Author Bio

The term “Fiscal Cliff” is being tossed around everywhere since last week’s election. You know it’s a big deal when it hits the New Yorker, known to make political satire out of just about any government-induced malaise.

I came across the article today on NewYorker.com, “The Absolute Moron’s Guide to the Fiscal Cliff,” and it spurred me to write this post. What I think few Americans understand is what the looming doom of the Fiscal Cliff means to our economy and how radically it can change. Some say it will be more like a waterslides, slow and loopy but an eventual drop. Others say it will be more like a cliff, a big drop fast. Regardless of what you believe will happen, the fact is that you need to educate yourself of the basics of what the “Fiscal Cliff” means as there’s an important deadline of January 1, 2013 coming up that could change everything.

First, we need to take a ride in the way back machine to the year of 2001, when, according to the New Yorker post,

“George W. Bush signed a massive round of tax cuts that were supposed to expire ten years later, in 2011. President Obama later extended the expiration date to January 1, 2013. After that, your rates will go back up to the rates you paid in 2001. A bunch of other tax changes, like the expiration of a “payroll tax holiday” and the elimination of some tax credits, will also hit on January 1, meaning that no matter how much you pay now, you’ll probably pay more after the new year unless there’s a deal.”

So, your question after reading this might be, “Who the heck do I blame for this crazy freakenomics?” The answer is unclear. Do you blame the Republicans for setting a round of tax cuts in the first place? Or do you blame the Democrats for prolonging the decision on said tax cuts to buy time? Regardless of who you blame, if we don’t have a plan and a deal before the expiration date, experts warn of spending cuts and potentially a recession.

Could this fiscal stalemate be Obama’s way to get what he wants in terms of tax hikes? In the words of Voltare, “A long dispute means that both parties are wrong.” Both parties are wrong because no one is right – that’s what compromise, meeting halfway, and making unbiased decisions for the greater good is about.” Let’s see if the leaders of our countries can turn a fiscal cliff into a fiscal decision that keeps our economy from taking a nosedive.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Author Bio

Equity investors have enjoyed a sustained advance in stock prices for several months, as expectations premised upon the belief that policymakers are miracle-workers, allowed the major market averages to move sharply higher.  An overdue reality-check was sure to arrive at some point, and so it has, as corporate America’s most disappointing quarterly earnings season in many years, reveals that ‘big business’ is not immune to the troubling deterioration in global economic momentum.

The third-quarter reporting season is well underway at this stage, and the latest numbers reveal that corporate America is set to post a year-on-year decline in quarterly earnings-per-share (EPS) for the first time since the autumn of 2009.  Consensus estimates forecast a two per cent drop in quarterly EPS, as a sharp slowdown in revenue growth alongside margin compression, has sent corporate profitability into reverse.

Corporate America has enjoyed an extraordinary earnings boom over the past three years, as an intense focus on costs allowed margins to surge to record levels – more than three percentage points above their long-term mean, while a strong contribution from global operations more than offset tepid revenue growth in the US.

However, the ability to tap further cost efficiencies is largely exploited at this juncture, while the economic malaise in the euro-zone, and a marked slowdown in the pace of economic growth in emerging markets including China, means that foreign operations are no longer bolstering bottom-line performance.

The recent trends are unsettling.  FactSet reports that the percentage of companies reporting earnings above expectations thus far is in-line with historical averages at close to seventy per cent, but the aggressive reduction in earnings estimates during the pre-reporting season means that this figure is not particularly impressive.

Further, the percentage of companies posting revenues above consensus estimates at about 35 per cent, is more than twenty percentage points below recent experience, and as low as the number seen in the first quarter of 2009, when the global economy was deep in the throes of the worst downturn in generations.

The top-line disappointment is almost exclusively an international affair, with a spate of companies including GE, Ingersoll Rand, and Microsoft attributing the shortfall in sales to weak economic conditions in Europe, and others including Caterpillar and Intel, citing soft activity in China.  Currency issues were mentioned in a number of earnings reports, but this was just a minor irritation, with sluggish revenue growth stemming primarily from soft demand.

