WHATEVER you plan to trade, David Morrison, CFD market strategist for GFT, suggests these five indicators to help gauge market conditions.
1. DOLLAR INDEX
Since 1973, this index has tracked the strength of the dollar against a basket of other major currencies, including sterling, yen and the Swiss franc. Benchmarked initially at 100, it has traded as low as 70 (in 2008) and as high as 148 (in 1985). With major commodities quoted in dollars, the index also indicates the health of that market. David Morrison points out that the dollar index has broken below multi-year trend lines on the downside. There has been a bit of a bounce recently. Watch for signs of a major trend reversal.
2. BOND YIELDS
Bond yields, especially 10-year yields, are all worth following. Eyes are on spreads of Eurozone bonds, US Treasury notes and, to a lesser extent, UK gilts.
On the T-bill front, with the end of the second round of quantitative easing (QE2) in sight, and the Federal Reserve pulling away from propping up US Treasuries, one would expect Treasury prices to come down.
A healthy range for US bond yields, which move inversely to prices, is between 3 and 4 per cent in the present climate. Any breakout from this band ought to trigger alarm bells for traders.
There is potential for some shake-up in the bonds market, depending on whether QE2 becomes QE3. According to Nick Beecroft, senior markets consultant for Saxo Bank, “inflation expectations for a year from now, which are always closely correlated with the contemporary releases of headline CPI figures, fell sharply from 4.4 per cent to 4.1 per cent, but much more importantly, the five year ahead expectation figure also fell back to 2.9 per cent.” This may alter the Fed’s thinking. Beecroft says: “It will calm the hawks and trouble the doves, who mourn the passing of QE2, lending yet more support to the growing expectation that QE3 is more than just a twinkle in the FOMC’s eye.”
3. CRUDE OIL
Ever since Fed chairman Ben Bernanke’s speech at Jackson Hole last August, that paved the way to QE2, oil has been climbing and climbing. Combined with the geopolitical instability throughout the year to date, crude has soared.
Oil prices are highly speculative and are perhaps the biggest anti-dollar trend out there. It is difficult to know how much of the price is driven by markets and how much is price gouging. With the soaring price, there will be some demand destruction, but there is only so much of this possible due to the level of reliance upon the black gold.
4. PRECIOUS METALS
Precious metals are for some the only real money. Gold has been the headline-grabbing precious metal this year, seeing a large amount of investor inflows during periods of market volatility.
Most stock indices this year have fallen when priced in gold. According to David Morrison, “over the last 20 years, central banks have been net sellers of gold. Now they are net buyers, especially in emerging markets – China in particular – as central banks want to diversify out of their euro, dollar and yen holdings.”
5. VOLATILITY INDEX
The volatility index is calculated by the Chicago Board of Options Exchange (CBOE) which launched the VIX in 1993, tracking the S&P 500. Markets will typically see a VIX level of between 15 and 16 per cent. Anything above this is a sign of nervousness in the market. 2008 saw numbers as high as 90 and, in the flash crash of May last year, we had numbers around the 45 mark.
If traders keep an eye on these five market barometers, they should be able to spot any storms on the horizon.