Capital Markets: "Equity Slump Continues, Lifts Bonds, Bolsters Yen"

From Marc to Market, Dec. 6:

The swoon in equities, perhaps sparked by a rotation spurred by potential US tax changes, is continuing today. It is providing a risk-off mood, which is expressed in the foreign exchange market as a stronger yen. The most compelling answer of yen strength is not that investors are buying yen as a haven. Japanese stocks are among the worst of the major markets over the past five days, ensured by today's nearly 2% drop by the Nikkei. Nor, of course, are Japanese interest rates attractive. Rather the yen's strength reflects unwinding trades use the yen to finance the purchase of other assets, like equities. As the equities are sold, the yen is bought back.

We see the speculative directional plays as secondary in importance. Speculators in the CME futures had accumulated the largest gross short yen position in a decade in the middle of last month and were already reducing it, though the dollar pushed through JPY113 at the start of the week, the high since November 17.

The S&P 500 fell for the second day in a row yesterday and closed on its lows, just above the support we noted near 2628. It will likely push through there in the early going today and test the 2600 area, which marks the low from the end of last week, the 20-day moving average and congestion from the end of last month. Below there an unfilled gap from the higher opening on November 21 may draw prices. The bottom of the gap is near 2585.

The sell-off in Asian equities gained momentum. The MSCI Asia Pacific Index fell 1.25%, matching its largest drop of the year. It is the eighth consecutive loss, the longest losing streak in a couple of years. Chinese shares were mixed, with the Shanghai Composite off 0.3% and the Shenzhen Composite up almost 0.7%. However, the high-flying Hang Seng China Enterprise Index (H-shares) shed 2.8%, which took a tool of the Hang Seng Index, which fell a little more than 2%.

European shares are also being hit by profit-taking. The Dow Jones Stoxx 600 is off nearly 0.75%. This could be the largest loss in a month. Information technology and materials are the largest drags. The weakness in these sectors are global. With extensive supply chains, the tech sector often seems highly correlated across countries. Copper is stabilizing after it suffered its biggest single-day drop in more than two years. However, other industrialized metals, including iron ore, aluminum, and zinc remain under pressures ostensibly due to concerns about demand from China next year. The energy complex is lower amid concern about the US industry association seeing a build in gasoline inventories. Gold is recovering after dipping below $1260 for the first time since August.

The greenback is testing support near JPY112.00. A convincing break could signal a move toward JPY111.40, and possibly even a test on the late-November low near JPY110.85. Note that the five-day average is set to move below the 20-day average for the first time since the middle of last month. The euro has moved in about a third of a cent today but remains at the lower end of yesterday's range. The $1.1800 area, were several technical levels coincide, remains intact. News of stronger than expected German data (factory orders rose 0.5% increased of falling 0.2% as many economists expected and the September series was revised to 1.2% from 1.0%) failed to impress traders. ....

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