The fourth-quarter earnings season is unlikely to prove any kinder than the current reporting period, as more than three-quarters of the companies that issued forward guidance, provided an earnings outlook below the Wall Street consensus. This the highest number since FactSet began collating the data in 2006.

The negative guidance appears to have had little impact on the bottom-up analyst community, who forecast a resumption of earnings growth during the fourth quarter, with an eight per cent increase in EPS pencilled in.  The optimism continues for 2013, with a four per cent increase in revenues expected to lead to EPS growth of ten per cent.

The numbers appear fanciful as the US economy continues grow at subpar rates, the euro-zone crisis is ongoing, while structural issues could well see growth rates in emerging markets such as Brazil, China, and India that are well below recent norms.  Further, it is difficult to see how low, single-digit sales growth will propel margins any higher than they already are.

Corporate America’s good fortunes in recent years have been premised upon a concerted effort to control variable costs, with incremental revenue increases dropping straight to the bottom line.  Costs have already been pared to the bone, which means that further margin expansion is not feasible without robust top-line growth.  Indeed, revenue increases in the three to four per cent range, at such an advanced stage of the earnings cycle, have typically been accompanied by margin contraction, and not expansion.

In this regard, it is instructive to observe that current earnings have reached levels – relative to their ten-year average – that have rarely been exceeded during the past half century and typically followed by poor growth outcomes in subsequent years.  Statistical analysis reveals that corporate earnings are roughly 25 per cent above trend, and given the soft global economic picture, it would be unduly optimistic to expect double-digit percentage point gains to continue.

The third-quarter reporting season has been notable for the sluggish revenue growth that has brought an end to corporate America’s winning streak.  Wall Street remains bullish on the outlook for the remainder of this year and beyond, but a more constructive analysis suggests the boom in corporate profits is at an end.

Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Author Bio

I believe it was New Jersey governor Chris Christy I saw saying to his constituents before Hurricane Sandy hit something to the effect of damage was going to happen despite their best efforts because they couldn’t prevent the storm barreling through.  This is a lesson for investors.

Markets do not always do what we want them to do. That’s a fact of life as an investor or trader. We can do all kinds of great analysis, pick just the right market or security or investment vehicle but still get hit by something unexpected or unavoidable. The investors who survive these sorts of events, and even thrive coming out of them, are the ones who are prepared, while those thinking only of how much they stand to make in the markets are the ones swept away.

It all comes down to risk management. And it has become clear in recent years that the old methods of diversification through spreading money around low-correlated markets are no longer sufficient. Markets which are largely uncorrelated during good times have a tendency to becoming strongly correlated during troubled times – exactly what the old diversification systems relied on them not doing. As I shared with my Twitter and Facebook followers, even just looking at stocks we have seen big swings in the correlation of individual securities with the overall market (which interestingly has gotten low recently). This requires a different type of thinking.

And even if we get the diversification side of things right, that doesn’t completely mitigate our big picture risk. There is always something that can come along and put our hard-earned money at risk. That is where worst case scenario type analysis has to take place. This is where many in the financial sector fell flat, leading to the financial crisis. They felt comfortable with the risk of their portfolios as indicated by the Value-at-Risk (VAR) models they were using, forgetting to account for what could happen beyond the 95% confidence level – events virtually inevitable in the long run. It’s the remaining 5% they should have been worried about, as it’s in that area where they lost their business and very nearly locked up the whole financial system.

The same goes for an individual. Identify the worst and prepare of it. The tools Currensee has put in place in the Trade Leaders program definitely help do just that. You won’t be able to avoid taking some losses along the way, but if you prepare properly you can avoid seeing your financial well-being get swept out to sea.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Author Bio

Tuesday, October 30, 2012 marked the first time since 1888 that inclement weather conditions caused an NYSE shutdown for two consecutive days. Curious speculators wasted no time in coming up with a myriad of possibilities as to which condition exactly was causing the exchange’s dormancy.  An entertaining DailyFinance article even mentioned amusing, yet erroneous, Internet reports claiming the trading floor had been flooded.

