【May 7th Trade Strategy】The major market move is finally starting ～Tetsu Emori's Real Trading Strategy～
Tetsu Emori's Real Trading Strategy May 7, 2018 8:23 AM
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〔EQUITY MARKET〕
【Market commentary and analysis of U.S. stocks and Western bond markets】
U.S. stocks advanced sharply. Buying in tech stocks led by Apple sent the Dow Jones Industrial Average back into the 24,000s, and the Nasdaq Composite also rose substantially. In Beijing, negotiations on avoiding a U.S.–China trade war, held on the 3–4th, showed no notable progress, and the market began with selling on concerns about a prolonged trade frictio n. The Dow fell briefly by more than 150 points early on. However, the sharp rise in Apple shares improved investor sentiment. Berkshire Hathaway, led by Warren Buffett, was reported to have increased its Apple holdings by 75 million shares in the first quarter, which was seen as a bullish factor.
The rally helped to dispel concerns about weak iPhone X sales, and investor demand recovered. As a result, Berkshire Hathaway rose to become Apple’s second-largest shareholder, with a stake of 4.7% (up from 3.3% at the end of last year). Apple stock posted the largest weekly gain since October 2011. In addition, tech stocks such as Alphabet and Facebook attracted buying. Apple rose 3.9%, Alphabet 2.4%, Netflix 2.7%, Facebook 1.5%, and Microsoft 1.2%, all firm. In April’s U.S. jobs report, the average hourly earnings, a leading indicator of inflation, rose 0.1% month over month, below market expectations of 0.2%, indicating wage inflation pressures remain weak. In response, expectations for a slower pace of Fed rate hikes spread, contributing to investor comfort in buying. According to Thomson Reuters, S&P 500 component companies are expected to report first-quarter 2018 earnings up 25.7% year over year. So far, 409 of 500 companies have reported, and the proportion beating profit estimates is 79.2%, above the long-term average of 64% and the four-quarter average of 75%. First-quarter revenue is expected to grow 8.4%. For 2018 Q2, the number of companies forecasting per-share earnings to deteriorate or miss estimates stands at 35, while 27 expect improvements or above estimates. The forward four-quarter P/E for S&P 500 constituents stands at 16.1x. The week starting May 7 is set to see 44 companies reporting quarterly results.
The April employment data showed the unemployment rate at 3.9%, down from 4.1% in the prior month, marking a return below 4% for the first time in 17 years and 4 months since December 2000. This reinforced the view of a robust expansion. Nonfarm payrolls rose by 164,000 in the month, with growth accelerating from the prior month. Private sector payrolls increased by 168,000 (versus 135,000 previously), with goods-producing sectors adding 49,000, mining and logging increasing by 8,000, construction by 17,000, and manufacturing by 24,000. The services sector added 119,000. Government payrolls fell by 4,000. The average hourly wage was $26.84, up 0.04 from the prior month. Year over year, wages were up 2.6%. The average workweek remained at 34.5 hours, and the labor force participation rate stood at 62.8%, down 0.1 percentage point. Both long-term unemployed (six months or more) and those who want full-time work but can only find part-time jobs declined.
On the other hand, U.S.–China trade frictions are becoming more complex. Both sides pressed sanctions and countermeasures against each other, but the Trump administration’s decision to ban U.S. companies from doing business with China’s telecom giant ZTE has put China’s plan to cultivate a high-tech industry centered on that company into a difficult position. In April, the U.S. Department of Commerce announced a seven-year ban on exports of parts to ZTE. In China, there is growing concern that without core components from U.S. firms, ZTE could go bankrupt. The Trump administration is also reportedly considering product sales restrictions on Huawei for national-security reasons, making two Chinese tech stalwarts targets. The administration is wary of China’s industrial policy “Made in China 2025,” which aims for China to lead global manufacturing by 2049; first targeting aims for the 2025 milestone to join the ranks of leading manufacturing powers. U.S. representatives reportedly pressed for immediate cessation of industry support based on this policy during talks through the 4th. For a country like China, where the economy relies on state-led development, this is hard to accept. Yet China also needs to resume rapid commerce with U.S. firms such as ZTE. The Chinese side’s strong protests about the trade ban in this round of talks suggest that negotiations are leaning in the U.S. direction.
