the federal reserve and the future of money printing 2013

Invast Insights

Week Commencing September 23, 2013

www.invast.com.au | 1800 468 278

This week we look at the following topics:

1.0 The Federal Reserve and the future of money printing

1.1 How does the September decision impact Australia

1.2 Quality of assets for Australian banks

1.3 The key data set to watch

2.0 Brent crude back to "normal" trading range

3.0 Pivot points explained

4.0 Client question and answer - liquidity


1.0 The Federal Reserve and the future of money printing

Despite market expectations of the Federal Reserve easing its money printing

by around US$10bn a month - Bernanke has made it clear that the pace of US

improvement is still below expectations and the door will remain open for

money printing until the unemployment rate reaches 6.5% from around 7.2%

currently. This is now NOT NEGOTIABLE.

The Federal Reserve has been busying printing money really since the global

financial markets shocked investors globally. The most recent strategy, called

QE3, had the Fed buying $85 billion of bonds every month. The bank has said

it will phase out those purchases as the economy improves. The timing of that

phasing is now subject to market speculation - it's not really a matter of if, but

when. The September meeting showed that the foot will be taken off the

pedal, only when unemployment approaches the 6.5% benchmark level set

by the Federal Reserve.


If you are a currency or commodity trader you would have noticed some large

volatility on Thursday morning Australian time when the news was

announced. We update the Invast blog daily with important pivot points for

traders. This week we have explained how these pivot points work, read on

below to section 3.0.

1.1 How does the September decision impact Australia

We think the Fed is cautious on the quality of job creation in the US economy

and potentially sees some of the gains made by the Reserve Bank of Australia

(RBA) over the past two years stalling in the months ahead. Risk currencies

will remain in favour and that means a lot of the hard work the RBA has been

doing to drive down the currency will now be eroded.


The RBA must maintain its door-open policy and hope the financial system

bares the consequences of its loose policy - which banks will probably exploit.

The only saviour for the Australian economy at the moment is a breakout in

commodity prices and a resumption in some large project spending which

will kick start the stalling job market - a long shot. The US economy can cope,

the Australian central bank though has a very tough task between now and

the end of the year. It will try its best to caution the financial system against

poor lending but it knows that the cost of cheap rates can mean asset quality

deterioration in banks over the medium term.

It's a bet the RBA must take. We see some major resistance for the A$/US$ at

around the 96 level which could be tested over the next few days. Vito will be

updating the blog on a daily basis with his key support and resistance levels

but this is our view as at the time of writing. We don't see a major upward leg

on the Aussie towards parity unless the copper price can break out of the

US$3.30-35/lb level. We wrote about the copper price in the Invast Insights

issue published on 2 September.


1.2 Quality of assets for Australian banks

The RBA released its September meeting minutes a few days before the

Federal Reserve meeting. The minutes showed the trade-off with lowering

interest rates in Australia - stimulating below trend growth but also watching

the unintended consequences towards asset quality within the banks and the

health of the financial system overall. Many offshore investors have been

burnt badly by shorting the Australian banks on hopes of a housing collapse.

ANZ Bank, Commonwealth Bank of Australia, National Australian Bank and

Westpac have over the past year posted total shareholder returns of 31.6%,

39.6%, 45.4% and 39.8% respectively.

Most banks blow up because of bad loans and a loosening of lending

practices, as warned by the RBA, will be the main trigger for bad loans

accumulating. Luckily, because of the fantastic disclosure requirements the

Australian regulators impose on the domestic banks, we have access


to data which foresees trends in bad problematic loans. One of the best

indicators we use is the trend in arrears - loans that have not been paid on

time but have not yet turned into bad loans for the banks. Arrears don't pre-

empt bad loans (sometimes loans go bad overnight) but the trend is very

important to watch. The most common measure of arrears are those with a

term of around 90 days - loans which are overdue by 90 days by the borrower.