In an industry where news is one of the key players affecting market movements, predictions of where stocks would go on the (re)opening day of trading on Wednesday October 31 ran both bullish and bearish. An article published on CNN Money seemed to take more of a bullish stance and anticipated very high trading volume due to a two day back-up of buy and sell stock orders.

On average, 3.5 billion shares are exchanged each day; multiply that by two and how could trading not rush aggressively out of the gates at the opening bell?

But, much to everyone’s surprise, markets didn’t explode into a vigorous fury of trading. Instead, they resumed business as usual, ending relatively flat on at the end of the day Wednesday. Major indexes reflected the apathetic performance, with the Dow Jones and NASDAQ losing 11 points, and the S&P climbing less than a point.

Early yesterday morning, Thomson Reuters Senior Forex Analyst John Forman offered some pretty spot-on comments on the forecasts:

“My initial reaction is that while yes there is likely to be some uptick
above normal volume due to pent up need for trading, it’s probably not going
to be as much as the article makes out. Barry Ritholz points out some
reasons to expect it not to be a particularly huge day:

http://www.ritholtz.com/blog/2012/10/make-believe-nyse-opening

I think the whole month-end/year-end (mutual fund) thing is likely
overstated given that good shops would have anticipated weather-related
issues with the NYSE and done their major business last week. That really
just leaves folks reacting to how the futures have traded the last couple
days and the impact of Sandy on certain stocks.”

So where do we go from here? In terms of futures as John mentioned, stock indexes have been on the rise this morning after the release of a positive ADP private sector employment report and optimistic jobless claims.

In my opinion, it all depends on how you’re monitoring the markets. Fundamentalists might assume a long position on index futures, anticipating gains as a result of tomorrow’s presumably positive US Labor Department’s October Jobs Report. Bloomberg reports jobless claims decreased by 9,000 to 363,000 while Reuters reports October ADP private jobs up 158,000.

Technicians, on the other hand, might take this building rally as a bearish indicator, and short index futures.

It will be interesting to see tomorrow’s settlement prices at the end of the day post Job Report. Stay tuned!

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Author Bio

In October of 1987 I was only 17, but already very interested in trading and the markets. As a result, when the Crash happened I was very interested, and impacted. I may not have yet had my own trading account, but I did have money in a Dow Chemical dividend reinvestment program (DRIP) my mother had made me contribute into out of my paper route money when I was younger. I watched the value of my shares get cut in half that one day, something I’m sure a lot of people who were in the market then (and none too few who have experienced the two major bear markets since) can relate to on some level. That had a major impact on me, as it did on many, many others.

Here’s the rub, though. The Crash of ’87 didn’t send me running away from the market the way it did for a great many investors (and they didn’t come back until the middle to latter 90s). It actually motivated me to try to understand the markets and could easily be pointed to as a major factor in my eventual move into the ranks of professional market analysts.

More importantly, though, the Crash taught me a major lesson that I think too many traders and investors fail to learn until it’s too late. This is that the markets can do just about anything at any time.

There is the old saying that generals fight the last war, meaning instead of thinking forward they are caught up with trying to avoid past errors. Traders and investors are the same in many ways. It relates to recency bias. This works both in positive and negative times, and in both cases it keeps us from realizing the markets will do new and surprising things in the future.

Whether you are trading or investing your own money, or putting that money to work with others through alternative investing, managed accounts, or autotrading you need to always have that “anything can happen” mentality. It needs to always be a part of your decision-making. That way, though the market may throw the occasional surprise twists your way, you’ll never be overly damaged by them.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Author Bio

It is almost four years since central banks in the Western world first adopted near-zero interest-rate policies – alongside the implementation of substantial quantitative easing measures – intended to halt the sharp and swift decline in economic activity that followed the acute myocardial infarction that struck at the heart of the global financial system.  The prescribed medicine successfully revived the ailing advanced economies, but failed to restore the patient to full health, as the deterioration in vital signs in the years leading up to the crisis, precluded a rapid and robust recovery, no matter how high the dosage.