Prime Minister Abe spoke by phone with Chinese President Xi Jinping on the 4th. It was the first such phone call between Japan’s prime minister and China’s president, but Abe emphasized that “the improvement in Japan–China relations is progressing, and it is extremely important to demonstrate to the international community that we will cooperate closely on international issues like the North Korea issue.” They also agreed with Xi that the inclusion of complete denuclearization in the Panmunjom Declaration should be evaluated positively, and that “North Korea must take concrete actions, and we must work with the international community to urge it to do so.” Abe also expressed renewed respect for Xi’s efforts toward resolving North Korea’s nuclear and missile issues. They also agreed to continue coordinating on this issue going forward. This month Li Keqiang is scheduled to visit Japan for the first time by a Chinese premier in eight years. Using this high-level exchange as an opportunity, both countries agreed to dramatically expand people-to-people exchanges across all fields and to take Japan–China relations to a new stage in time for the 40th anniversary of the Japan–China Peace and Friendship Treaty.
South Korea’s Moon Jae-in also spoke by phone with Xi on the 4th to explain the results of the April 27 inter-Korean summit. Xi congratulated Moon on the success of the talks and stated that North Korea’s denuclearization depends on the outcome of the U.S.–North Korea summit, and called for stronger China–Korea cooperation. Xi added that North Korea’s Kim Jong-un, during a visit by Chinese State Councilor and Foreign Minister Wang Yi, reaffirmed a willingness to denuclearize, including closing the nuclear test site. Moon and Xi reportedly agreed to declare an end to the Korean War by year’s end and for Kim to express strong intent to end the hostile history on the peninsula. Moon told Xi that China’s contribution is important for complete denuclearization and lasting peace on the Korean Peninsula, and the two leaders agreed to actively cooperate toward the end-of-war declaration and toward transforming the armistice agreement into a peace treaty.
Meanwhile, President Trump said that the U.S.–North Korea summit with Chairman Kim Jong-un, planned for early June, has “a date and a venue set. It will be announced soon.” The Panmunjom area at the armistice line is a strong candidate, but third countries such as Singapore are also being considered. Trump has previously indicated that holding it at Panmunjom would be a wonderful celebration if the talks go well, showing a favorable attitude toward that location. However, aides to Trump are reported to be leaning toward neutral sites like Singapore. Regarding the three U.S. citizens detained in North Korea, Trump said, “Much has already occurred. We will see something very good soon,” suggesting a possible release. If these three are released, the Trump administration would view this as a goodwill gesture to help foster trust ahead of the summit.
U.S. Treasuries yielded only modestly. Following the April employment report, the 10-year and 30-year yields briefly touched a two-week low, while the 2-year yield also fell to a one-week low. The 10-year yield stood at 2.9440%, the 30-year at 3.1140%, and the 2-year at 2.5010%. The yield spread narrowed to 0.4430%. At one point it briefly contracted to 0.4390%, a two-week low. NY Fed President William Dudley described the economy’s outlook as “extremely favorable for next year” and said the economy is growing above potential. He added that both the household and corporate sectors are in good shape and that it would be surprising if the expansion ends next year. He also noted that longer-term risks include uncertain trade policy and rising federal deficits. San Francisco Fed President Williams said the Fed should continue with gradual rate hikes and suggested that 3–4 rate increases this year would be appropriate. He also indicated that an increase of 80,000–120,000 in nonfarm payrolls would keep the economy solid and that unemployment could fall to 3.5% with inflation not rising sharply. Williams is due to become the president of the NY Fed on June 18. Atlanta Fed President Bostic, who votes on FOMC, described the U.S. economy’s outlook as favorable and expressed strong support for two more rate hikes this year. He also pointed out that stimulative effects from tax cuts and increased spending could push the economy above trend, and that there are few signs of inflation running hot. He also estimates the neutral rate at about 2.5%. In contrast, Fed Vice Chair for Supervision (Regulation) Randal K. Quarles stated that the Fed does not target asset prices, and “a rate cut will not be made merely because stock prices fall sharply.” He warned against relying on stock-price moves to signal the real economy, stressing that the Fed should not act based on such price swings alone.
