Right of response was granted to Tom McClellan who emailed about my charts note yesterday:
“1. You misstated my assertions about the meaning of the eurodollar COT data. It shows an important top due in mid-March, and not an upswing at the end of March as you stated. Furthermore, you should already know that eurodollar futures don’t have anything (directly) to do with FOREX. It is an interest rate instrument, not a currency instrument. They are not the same thing as euro currency futures as you implied. (VL: My error first on the timing, which I think is likely to be variable and vague with a new overlay; on the rest, please see below.)
“2. You misidentified the name of my service. Mcoscillator.com is the domain name of my web site. The publication from which you were (incorrectly) paraphrasing is the Daily Edition of the McClellan Market Report. (VL: I was just trying to help those who want to learn more find you. It does. Sorry.)
“3. You hypothesized that charts only ‘work’ because of a self-fulfilling prophecy, i.e. people see what the chart says should
happen, and respond accordingly making it work. That is an interesting hypothesis, and it is also a testable one. All one needs to do is to look at stock price or other data from years when charts were not in common (or any) usage, and see if the “rules” of price behavior that one is interested worked back before people could know about them.
It turns out that chart analysis became popular between the 1930s and 1970s IN SPITE OF a multitude of assertions that it was akin to voodoo. I know people who got fired from banking jobs for being caught in possession of chart books. But over time, analysts realized that there was merit to technical analysis, and that realization continues to grow which is why the ranks of the Market Technicians Association are growing so quickly. People are finding out that the “school way” of analyzing the market does not work so well, and so they are migrating to things that do work.(VL: That is exactly my point. The degree of predictability will rise as the number of chartists does.)
“The bigotry against technical analysis is finally starting to die down because people are seeing for themselves that it works, just as the objections to black people being admitted to Harvard eventually died down when it was proven that they could do just as well as white students despite what the “experts” said. Sadly, such bigotry still exists in pockets, against both racial minorities and chartists. (VL: Okay Tom, take it easy. And the civil rights analogy is overstated, I think. W.E.B.DuBois was admitted to my old college in 1890-something.)
“Signed: Tom McClellan”
Vivian replies. Chartism is not proven by the fact that backtesting charts into the antedeluvian era before they were widely used seems to confirm the theory. True, when certain levels of pricing are breached upwards or downwards, the stocks rise or fall further. That is simply a reflection of human nature.
Momentum works because people like to buy a winner and sell a loser.A proof that you don’t need charts for people to subconsciously use them is shown by how stocks which have split 2:1 tend double to prior levels more quickly than stocks which did not split. Investors have a recollection of what price a share commands and this pushes split stocks up.
As for the link Tom alleges between the eurodollar rate and the stock market, this really is voodoo. The eurodollar rate serves a bunch of functions besides being a way for foreigners to buy dollars (which despite what Tom wrote, has foreign exchange implications.) Offshore buyers buy offshore unregulated dollars because they get a better yield thanks to the absence of Fed reserve requirements and other regulations applying to normal dollars here.
Then too check accounts for corporations “sweep” surplus money into eurodollars because yields are higher. You set this up with your bank or have a smart CFO do this, but it only pays off for megabucks.
The eurodollar market is also used, as Tom notes, to lock in yields for large players planning to borrow or lend later. This is a pure interest rate measure although because the eurodollar pays out interest in advance and is leveraged, it is also a cool way to do interest rate speculation.
And finally the eurodollar is part of the TED spread, a way to benefit from market complacency or panic by buying T-bills and selling eurodollars, or the reverse. If there is panic, deposits flow to T-bills. T-bills pay less than eurodollars but are perceived as safer and then in demand. This pushes their yields even lower so eurodollar yield spreads become more profitable. In periods of calm, more funds go into eurodollars for the extra yield, and the spread in prices shrinks.
A supposed link between this large market in offshore dollars and any S&P movement is voodoo (despite Tom McClellan’s charts). The reason: I cannot figure out how the two markets are linked in the real world. While we can’t quantify it, we know pumping more carbon into the atmosphere increases global temperatures. I can see why a huge shift in tectonic plates off the west coast of Chile can wiggle the earth’s axis a few mini-seconds from the prior balance.
But apart from the chart itself, I cannot explain why the eurodollar price 14 months ago will affect the stock market this month.
We reported (mistakenly along with everyone else) that China had cut its purchases of US T-bills in Dec. In fact, the latest wizard analysis says China is buying as much US debt as before, channelled via London and Hong Kong. Fund flow analysis is not easily grasped and even charts miss stuff.
Value destruction via mergers continues. The latest victim is AmBev which we sold over concern over its gulping down Anheuser Busch. It missed its targets for Q4 (except in the old InBev pre-merger heartland of Brazil) and forecast further sales erosion. Cheers.
While the Euro (not the same crittur as the eurodollar) fell today on news than Angela Merkel does not want German ants to help fund profligate Greek grasshoppers, Greece in fact is moving toward a 10-yr bond issue. It will be at something like 310 basis points over the euro mid-swap level (down nicely from the 365 bp spoken of a week ago.) The amount is uncertain, around euros 5 bn to 10 bn, so there will be more issues. This one will pay on my birthday, June 19, and run to 2020. Any reader wanting to buy me a chunk should accept that the value of the euro may even go up over the next decade as tightening comes, however belatedly, to euroland. So the payoff to me will be even higher. By 2020 I will have retired in any case and I will show my gratitude by consulting for the donor.
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