Monday, June 21, 2010

Market Moves and Foreign News - What's Changed in 30 Days?

The US markets are up strong today after a week of big gains. The market moving news today (in part) is that China claims it will finally let its currency (yuan) appreciate against the dollar. The prior stance has been to peg the yuan to the US dollar (no floating rate).

Before we delve into the implications of such a move, let's just recall how volatile the US markets have been (up and down) and how sensitive it has been to foreign happenings.

The Charts Tab (6 months) for the VIX is below (click to enlarge). The top portion is the spot value, the bottom is the vol (IV30™ - red vs HV20™ - blue). The yellow shaded area at the very bottom is the IV30™ vs. the HV20™ vol difference.

We can see the VIX hit 48.20 exactly one month ago (5-21-2010). Today, it's been as low as 22.87. We also see the IV30™ in the VIX (the vol of the vol) was 136.28 on 5-21, today it's 83. The driver of the market implosion and VIX explosion was Europe. The fear that Greece, Italy, Spain, Portugal, Hungry and others were in no position to handle their debt load. The very future of the Euro came into question. To read the details of the Euro contagion fear, you can Click here, posted 5-18-2010.

But not to worry, in 30 days, we realized everything was ok. The S&P 500 Charts Tab is included (click to enlarge).

A broader feeling that Europe may not have as deep an impact on the US economy (and therefore financial markets) pushed markets upward. Market up, vol down, happy days (not the TV show)! Note that the up and down swings are mostly "foreign market" driven. Now, back to the news today...

Why Does China's Currency Decision Matter?
As of now (sans today's news) China has kept the yuan low to help exports. i.e. if the yuan is low, buying goods from China is cheap. The ire from the US was simply that the "artificially" weak currency makes exported goods expensive for Chinese consumers.

Good news part (1): We really wanna sell to those 1.3 billion people in the second largest and fastest growing economy in the world and a stronger yuan makes US goods cheaper (to China).

Good news part (2):
The stronger yuan (or just a floating yuan) reduces the threat of inflation in China - or so Monetarist's would have us believe. i.e. Free flowing market prices force equilibrium (generally a good thing). Lower inflation in China implies the government may not need to raise interest rates. In English, the world was worried that inflation in China would force the Chinese government to slow growth. Ah!, slow growth! Since China is the only country still growing, a slow in their massive demand could be catastrophic to a slowing Europe and a "who-knows" US.

Keep in mind, earlier this year China tried to prevent a real-estate bubble by forcing banks to hold larger reserves. i.e. Lend less. Since the yuan will float, I guess we don't need to worry about a real-estate bubble. I mean, do real-estate bubbles ever matter really? I can't remember a single time in the last 2 years minutes when a real-estate bubble had an impact on the world economy.

The Skew Tab for the VIX is included (click to enlarge).

To read VIX Skew - What it Indicates and How Accurate It is, click here.

All in all the news feels good today. A month ago, you know, when the world was ending, things looked bleak. But thankfully the world landscape has changed dramatically (?) in the last month. The VIX is down ~53%, IV30™ in the VIX (vol of vol) is down ~40%, the S&P 500 is up a whopping 7.1%... Wait, is that whopping? Hmm...

Well, I think the US has a good shot of making it to the second round of the World cup. That's pretty good...

This is trade analysis, not a recommendation.

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