The euro-area financial and bond markets saw generally higher yields. The euro-area 10-year yield rose by about 2–4 basis points to around 0.52% at one point, with the German 10-year yield at 0.545%. After the U.S. employment data, there were moments when it fell to as low as 0.52%. In Italy, political uncertainty pushed Italian government bond yields higher, with the 10-year yield rising to 1.97%. Since March elections, coalition-forming talks have stalled, and President Mattarella is scheduled to meet party leaders on the 7th.
【U.S. stock trading strategy】
No change to the long strategy. The Dow narrowly rebounded, reclaiming the 24,000 level. This confirms that the market has not broken the 200-day moving average and suggests the floor may be holding. If the Dow recovers to around 24,300, there is a possibility of topping the 25,000 level soon, which could reduce downward pressure. As earnings of S&P 500 companies have been strong and P/E ratios have declined, improved sentiment should reduce the risk of further declines. The Nasdaq index shows technology-led strength in U.S. equities, and looks likely to resume strong movement this week. If this continues, broad U.S. stock gains could be led by tech stocks. In that case, the Dow could rise above 25,000 and the S&P 500 above 2,700, turning the earlier soft market into an uptrend. If that happens, the first eight years of the long-term uptrend that have been discussed could extend into the range up to around 2020. The level at which a long-term trend would be considered ended is around 20,500 on the Dow, 2,300 on the S&P 500, and 5,750 on the Nasdaq—substantially lower levels. It would not be prudent to fear this at the current stage. For long-term investors, recent retracements are not painful. Looking at the long-term horizon, future price levels are higher than today, so the investment posture should be “buy on dips.” If weak movement persists, I will gradually add to positions. If rates rise, some may view that as a negative, but that is not correct. As long as U.S. long-term rates rise toward roughly 3.5–4%, stock prices may rise by about 25%. That is a normal path. I expect Dow at 30,500 and S&P 500 at 3,300 in the future.
［Reprint］The Dow’s long-term trend end level is around 19,000. This is a rather low threshold, so for short-term trading you should monitor these levels, but for long-term investing there is no problem. Continue buying the dips. Of course, it is not that simple, so you should also watch price action. Still, with solid corporate earnings, stock prices should eventually recover. If that is the case, the discrepancy between prices and fundamentals should be used to enhance returns. The USD/JPY has risen to the high 109s. The Bank of Japan’s quarterly Tankan shows the expected FX rate for the current year at 109.66; it has surpassed that. While a decline in profits is possible, it should not turn into a negative earnings situation. The Nikkei 225’s price-earnings ratio sits in the 13x area, still undervalued. In the short term, technical indicators may show overheating, but a truly strong market will rise regardless. Many individual and institutional investors appear not to have recognized this yet. Since the stock-price rebound since February, bearish sentiment has surged. North Korea remains a concern, but it should not derail everything. The core of stock-price formation is corporate earnings. If valuations look cheap today, they should recover. In addition to long-term trends, it is essential to compare corporate earnings with stock prices to time entries and exits reasonably well.
【Dow Jones Industrial Average: 2018 Expected Range】
Bull case 24,236–28,287 (year-end 27,996) / Bear case 20,995–25,130 (year-end 22,790)
【Dow Jones: May Range】
Bull case 25,485–26,672 / Bear case 23,933–25,064
【S&P 500: 2018 Expected Range】
Bull case 2,614–3,107 (year-end 3,076) / Bear case 2,255–2,734 (year-end 2,419)
【S&P 500: May Range】
Bull case 2,745–2,885 / Bear case 2,581–2,706
【Nasdaq Composite: 2018 Expected Range】
Bull case 6,747–8,375 (year-end 8,282) / Bear case 5,348–7,199 (year-end 5,702)
【Nasdaq Composite: May Range】
Bull case 7,131–7,555 / Bear case 6,177–6,770
【U.S. Treasuries Trading Strategy】
Maintain the strategy of going short on 2-year Treasuries and long on 10-year Treasuries, betting on a flattening of the yield curve.
