In the past week, most of the selling has been focused on high-flying, high-beta tech stocks and recent IPOs, as well as small-caps and biotechs of all stripes, while most of the buying has been focused on large-cap value in both the Dow and the S&P 500.
If it feels like we’ve seen a lot of volatility this year, well, it’s because we have: The Dow 30 have had 22 triple-digit moves this year, more than double the amount at this time last year. There have been lots of ups and lots of downs, but the NYSE Composite remains near 10,400 as investors wait for the next big catalyst. Trading has been very choppy, which is the opposite of trending.
Now, you may not realize it, but there has been a similar effect at work in the currency market. Exchange rates have had an outsized influence on the stock market since late 2012, when Japanese central bankers unleashed the yen devaluation strategy, thus encouraging massive participation in the yen carry trade (shorting the yen, going long the dollar or euro, and buying stocks with the proceeds).
More often than not, on any given day, if you’re watching the tick-by-tick action in stocks you’ll notice that they are following the tick-by-tick moves in the yen. Strange but true.
Currencies are typically one of the most volatile asset classes around – but after dropping in the wake of the surprisingly hawkish Federal Reserve policy announcement and press conference, the yen has been constrained by a very tight trading range over the past week.
The last time I remember a currency acting so sober and calm was back in early 2011, when the U.S. dollar tightened up amid a parabolic rise in silver prices. The dollar marched sideways, and it all felt like the eerie calm before a storm. Sure enough, after Seal Team 6 took out Osama Bin Laden in a daring cross-border raid in Pakistan, the dollar leapt in Sunday night futures trading as the United States suddenly appeared to be a stronger, more vigorous nation. Silver collapsed in response.
It felt like a similar (if less dramatic) break happened during Thursday’s session. The yen surged higher without any clear catalyst, pinching carry trade positions — and stocks collapsed into the red shortly thereafter.
It’s amazing how closely interconnected the global currency markets are with the U.S. stock markets. One reason is that the big hedge funds that comprise much of the action these days use complex currency-trading strategies to fund their stock trades. If they are working properly, the currency trades amount to something like cheap borrowing, and then that low-cost money is used for higher-risk equity trades.
When the low-cost money dries up due to a change in currency regimes — i.e., when the yen abruptly reverses and rises — the funds naturally have to cut back on their stock trading. So in essence there is this hidden relationship in currency flows below the market’s surface that is driving what you see on the surface in equity flows.
When that happens, institutional money jettisons the small-caps and high-fliers that have been flying too close to the sun, and big-cap value has been the beneficiary. That’s why I am now recommending Dow component Verizon Communications (VZ).
The major U.S. telecom carrier has units specializing in fixed-line, wireless and Internet connectivity — and its fundamentals are surprisingly robust. While earnings have been mostly disappointing, my research suggests that a lot of the fear of a weak Q1 is already discounted into the shares.
I realize that the chart does not look like much, but VZ is the kind of low-beta, large-cap value stock that major investors are swinging back to at this time as they pull money out of the high fliers. AT&T (T) lifted out of a pattern much like this and rose several points in a week. VZ can do the same, practically out of nowhere.
Verizon started Friday’s session with a 0.4% gain, and the shares looked like they were poised to break out, but sellers came in midday. Due to that failure, shares might have to pull back farther to attract interest. I recommend that you buy VZ at $46.45 limit, good till canceled. When filled, set up to sell half at initial target $49.50, and hold the rest for future gains.
Jon Markman operates the investment firm Markman Capital Insights. He also offers a daily trading advisory service, Trader’s Advantage, and CounterPoint Options, a service that helps individual traders make steady, consistent profits with volatility-related instruments.
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