I’m often asked by traders which are more important-fundamentals or technicals. The facts are that both can and do exert influence on price movement at different times. If your goal as a trader is to assess the risks to your trade, to ignore one is to expose yourself and allow the person on the other end of your trade to take advantage of you.
There’s an enormous advantage available to you as a trader if you can have a basic understanding of the interrelationships between the various asset classes-currencies, stocks, commodities and bonds and then put that together with an assessment of which way the fundamental winds are blowing. These relationships are based on risk or more specifically, investor’s appetite for risk (or lack thereof).
In general, when the fundamentals are positive and the market is buying risk, stocks and commodities go up while the dollar depreciates against currencies like the euro, pound, Australian and New Zealand dollars (the higher-yielders) as it gains on the yen. Bond prices will fall, which naturally drives yields higher. In the current environment however, very positive U.S. economic news can cause the dollar to strengthen however because it will indicate to traders that the Fed is moving closer to either restraining liquidity and/or raising interest rates from their current emergency levels. Here’s an example of what I mean:
If December’s NFP report would have been strong, the dollar would have gained on speculation that the Fed was indeed closer to making a move on interest rates. Bond prices would have fallen. Stocks and commodities likely would have gained as well, on speculation that the economy is healing. On the other hand, corporations reporting profits that beat expectations would tend to drive stocks higher and the dollar lower, because corporate profits do not have an implication for Fed policy. Bond prices would have fallen to reflect a higher rate of interest from the Fed.
The reverse tends to happen when the news is bad, and this is generally easier to deal with because the relationship will hold in nearly every situation save one. Bad news will tend to drive stocks and commodities lower while bonds gain. The dollar will gain against all currencies except the yen. The only time this relationship wouldn’t hold is if there is a currency crisis in the dollar, with a currency crisis broadly defined as the depreciation of currency and bond prices in the face of bad news (this is basically an end of the world scenario, so let’s hope we don’t get to see it).
In looking at some fundamentals, we see there is enough bad news to push investors into what’s called risk-aversion mode in the overnight markets. Stocks and U.S. stock futures markets are falling, as are commodities. The dollar is gaining against the higher-yielders as it falls relative to the yen. Bonds are gaining. The reason is because Chinese banks have begun restricting new loans, responding to a push by regulators to contain credit, and because Japan’s sovereign credit rating outlook was lowered by Standard and Poor’s because of diminishing “flexibility” to cope with a swelling debt load and concern about the lack of a plan to rein in budget deficits.
This last bit probably sounds somewhat on the complicated side, but it really can be broken down into what I call the “smell test.” Banks restricting loans and lower credit ratings smells pretty bad to me, and if something smells bad it is bad and therefore, risk-aversion is likely to be the order of the day.