【Japan Stock Market: Market Commentary/Analysis】
［Repost］On the 2nd, the Nikkei index closed down 35 points, down for the fourth day, as selling to secure near-term profits held some sway. 38% of stocks declined, while 58% rose. The dollar/yen appreciated as the yen weakened and the dollar strengthened around the 109 level; after this, ahead of the second half of the long holiday period, profit-taking trades gradually became dominant. However, buy orders were seen in positions where earnings were strong, so the Nikkei’s decline was limited. In the U.S., the FOMC was in session, and investors were watching for the results and April’s jobs data due on the 4th, which could lead Western short-term funds to trim positions temporarily but may have kept a lid on upside. If the long holidays end and the yen remains soft, the prospect for further earnings growth could push stock prices higher after all.
【Nikkei 225 Futures Trading Strategy】
Maintain the long strategy. In Chicago, the trend remains intact with the index rising to as high as 22,510 yen, and the trend is still pointing upward. The dollar/yen is also holding in the 109s, suggesting a genuine move higher may begin this week. If the close exceeds 22,600 yen, the market may shift into a bull phase. With the Golden Week over and investors returning, I would look to add on strength. There are no current short-term trading positions. Since prices have broken higher, I plan to take on a modest long position. The core long from lower levels remains. There should be further opportunities for trading profits. This move would have already generated around 500-yen per trade in 5–10 rounds, bringing in corresponding gains. If prices retreat, I will maintain a policy of buying gradually. Target levels include 21,750; 21,500; 21,250; 21,000; at these levels I will add to long positions again. The lower bound of the May bull-range is 23,570. If prices do not surpass this, the market cannot be considered bullish. The hurdle is not low, but the odds remain favorable. First, surpass the upper bound of the bearish-range, 23,320, clearly. If so, the market mood should improve significantly.
［Reprint］The level at which I would judge that the long-term trend has ended is 19,000. It is a very low level, so for short-term trading you should monitor these levels, but for long-term investing there is no problem. Keep buying the dips. Of course, this is not easy, so you will also have to monitor price movements. Still, if corporate earnings stay solid, prices should eventually rise. Except for short-term trading, a careful comparison of long-term trends, corporate earnings, and stock prices should keep timing reasonable and avoid large misses.
【Nikkei 225 Index: 2018 Expected Range】
Bull 22,089–27,115 (year-end 26,839) / Bear 18,745–23,688 (year-end 19,392)
【Nikkei 225: May Range】
Bull 23,568–25,220 / Bear 21,784–23,316
【TOPIX: 2018 Expected Range】
Bull 1,779–2,168 (year-end 2,150) / Bear 1,523–1,883 (year-end 1,578)
【TOPIX: May Range】
Bull 1,903–2,025 / Bear 1,746–1,855
〔CURRENCY MARKET〕
The USD/JPY is little lower. While yen buying and dollar selling briefly dominated after the U.S. jobs data, the upside has since been capped. In April’s payroll report, nonfarm payrolls grew less than market expectations, sending the dollar lower to around 108.62 yen on the initial reaction. This was attributed to the belief that weather factors had restrained employment growth, but with the unemployment rate improving to 3.9%—the lowest in about 17 years and 4 months—markets viewed June rate hikes as more justifiable. Attention also focused on speeches by Fed officials. The dollar index briefly rose to 92.90, a level not seen since December 28 of the previous year, and the dollar appreciated versus the Swiss franc briefly to 1.0022 francs, breaking parity. With major central banks gradually withdrawing stimulus, the Fed is expected to continue rate hikes, supporting a stronger dollar. This outlook suggests the dollar will rise unless European indicators improve or the ECB signals hikes. April’s euro-area flash PMI indicated an improving but still uncertain economy with the composite PMI at 55.1, down from 55.2 in March, though new orders remained high. The services PMI was revised to 54.7 from a preliminary 55.0. The output price index was 51.8, down from 52.1 in March, the lowest in seven months. CFTC data showed that by May 1, non-commercial traders reduced their net shorts on the dollar across the six major currencies (JPY, EUR, GBP, CHF, CAD, AUD) to $15.15 billion from $19.77 billion the prior week; net shorts for ten currencies including NZD, MXN, BRL, and RUB fell to $18.32 billion from $23.81 billion. However, CHF shorts remained elevated at 194,56 contracts since February. The yen shifted from net buying to net selling by 1,405 contracts the prior week.
