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MARKET INSIGHT REPORT

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Dont fight the Fed was the old adage we have fought at times to our regret, but mostly because we couldnt tell where the Fed was. In the years before Bernanke, the Fed didnt want the investing public to know where they were, probably because they were humble enough to know they werent sure themselves. They were positive they did not know where the economy was going in the next few years. In the 1987 crash, Alan Greenspan discovered he could create a put, an idea he expanded to the point that we began to know it was there. After the 1987 episode, where almost everyone agreed it was valuable, it reappeared in the savings and loan crisis in 1990 and then once again in the Mexican meltdown at the end of 1994 and early 1995. By that time we all looked for the put and theorists were talking about moral hazard, but through everything Greenspan never let on that he could actually forecast what was going to happen in the future. He actually commented to those who implied he was predicting, that they must have misunderstood him. His cards were for no other eyes; even the data he looked at was his secret. After the unsuccessful Fed meddling of the 1970s under Arthur Burns, most academic and investment professionals recognized that econometric models were far too nave to allow fine tuning and that constant changes were far worse than doing nothing. Volcker and Greenspans successes at keeping the economy on a successful course as we perceive it, in hindsight had a negative feedback. It was enough to lure the younger among us to think things could be controlled even though the Fed of that era did not. With Bernankes arrival, things changed. He saw the future clearly, through Depression-era lenses. If the future could be predicted, and therefore controlled, and the increasingly technological investment world agreed, we were back to the late 1960s back to econometrics, as it were. If Bernanke knows, and now Janet Yellen knows, how the future will transpire, then why would anyone fight the Fed? Why indeed? !

! Greenspan often said the yield of the 10-year note told him if the market was fully

valued, or not. Using that, now, very widely used yardstick, the equity market has seen its position as fairly valued as rates dropped for almost 30 years, but using that as a metric the market is now at risk. If the market is valued correctly today, with the 10-year at 2.70% and the S&P 500 at 1870, then the market was way undervalued last April when the 10-year was at 1.70% and equities were around 1580. Granted this has always been a rough estimate, so we can excuse this error. But is there room for 10-year rates at 3.30%, a level widely forecast for year-end, with equities higher than today? There isnt. Perhaps if earnings and multiples climb as well, but then yields would be higher, and history shows that sharply climbing earnings would depress multiples. On the other hand, if yields declined back to 1.70% would we expect higher stocks? Blindly using Greenspans metric we would, but if rates drop so sharply the economy would be in recession and equities would be somewhat lower, if not very much lower. Low rates are a conundrum. Rates are low because growth is low and the expected return on capital is low as a result. Because margins on capital are related to the level of growth, any reversion toward the mean from current historically high margins will negatively impact valuations. There is no exit. As cyclical analysts we see equities at a very time-critical junction, while at extreme valuation levels. This should lead to significant weakness over the next year to two years. The implication is a decline similar to those of 2001-2 and 2007-8 more proof that financial engineering is a fools game. They are not it control.
To contact FX CONCEPTS New York: 1 (212) 554-6830; London: +44 20 7213 9600; Singapore: (65) 67352898; research@fx-concepts.com

FX CONCEPTS!

GLOBAL MACRO RESEARCH

! ! ! CURRENCY Asia Long-Term View !

INTEREST RATES

Asia Breaks Out

By John R Taylor, Jr

Despite impressive central bank intervention across the region on Wednesday, the Asian currencies all either broke higher against the dollar or continued their recent powerful moves to the upside. The picture is continent-wide and it anticipated the FOMC minutes and the positive reversal of European and American equity markets. This move seems to have been generated out of Asia itself. The most immediate cause could be the reversal of the Chinese yuans weakness and the rational way in which the Chinese authorities have handled both the slowing economy and the financial problems ranging from high-yield bond defaults, trust fund failures, and the shadow banking issue in general. Although there might still be what we see as an unreasonable expectation of money being thrown at these problems in a willynilly fashion, it seems more that the Chinese financial elite has decided to treat this situation as a mature capitalist society would carefully, rationally and with an eye toward the future. By saying that, we are suggesting the Chinese have risen beyond the West and have applied the monetary and capital theories that apply in a coherent manner. As our cycles show the Shanghai composite index as recovering into July or August from a base about three weeks ago, this Chinese reason behind the Asian strength seems the most appropriate. As the same cycles seem to apply to the three currencies on our chart to the right: the Singapore dollar, the Malaysian ringgit, and the Singapore dollar, the correlation seems secure. !

! There is a second event that could be impacting Asia this year as it did 17 years ago,

and that is the increase in the Japanese sales tax and the effect it had on the economic growth and trade flows within the region. Although we believe the impact inside of Japan will be and already has been dramatic, we feel this will have less influence in Asia today as the Chinese economy is so much larger now than it was then and the Japanese economy is so much less important. Still, the abrupt reversal of yen weakness and newfound yen strength will add to the strength of other Asian currencies, especially the Korean won and the Taiwan dollar. !

! The dollar highs that were seen at the end of January and in the middle of March
actually dragging on into the start of April according to our cyclical measures match perfectly and all call for dollar weakness into the last days of April or the start of May. Once again, we look to the FOMC meeting as a critical cyclical point, this time a dollar low whereas in January and March it was a dollar high. Although we are aware that the central banks will be very active, these formations either heads and shoulders or double-tops call for significant dollar weakness ahead. For USD/SGD a move to the 1.17 area seems likely. For the USD/MYR, we are looking for 3.05, which seems more aggressive than the others. In Korea, the move should be less as we have seen so much in the past few days, but perhaps the strengthening yen will cause the won to overshoot. Our target for USD/KRW is around 1028.00.

To contact FX CONCEPTS New York: 1 (212) 554-6830; London: +44 20 7213 9600; Singapore: (65) 67352898; research@fx-concepts.com