The lacklustre recovery – characterised by persistently elevated levels of unemployment, and subpar business investment rates – has seen central bankers reaffirm their commitment to do “whatever it takes,” in the words of the European Central Bank’s President, Mario Draghi, to return the industrialised world to a more familiar growth-setting.  The rhetoric has been followed by action, as monetary policymakers in Frankfurt and Washington have reached into their medicine chest, and upped the dosage in an effort to remove negative fat-tail risks, and keep their economies afloat.

Return-starved investors’ anticipation of further monetary stimulus fuelled an unseasonal rally in the world’s major stock market averages during the summer that has seen prices advance to within touching distance of multi-year highs.  Surprisingly, the robust double-digit, percentage-point gain in equity values has taken place in spite of mounting evidence that suggests global economic growth has slowed to stall-speed, which is often a prelude to recession.

Further, stock market indices have moved higher on economic data, both ‘good’ and ‘bad,’ which means investors must believe central bank action will ultimately, result in a significant improvement in economic activity.  The conviction is difficult to fathom, given that the ambitious monetary policies pursued in both Europe and the U.S. post-crisis, have already failed in igniting anything like a standard economic recovery, and that further life-support operations are required simply to sustain economic growth not too far below trend.

The evidence of the past four years is virtually a carbon copy of the Japanese experience following the collapse of its twin property and stock market bubbles in the early-1990s.  The Bank of Japan reduced short-term policy rates somewhat belatedly to zero in 1996, and launched the first in a series of quantitative easing programmes early in the new millennium.

However, the unconventional policies adopted in Japan did not produce any real traction in the economy, and the nation’s economic output is now forty to fifty per cent below the level that reasonable forecasters would have projected it to be way back in 1991.  Ultra-accommodative monetary policy was unable to prevent two decades of economic stagnation, as the banking crisis and private sector deleveraging that followed the implosion of the credit-fuelled asset bubbles, seriously curtailed its potency.

Investors refuse to acknowledge the possibility that the Western world might succumb to a more than decade-long, Japanese-style stagnation, even though the starting points were much the same, and the recovery to date has followed a similar path in the presence of equally expansive monetary policies.  The notion that the advanced economies in the West merely skipped a heartbeat, and did not suffer a cardiac arrest, does not stand up to serious scrutiny.

The euro-zone, the U.S., and the U.K. all entered the current episode with non-financial private sector debt ratios that were close to those of Japan two decades ago, and well above the thresholds that have been shown empirically to retard economic growth.  Not surprisingly, the slump in property prices, alongside a severe decline in equity values, prompted a sharp drop in the private sector’s demand for credit, as both the household and corporate sectors attempted to rehabilitate their weakened balance sheets.

Just like Japan, private sector deleveraging continues in spite of historically low interest rates, as subdued growth in disposable income means prospective borrowers are in no hurry to add to their already difficult-to-manage debt burdens, while capital-constrained banks are reluctant to lend to all but the highest-quality debtors.

Further, the Japanese experience demonstrates that the continued suppression of long-term interest rates via quantitative easing, risks undermining the availability of credit even further, as the potential rewards from incremental lending fail to compensate for the risks attached.

Troublingly, years of private sector deleveraging in Japan did not prevent the combined government and non-financial private sector debt ratio from moving higher, as the improvement in corporate and household balance sheets was more than offset by the steady deterioration in public finances.

The same phenomenon has been apparent throughout the advanced economies of the Western world in recent years, as declining tax revenues, increasing unemployment benefits, not to mention sizable bank recapitalisation costs, caused fiscal deficits to skyrocket during the recession, and the subsequent recovery has not been sufficiently robust to stabilise public debt ratios.

Aggregate debt ratios remain close to or at record levels throughout the Western world, and as in Japan, the right-sizing of balance sheets is set to become even more difficult, due to an unfavourable demographic picture that is certain to lower potential growth.  The task could prove even more onerous should elevated unemployment rates and subdued investment in the capital stock, result in lower productivity.

