Range Bound Markets

In case you haven’t noticed, things have been kind of range bound over the past month or so for the major currency pairs as well as the S&P 500. Understanding why that’s happening  will lead you into the next trend when conditions change, setting up a good trade.

For many traders, this kind of back and forth movement is much harder to trade than when prices are moving in a trend. I posted a long trade on GBP/JPY and AUD/JPY May 26 on twitter that returned about 1000 pips by June 1 but on June 8 I said “it isn’t a good time to trade currencies due to the lack of a strong fundamental driver.”

This is exactly where trend-following trading systems fail, because there’s no indicator to tell you that markets will go range bound. You have to rely on fundamentals (and your instinct) in order to make a judgment call like that.

While there are a number of arguments that can be made regarding why this is occurring now, for my money it’s the fundamental state of the economy which is dictating the action here at the end of the second quarter. Simply put, it appears that a depression has been avoided and that the recession is slowly coming to an end.  But what also appears to be the case is that the economy will remain sluggish for a period far beyond the end of the recession as the unemployment rate edges inexorably towards 10% (or higher).

This is the view of none other than Nouriel Roubini, who believes that 2010 will “fell like a recession” even if the economy is technically out of one. Meanwhile, San Francisco Federal Reserve Bank President Janet Yellen believes that although the recession is likely to end later in 2009, a “frustratingly slow” recovery marked by continued high unemployment is likely to follow.

“I am not optimistic that the economy will spring back to normal anytime soon,” she said on Tuesday during a scheduled speech. “I’m more concerned that we will be tempted to tighten policy too soon, thereby aborting recovery.”

Unemployment will “remain painfully high for several more years,” she said, which obviously points to more troubled loans for the banks in both residential and commercial mortgages.

She also implied that policy makers will leave the Fed Funds Rate near zero for the next several years, saying that such a policy is “not outside the realm of possibility,” in the press conference which followed her remarks.

Here’s something interesting I found on Bloomberg regarding a Goldman Sachs currency trade:

“Goldman Sachs exited a bet that the Canadian dollar would strengthen versus the Mexican peso,” the article said. “Goldman entered the trade on June 8 and stands to lose about 5% including the cost of carry after being “stopped out” when the peso traded beyond 11.40 per Canadian dollar yesterday.”

This just goes to show that even the best of the best can lose when the fundamentals are too unclear or when they fail to provide a strong impetus.

On To The NFP

The much smaller loss of jobs last month (-345K vs. -504K previous) was accompanied by an increase to 9.4% (from 8.9%) in the unemployment rate. Stocks fell a bit on the news and the dollar gained that day.  Stocks gained for a few days afterwards on the realization that the increase was due in part to greater labor force participation (people who had given up looking for jobs started to look again, a good sign). The rest of the month was basically flat.

Now, if we put the NFP together with what we believe to be the prevailing view of the economy, what we (as traders) want to see is some data that indicates the prevailing view is wrong. So what I would suggest is to come back to this article after the NFP is released; not for an immediate short-term reaction but to see if a reason exists for a trend to be established which will be where the best potential for a good trade will exist.

For example, if by some miracle the unemployment rate were to fall, there would be a good chance to see stocks get a boost over the next few weeks. That would put some pressure on the dollar vs. the euro, pound and A$, and it probably would be positive for those currencies against the yen as well.

A Great Trader

In any discussion of great traders, Marc Faber (the original Dr. Doom) surely comes to mind as being right at the top of the list. He correctly called the commodity rally and dollar bear market early in the decade and more recently said back in March that stocks had probably bottomed.

I always look for his interviews on Bloomberg and CNBC because they’re both entertaining and informative. And I just love the way he concluded his monthly bulletin back in June 2008:

“The federal government is sending each of us a $600 rebate. If we spend that money at Wal-Mart, the money goes to China. If we spend it on gasoline it goes to the Arabs. If we buy a computer/software it will go to India. If we purchase fruit and vegetables it will go to Mexico, Honduras and Guatemala. If we purchase a good car it will go to Germany. If we purchase useless crap it will go to Taiwan and none of it will help the American economy. The only way to keep that money here at home is to spend it on prostitutes and beer, since these are the only products still produced in US. I’ve been doing my part.”

Faber was on Bloomberg the other day saying that the dollar was likely to gain over the next 4 to 6 weeks. If we get a big jump in the unemployment rate he could turn out to be right, especially if riskier assets like stocks and commodities are sold (we did get a jump of 0.5 last month and we didn’t see a strong sell off). But if the data goes the other way (meaning the unemployment rate falls), he’ll likely wind up with egg on his face.