【Currency Trading Strategy】
We will stay out of USD/JPY. It remains in a short-term downtrend, so we will first confirm a bottom. There is room to move lower, and in principle we should short. However, if U.S. equities rally and Japanese equities do not fall, USD/JPY could rise as carry trades support it. If we can reclaim 109.40, the pair could move higher. A move beyond 110 would improve the market tone further. In the near term, we will watch whether this develops. If it declines, I want to see if it finds support around 108.35; if so and if it becomes oversold, a bottom could form there. Right now, dollar buying is advancing, so USD/JPY may rise. This is due to U.S. repatriation flows stimulated by Trump’s tax cuts—something many Japanese bankers and brokers may not realize, as they lack access to overseas flow information. Regardless, since we did not breach 110, the adjustment will take priority. The 110 level sits on a long- and medium-term trend line; if we cannot break it, a stronger yen trend will continue. The theoretical value of USD/JPY, based on the real interest rate differential between the U.S. and Japan, was around 111.65 yen at the end of April, implying upside room. However, if we cannot break 110.15, the trend remains weak. Of course, if we break 110.15, we should ride the momentum. The U.S. jobs data were not particularly decisive, but the dollar’s uptrend remains intact. With rising U.S. long-term yields and a weaker European currency, USD/JPY looks more ascendant. Yet it remains to be seen whether the U.S. will allow a substantial depreciation of the yen. “FX moves are driven primarily by interest rates in the short term, and by politics in the long term,” so levels around 110 may not be easily breached. If inflation rises due to higher oil prices, the theory would be that dollar weakness is possible, yet higher rates could push the dollar higher via real rates. Caution is warranted. To restore a bullish trend, a sizable yen depreciation would be necessary, and I believe there is a ceiling to yen depreciation.
EUR/JPY is being watched. It’s oversold, but there is a risk the trend could break. Long-term support sits around 128. As long as this holds, long positions remain favorable. If it retreats and then rebounds, I would consider adding to longs at that point. A move back to 131 would be a trigger to consider adding longs. The theoretical value based on real rate differentials is around 131.
EUR/USD is being watched. It is oversold and attempting a rebound. If it can reclaim 1.1970, I would consider going long. There remains a downside risk toward around 1.1650, so proceed cautiously. It is unlikely to move above 1.25 this year. By the way, the theoretical value for EUR/USD based on real rate differentials is about 1.1735. There is a long-term trendline near 1.17. If it falls to this level, going long there would carry little risk.
GBP/JPY is being covered by buying back shorts. It has broken below 152 and is in a downtrend, but the move has been oversold and it found support at 147, so I will buy back for now. If it goes above 148.50, I will consider a long. The theoretical value based on real rate differentials is around 167.85. The current level is quite undervalued.
GBP/USD is being watched. It is oversold, and I will consider longs on a rebound. If it holds at 1.3540, the rebound is more likely. The long-term trend is around 1.3875. The theoretical value based on real rate differentials is around 1.4970. The current level is quite undervalued.
AUD/JPY will buy back the short. It is testing a rebound from an oversold level, so I’ll buy back and look to re-sell. The target is around 82.75. If hit, I will consider re-shorting. Long-term resistance sits around 86, so selling on rallies is advantageous up to there. The theoretical value based on the real rate differential is around 83.60. This is fairly close to fair value.
AUD/USD is being watched. It is in a rebound from an oversold state; it should move back to 0.7640, after which I will sell again when overbought. The basic stance is to stay bearish until the long-term trend of 0.78 is breached. The theoretical value based on the real rate differential is around 0.7460. The current level is roughly fair value.
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