Stock prices have staged an impressive rally on the belief that monetary stimulus will produce a self-sustaining economic recovery any day now, but round after round of unconventional programmes suggests the Western world is edging ever closer to Japanese-style stagnation.  Investors should take note.

www.charliefell.com

Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Author Bio

On September 26, Currensee announced the launch of their newest Forex investment product, the Intelligent Multiple Account Manager (IMAM). This product came in response to recent regulations on PAMM accounts that made it harder for some managers and CTAs to offer them without registering as Commodity Pool Operators or CPOs.
Previously, PAMM accounts had allowed investment management firms and CTAs the ease of managing individual client accounts by pooling them together and trading the aggregated capital and distributing gains and losses on a percentage basis. However US regulators determined that this method was too similar to a Commodity Pool operation, but without the CPO regulations, putting smaller PAMM investors at risk for liquidity problems.

Now, with Currensee’s IMAM solution, managers have an alternative to a PAMM that still provides a way to enjoy centralized management, and does it without additional record keeping and accounting hassles.
The IMAM will help managers by allowing them to set allocations from one central location for all accounts. It differs from a PAMM by using Currensee’s Intelligent Trade Replication Technology (the same techy goodness that makes the Trade Leaders Investment Program possible), which executes trades at the same time, but separately in each investor’s individual account, at each investor’s correct position size and leverage. This is the key differentiator that makes the Currensee IMAM more than just a PAMM alternative
For more information on how the IMAM works, visit Currensee IMAM

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Author Bio

The world’s major stock price averages have registered robust double-digit gains, since early-summer, to within touching distance of multi-year highs, a somewhat puzzling development given that virtually all of the most recent data confirms that global economic growth has slowed to the most sluggish pace since the ‘Great Recession’ came to an end three years ago.

A troubling slowdown in economic activity is detectable almost everywhere, with stagnation or outright contraction evident across much of the developed world, while several emerging market economies have struck a nasty speed-bump.  The deterioration in the global economic outlook is beyond dispute, and reflected in rising unemployment, falling investment rates, as well as the volume of world trade, which has slowed to a standstill.

Hope continues to trump reason however, as investors continue to demonstrate blind faith in policymakers’ ability to deliver stimulus measures that will lift the global economy from its current soft patch.  It is staggering to observe that many seasoned market players persist with such a belief, given that all the evidence suggests that the various growth models responsible for the robust expansion in economic activity, in the years that preceded the global financial crisis, are now exhausted.

The debt-driven model that underpinned economic growth throughout most of the Western world, for at least the past two decades, is undoubtedly beyond rescue at this juncture.  The rate of increase in non-financial private sector debt outpaced GDP growth by more than three percentage points a year on average through the 1990s, and the gap widened to almost six percentage points a year in the early years of the new millennium, which inevitably pushed debt ratios to dangerous levels.

The unsustainable private sector borrowing spree duly came to an end once the ‘Great Recession’ struck in 2008, and the resulting plunge in economic activity required fiscal and monetary stimulus on an unprecedented scale to prevent a worldwide depression.  The unthinkable did not happen of course, but policymakers’ efforts to promote a self-sustaining economic expansion have been less than impressive.

The U.S. economy for example, is experiencing the weakest recovery in post-war history, with annualized economic growth, quarter-on-quarter, averaging little more than two per cent since the downturn ended, or less than half the pace recorded over a comparable time period, following the previous ten recessions.  Additionally, although real output has reached new highs, not one of the four indicators that the National Bureau of Economic Research employs to date business cycles, has exceeded their pre-recession peaks.

Meanwhile, European economic performance has been even less inspiring, with activity failing to recover its pre-recession peak in both the euro-zone and the U.K., such that GDP-per-capita is still roughly two per cent below its 2007 level in the former, and six per cent below in the latter.  Further, the post-recession experience in both economic regions trails the Japanese record following the deflation of its twin property and stock market bubbles more than two decades ago.

