of the year at the earliest.

Risk of BoJ Intervention

In the face of a deepening recession, a strong currency and little room to move on interest rates, everyone is wondering whether the Bank of Japan will physically intervene to weaken its currency. The problem is that the only type of intervention that has ever really worked is coordinated intervention and the BoJ will have a very tough time convincing the Americans and Europeans to take any steps that would strengthen their currencies. Since the problem is not unique Japan and stems from the West, the Japanese needs to stand aside and allow the US and Eurozone governments to work on spurring their own growth. If they weaken their currency and strengthen the dollar for their own short-term relief, it could actually be counterproductive. However with that in mind, as the economy worsens and the central bank runs out of options, intervention risk will grow.

Technical Outlook for USD/JPY

As you can see from the weekly chart of USD/JPY, the sell-off in the currency pair has been severe. Currently, the price is well below the 200-week and 50-week SMA and at the level not experienced since 1995. This puts USD/JPY in the Bollinger Band sell zone and even though a retracement could imminent, it could be an opportunity to sell rallies than buy on dips. The closest level of support is at the 161.8% Fibonacci extension of a low established in late 2007 and the high for the 2008 at 86.50. Resistance is at 94, the 10-week SMA.



Kathy Lien is Director of Currency Research at GFT, and runs KathyLien.com.