Below is the trend in arrears as reported by Australia's largest bank -

Commonwealth Bank of Australia - in August this year. Keep in mind that the

report is for a financial year ending June and so the loans below were loans

which were overdue by 90 days as at June. Since then, the unemployment rate

has risen gradually and this is the greatest risk to people paying off their

loans late or defaulting.


Image: 90 day arrears in Commonwealth Bank result presentation to ASX 14 August 2013


As the chart above shows, the level of arrears in home loans remains at

manageable levels and is actually falling. The other three Australian banks will

report over the next few months and their numbers should show a similar

trend. We will be writing a report on each bank when they report. But our

point here is that those shorting the Australian banks probably should know

that at the moment, asset quality is solid. Perhaps that is why the RBA is so

vocal in maintaining this quality and discouraging the banks from taking on-

board more risk in order to grow their profits.

1.3 The key data set to watch

With all this in mind, the key data to watch from US markets will be job

numbers. In Australia, the RBA will be hoping and praying for a good number

so that the Federal Reserve can start to taper, wind back its money printing

and stop devaluing its currency. To date, the US unemployment rate has been

falling but the quality of the numbers are not convincing enough to see the

Federal Reserve into action.


Image: Unemployment rate and employment growth via US Bureau of Labor Statistics September 2013


The smart traders know that the Federal Reserve will eventually act and the

key trigger will likely be a nonfarm payroll number somewhere between

250,000-300,000. We haven't had that type of job growth since February this

year and while in the short term traders are moving out of USD and into risk

currencies, this shift won't last forever. Keep an eye on the nonfarm payroll

numbers particularly the November and December read.

2.0 Brent crude back to "normal" trading range

In the Invast Insights report published on 2 September 2013, we spoke about

the oil price and how the headlines around Syria were much more frightening

than the actual economic situation. We cautioned against buying oil on news

headlines and discussed the range of military possibilities and how they will

impact oil markets. We also ended up report section by saying "...Aga in it is

important to not buy into the headlines before reading through the facts.

There is still a remote chance that no military action takes place in Syria and

somehow, things are sorted out..."


The latter has now occurred. We don't intend on going into another deep

analysis on Syria but instead want to make the point that Brent crude is now

coming back to more normal levels and we think it will continue to trade

within a brand of $107-$117 per barrel between now and the end of the year.

There could be some solid support at around the US$105 per barrel level if it

slips below this range. That's where we would be looking to buy.


Image: Brent crude spot price daily line chart via Invast MT4


3.0 Pivot points explained

Pivot points have been in use by traders long before technical charting was

introduced, and up to this day pivot points are still extensively used by both

fundamental and technical traders. Because both camp of traders employ the

same calculation method, pivot points became one of the most efficient

indicators in predicting potential support and resistances.

Some traders often referred to pivot points as pivot levels instead, and

typically consists of 5 points/levels. The pivot point, resistance 1, resistance 2,

support 1 and support 2; although it is also common to see traders employ

resistance 3 and support 3 to pre-empt major movement in the market during

high impact news releases.


Pivot points are a multipurpose tool used to provide an estimate of the

market range as well as key support and resistance levels for traders to work

with. Its use is very similar to the Fibonacci levels and it’s also considered as a

leading indicator.

Traders typically employ pivot levels as entry and exit levels to complement

their own trading strategy. Unlike Fibonacci which relies on swing highs and

swing lows in the market, pivots rely on the previous day’s open, high, low

and close. For this reason, it is more popular with traders. There are various

calculation methods to obtain pivot points, to name a few these are the more

common method of pivot calculations:

• Traditional

• Classic

• Fibonacci

• Woodie


• DeMark

• Camarilla

The traditional arithmetic average method is the most common and well

known calculation methods employed by traders globally and is generally

referred to when pivot points are discussed in general technical analysis.

The traditional arithmetic average calculation starts by determining the Pivot

point.

