Prague Twin

Sunday, April 02, 2006

Quarter 1 2006 Economic Report

Q1 was the best quarter for the United States stock market in 7 years. I had predicted a softening, despite experts "cautious optimism".

I couldn't have been more wrong.

One thing I have been consistently poor at is estimating the strength of the US economy. The ability of the US economy to grow at 3.5% per year is particularly amazing in light of it's size. Experts are, however, turning a bit more bearish, and the stock market ended down sharply on Friday. This may be a dark cloud on the horizon, but it may be just a small correction. It will be interesting to see if the market can maintain this near record level throughout the next quater or perhaps even extend the gains. I'm going to stick to my guns and suggest that the market will see a correction by mid-year. One thing we know about markets is that big gains are often followed by big corrections. If circumstances existed at the end of 2005 that would justify my bearish predictions at the end of the year, they exist now in spades. Don't be surpried if I have once again underestimated the resilience of the US market.

The fed continued with it's measured tightening schedule, predictably moving the short term rate to 4.75%. The long term rate quicly hit a new recent high at 4.86% underpinning market expectations of at least one further rate hike in May.

The dollar has stayed within a nice tight 5% range against the major currencies. The robust US economy and job outlook has nullified concerns over balloning public debt. Traders had expected the Euro to reach 1.25 by mid-year, but that prediction has been officially dashed. Two large 3-month expiry options at 1.24 and 1.2465 reflect this ammended analysis. Apparently, the Euro bulls will have to wait.

The Yaun ended the quarter with record stregth against the dollar, but this is largely academic at this point since the range is artificially maintained and the Yaun is not traded freely on the market. If only I could buy a bunch of Yaun right now.

What looms on the horizon for the currency markets is a policy shift by the BOJ. Should they begin raising interest rates (from 0%) in May, the yen could see significant stregthening. There was a flood of money repatriated this week to Japan as expected at the end of the fiscal year. This influx failed to significantly strengthen the yen, but as interest rates rise, and should the US economy start to produce diminishing returns, futher repatriation of funds out of dollar denominated investments could lead to significant yen stregthening in Q2. I think if I can get in at 1.18, I'll make a strong move.

This article is in no way meant to be professional.


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