Risk appetite may improve, but beware of buying into it blindly
The developments in the financial markets over the past year have been monumental, and to me, the subsequent impact on currencies has been fascinating. The Japanese yen has arguably benefited the most from all of the turmoil. The low-yielding currency was once the prime component of the carry trade, but as soon as risk aversion started to increase mid-year and volatility surged to record levels during the fall, massive deleveraging led the Japanese yen to gain 17% against the greenback, 24% versus the euro, 36% against the British pound, and an incredibly 40% versus the Australian dollar over the past six months.
At the time of writing, volatility has cooled but the Japanese yen has continued to rally, which has spurred speculation that Japan will intervene in the currency markets. Will the country do it? Probably. Is it an event worth trading? No. Simply put, it’s very risky.
Now, on to what I think will be the best trade in 2009…I think the JPY crosses, stock markets, and other risky assets could see a massive bullish retracement at the start of the year. This could be the result of a variety of factors, including a bailout for the US auto industry or indications of resilience in emerging market economies. There are sure to be great shorter-term opportunities to buy into these assets, including the JPY crosses, but I’m not so optimistic about the outlook for the financial markets in the long run. As a result, I’ll be treating a strong bounce in the JPY crosses as a selling opportunity.
In short, growth in the world’s major economies is going to take a long time to recover. Using the US as an example, job losses have risen to historically high levels, which has impacted consumption. This drop in consumption hurts nearly every facet of the economy, including the services, manufacturing, and housing sectors. The bottom line of businesses will subsequently be impacted, and when we see publicly listed firms report Q4 2008 and Q1 2009 earnings and profits, the results may be very disappointing. Thus, I think that any bottom we see in the stock markets in the near-term and optimism that results will be short-lived. Instead, risk aversion will start to make a comeback in the middle of the first half of 2009, and that will be the time
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