Pivot = (High+Low+Close)/ 3

There are variations by including the open of the day as well;

Pivot = (Open+High+Low+Close)/4

Throughout this article we will be referring to Pivot = (High+Low+Close)/ 3


Resistances and Supports can be derived from:

R1 = Pivot + (Pivot-Low)

R2 = Pivot + (High – Low)

R3 = R1 + (High – Low)

S1 = Pivot – (High – Pivot)

S2 = Pivot – (High – Low)

S3 = S1 – (High – Low)

Support 2 (S2) and Resistance 2(R2) are often considered as the highest

support and resistance for the day during normal market conditions, as such

the distance between the two is considered as the potential range of the

market for the day. Resistance 3 and Support 3 are typically reserved for

market moving events such as last week’s FOMC tapering decision.


Apart from the main pivot points, some traders employ mid points, these are

pivot levels located between key levels described above. These mid-points are

less accurate and carry little importance most of the time, as most traders

simply bypass them and look up to the main pivot points as reference. It is

best for new traders to avoid using mid- points as it could confuse them with

too many levels to work with. In this article, however, we will include the

calculation:

M1= (S2+S1)/2

M2= (S1+PP)/2

M3 = (R1+PP)/2

M4 = (R2+R1)/2


The shorter the distance, the less volatile the market is. However do note that

extensive periods of minimal volatility often sets the market up for potential

breakout situations. During market breakouts price tends to move beyond

S2/R2 and S3/R3. If no trend is visible market typically moves back and forth

around the pivot point.

Daily pivots and weekly pivots are commonly used amongst traders and the

only difference between the two is the data used to calculate them and their

purposes. Daily pivots are calculated based off previous day’s close, typically

traders uses London close (GMT+0/1) or New York close (EST+5). Forex and

futures traders normally prefer the London close while Stock traders in

America naturally use the New York close to calculate the daily pivots.

Australian stock traders would need to use the open/close during the

Australian session between 10:00 to 16:00 GMT+10. Different daily candles

will yield different results as such a thorough research of what majority of

traders are using for different markets is a necessity.


Weekly pivots, as the name suggests requires a weekly candle for its

calculation and since the open is ignored in traditional arithmetic calculation,

market closes are the only thing that would make a difference. Because of the

lack of potential variation, weekly pivot is considered to be the standard

benchmark that will not differ too much from traders to traders. Daily pivots

are typically employed by intraday traders to predict turns in the market

within the day. Weekly pivot points are a favourite amongst swing and longer

term position traders as it covers a much larger range of the market.

Traders generally agree should price in the market trade above the pivot

point, the market would be considered as carrying a bullish sentiment and

the expectation is for the market to continue moving higher. On the other

hand, with a price trading below the pivot point, traders expect the market to

fall even lower. This by itself is an additional purpose to gauge sentiments and

bias in the market.


Pivot points are one of the simplest indicator to use, in a nutshell market price

is attracted to pivot points. Think of it as a magnetic pull between price and

pivot points. For example, price trading above the pivot level carries a bullish

bias and will likely pull higher, attracted by the magnetic pull of R1. This

applies to all the other points as price pushes through them just like how

magnets with opposing polarity attracts. The flip side to this is that these

points also act as support and resistance levels, and has the potential to repel

price just how positively charge magnets repel one another.

Price bouncing off from supports and repelled from resistances are typically

due to market psychology and their reaction towards these pivot points.

Buyers would come in around support levels and sellers around resistance

levels; adding to this are traders with positions taking profits or cutting their

losses; hence the potential that these points could be the turning point

during the day, considering a lot of traders are looking at these same levels.


Below is an example of AUD/USD on the daily chart restrained by the weekly

pivot point following FOMC’s announcement to hold back tapering of

quantitative easing for now. Keep in mind that the R3 that kept the pair from

progressing further was projected 4 days before the FOMC announcement,

relying on previous week’s data.


Figure 1 Weekly R3 restraining the market post FOMC "no taper" .Source: INVAST MT4


Below is another example of the daily pivot constraining USD/JPY throughout

the transitional trend change from the 6thof August till 14th of August 2013;

as seen from the hourly time frame.