Three years have passed since the advanced economies of the Western world reached their nadir, and economic growth continues to disappoint, while aggregate debt ratios remain close to record levels, as the deleveraging of private sector balance sheets has been offset by the deterioration in public finances.  Further, persistently elevated unemployment rates, alongside relatively subdued investment in the productive capital stock, threatens to lower potential growth rates that are already pressured by an unfavorable demographic picture.

The debt-driven model apparent in most of the developed world is bankrupt, but troubling, the growth models applied in emerging market economies can no longer be relied upon to drive the global economy forward.  This is true not only in India, where persistently large fiscal deficits, a deteriorating external position, and stubbornly high inflation have undermined the sub-continent’s status as emerging-market darling, but also in China, where an unprecedented investment boom has limited the central government’s scope to offset the sharp slowdown in economic growth via a fiscal stimulus package centered on infrastructure spending.

The Middle Kingdom’s economy is already in desperate need of rebalancing towards household consumption, which at less than 35 per cent of GDP is well below that of countries at a similar level of in income.  Additional infrastructure spending at this juncture may well ease cyclical pressures, but would undoubtedly result in greater economic turbulence later.

China’s policy response to the global financial crisis precipitated a nine percentage point increase in the investment share of GDP to close to 50 per cent between 2007 and 2011.  However, the investment boom has been accompanied by an increase in the incremental capital/output ratio – the quantity of new capital required to generate an additional unit of growth – to levels comparable to its East Asian neighbors just before crisis struck in 1997.

Further, central government and corporate debt ratios are not far removed from Japanese levels just before its economic miracle came to an end in 1989.  Rebalancing, and not fiscal stimulus, is what the Chinese economy requires, and simple arithmetic suggests that this is not possible without a significant drop in the economy’s long-term growth rate.

Investors continue to push stock prices higher on hopes that stimulus measures will return the world economy to a more familiar growth trajectory.  Cyclical solutions cannot solve structural problems however, and it is troubling to note that there are no growth engines available to push the world economy forward.

www.charliefell.com

Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Author Bio

Modern Portfolio Theory remains a major part of many investment portfolio allocation processes. Basically, the idea of MPT is that one can combine a collection of securities into a portfolio which offers comparable return prospects with reduced risk. This is done by mixing together stocks and other assets which are not well correlated, or perhaps are negatively correlated.

Sounds good, right?

The problem is, as has been discussed, that individual stocks have become extremely highly correlated to the market in recent years. This, by definition, means they have become increasingly correlated to each other as well, reducing the opportunity for diversification in portfolios using the old methods.

Another issue with MPT-based portfolio development is the fact that correlations change over time and in different time frames. The chart below from Oanda shows a recent set of correlations between EUR/USD and other currency pairs (as well as gold and silver).

Notice in the AUD/USD column how the correlations to EUR/USD are strongly positive (darkest red) in the hour, day, and week time frames, but then are uncorrelated in the longer time frames, and even negatively correlated at 3 months. In the case of USD/JPY we can see the correlations are very time frame depended, running the full spectrum over the time frames. Even with silver and gold (XAG/USD and XAU/USD) the correlations aren’t consistently strongly positive.

All this correlation variation creates considerable challenges to standard asset allocation and portfolio development methods and approaches. Imagine creating a portfolio of stocks that have been properly minimally correlated only to have them all become highly correlated? It would totally change the portfolio’s risk dynamics, and likely at the worst possible time.

This is where the importance of considering diversification not just in terms of markets and securities, but also in terms of trading/investing approach becomes clear. This is the approach of fund-of-fund investors. They seek out uncorrelated money managers, exactly the same sort of thing you can do by taking part in the Trade Leaders program.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Author Bio

Labour Day has come and gone, which means the US summer season is officially over.  Wall Street brokers have made their way back from the Hamptons, and returned to their desks to prepare for the final stretch of 2012, a year that has been kind to the owners of common stocks so far, with the Dow Jones Industrial Average delivering solid, double-digit percentage-point gains during the first eight months of the year, while the S&P 500 has returned to the levels that prevailed just before stock prices descended into free-fall in the autumn of 2008.