Figure 2 USD/JPY movement const rained by Daily Pivots. Source: INVAST cTrader


As you can see from the examples illustrated above, Pivot points provide a

reliable level to work with and with minimal confusion. Entry level traders can

pick it up very easily, while traditional traders of ten rely on it as well.

At Invast, we believe Pivot points are the easiest and one of the more reliable

methods to help our traders obtain key levels to plan their trading day ahead.

We also published Pivot points daily covering the Currency majors including

EUR/USD, GBP/USD, AUD/USD, U SD/JPY and USD/CHF. These daily pivots are

published every morning around 8am GMT+10 (Sydney) and employ the

traditional arithmetic method together with Lon don Open/Close. We also

publish a weekly pivot covering the same majors as the daily pivots, every

Monday morning. Our blogs at http://blog.invast.com.au/ host these reports.

http://blog.invast.com.au/










4.0 Client question and answer

Question: Most of the stocks discussed in your 15 hidden gems report (Invast

Insights 0 2.09.13) seem to have very low liquidity, so would you consider

technical analysis to assist in timing entry to the stocks? Do you consider these

as buy and hold stocks or can they be considered for trading as well? – Abel

Answer: Abel, thanks for your question. Many of the stocks we identified in

that report do have low liquidity because of their market capitlisation and

nature of business. These are generally stocks that are not that known in the

market and so their turnover might also be low. But we think, having taken

this into consideration, the absence of large investors can sometimes be

positive.


Let's take Dominos Pizza Enterprises (DMP) as an example. The stock has been

illiquid in the past and a reason for many small cap fund managers and large

investors staying away. But as the business has grown, so too has turnover in

the stock and the amount of subsequent liquidity on the market. Dominos'

annual shareholding turnover has grown from 20.8% in 2011 to 50.8% this

year. The average buy/sell spread has also fallen from around 2% to 0.3%

during that same period. As the business grows, so too does the universe of

investors who can start allocating funds. Dominos has returned 35.9%

annually on average over each of the past three years - no doubt a market

darling with a current share price just under $13.

Illiquid stocks can also be dangerous when the market starts to decline. A

panic seller will often cause a spiral of fear which sometimes turns into a self-

fulfilling prophecy - the share price falls, lenders get edgy, customers are

cautious, business and earnings decline etc. So with opportunity comes risk.


The best way to trade illiquid stocks from our experience is using limit orders

and being patient. Averaging in and out of positions is also helpful so take

these tips into consideration. It's not easy but when everybody decides to

jump on-board, the share price gains can be significant. Our list of stocks is

built on the premise of businesses with earnings growth potential, so the list

is obviously compiled with share price gains in mind.

In terms of technical analysis, this can be useful but when liquidity is low the

historical price action can be easily distorted and so you need to treat the

charts with caution. It would be wise to include volume indicators or use a

volume weighted average price. In our client only webinar held on 17

September 2013, we said out of the 15 hidden gems, our preference were:

Looking attractive at the moment in terms of pricing - ADJ, EPD, JIN, TAN, VEI

Looking attractive if prices fall slightly from here - IMF, VOC, RFL, PPS, ALU

Nice business but attractive on a decent pullback - ELX, NEU, ITL, WBA, RNC


Please note that you should consider your own individual circumstances and

Invast is not licensed to provide you with personal advice. The views above

are of a general nature and please see the disclaimer below for more details.

We hope this answers your question Abel.


5.0 Disclaimer

Please note that you are receiving this report complimentary from Invast

Financial Services Pty Ltd (AFSL 438 283). Invast staff members may from time

to time purchase securities which are included in this or future reports. The

authors of this report may or may not be holding a position in the securities

mentioned. Please note that the information contained in this report and

Invast's website is of a general nature only, and does not take into account

your personal circumstances, financial situation or needs. You are strongly

recommended to seek professional advice before opening an account with us.

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the federal reserve and the future of money printing 2013

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