It is often said that bull markets climb a wall of worry, and the old, nineteenth-century adage has certainly proved true in the year-to-date.  Indeed, investors’ asset allocations appear to have been swayed more by the potential for further unconventional central bank action, rather than the myriad threats – from the persistent turbulence in the euro-zone to a rapid slowdown in Chinese economic activity – that would have been expected to keep risk appetites in check.

Long-term investors are undoubtedly cheerful, but they would be wrong to take comfort from the stock market’s relatively tranquil price action in recent months, as the latest upward move has been accompanied by a marked deterioration in technical indicators, and a growing air of complacency among the professional investment community.

The major market averages’ risk/reward profile is decidedly asymmetric at this juncture, with the potential downside far outweighing any possible upside.  As a result, a nasty surprise could well lie in wait for the increasing army of bulls, who display uncritical satisfaction with their current allocation to risk assets.

The ‘Dow Theory’ is a useful place to start given its long and rich history as a staple for wannabe technical analysts, and it reveals some discomforting divergences that question the true health of the stock market’s present condition.  Far from confirming the optimism of the diehard bulls, the study of recent price action and trading volume, suggests that the upturn in the major stock market averages has become increasingly fragile, and when some of the financial world’s savviest short-term traders hint that are they are positioning for an impending downside shock, perhaps it would be wise to take notice.

For those unfamiliar with Dow Theory, it was derived from a series of Wall Street Journal articles penned by the newspaper’s founding editor, Charles Henry Dow, from 1900 until his untimely death, aged just 51 years, in 1902.  The journalist assembled the Industrial Average in 1896 and the Railroad Average one year later, which meant that he had only a limited sample of historical data from which to develop a cohesive theory.

Dow’s failing health meant that he had little time to put all his thoughts on paper, but William Peter Hamilton, his successor at the financial newspaper, used his predecessor’s theory as the basis for the market predictions he made in more than 250 articles from 1903 until his own death in 1929.

Hamilton clarified the basic outlines of the theory in the 1922 classic, “The Stock Market Barometer,” and the study of stock price movements was further refined by Robert Rhea, who reduced the analysis to a set of theorems that an ordinary investor could understand, in 1932’s timeless, “The Dow Theory.”

Dow believed that both stock averages must confirm a trend, and Rhea noted in his text that, “The movement of both the railroad and industrial averages should be considered together…Conclusions based upon the movement of one average, unconfirmed by the other, are almost certain to prove misleading.”

In this regard, it is interesting to note that the recent cyclical high in the Industrials has not been confirmed by the Transports.  Indeed, the Transportation Average reached a cyclical peak during the summer of 2011, and registered a lower high earlier this year.  Rhea warned that, “A wise man lets the market alone when the averages disagree.”

Dow argued that trading volume should confirm price trends, and Rhea believed that investing in a market that had become “dull on rallies and active on declines” was foolhardy.  The entire advance off the crisis-induced lows during the spring of 2009 stands out in this regard, as trading volume has been consistently higher on weakness.  Indeed, the coefficient of correlation between the ninety-day average of trading volume and stock prices has been a disturbing –0.84 since the cyclical bull market began, as compared with a positive correlation of 0.88 during the early years of the great 1980s bull market.

Not only has trading activity collapsed, with volume at the recent cyclical high in stock prices almost sixty per cent below the figure recorded at the 2009 bottom, but daily price changes have also declined into insignificance.  Since the crisis-induced low, stock prices have registered a percentage point move of more than two per cent once every nine trading sessions, and a more than three per cent change once every 28 sessions.  Recently however, the daily fluctuations have been miniscule; there has been just a single two per cent change in almost fifty trading sessions, and the market has not registered a daily move of more than three per cent in nine months.

Dick Arms, a respected figure in the world of technical analysis, observes that, “There are times when the market gives the impression it is fading into nothingness.  Volume becomes very low, trading ranges become very small, volatility becomes very low.  Also, there is very little change in market levels, and day-to-day fluctuations are minimal.  Looking back at history, when that happens, it is almost always a sign of a market high point.”

Investors have been warned.

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