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Some Themes to Occupy the Minds of Traders in 2018

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Photo of an Oil Rig Set Against an Evening Sky (Image: skeeze, Pixabay)

1. Oil is the New Black
There continues to be a difference of opinion on the effectiveness of last year’s production cuts. The Organization of Petroleum Exporting Countries (OPEC) are saying their cuts will clear the glut in the oil market, while the International Energy Agency (IEA) thinks "total supply growth could exceed demand growth" in 2018. The unknown entity in these calculations is U.S. shale oil as State Side producers continue to drive down their production costs and disrupt the crude market.

On the charts, I’ve been tracking the US Oil Fund ETF (USO) since June 2017, where it found support and confirmed the bottom of its gutter channel. From a low of $8.65, it has since gained 43.6% and is currently trading at $12.42 - this continues to be the breakout point to watch in early 2018.
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Mining Bitcoin the Old Fashioned Way (Image: rebcenter-moscow, Pixabay)

2. Bitcoin and crypto-currencies
The inner workings of Bitcoin and other crypto-currencies are a mystery to the majority of people. This hasn’t halted the parabolic climb in value, but I will continue to watch from the sidelines in 2018. We can’t invest in crypto-currencies because they’re not an established and proven asset class. We don’t have the historic data to value them or see how they performed in bull and bear markets. We can’t trade them either, because the exchanges struggle to fill orders during periods of high volatility.

Unless we are mining bitcoin with a DIY server farm and a wind turbine on the roof, we should sit out this particular rush to riches. If cryptos are here to stay, they will be around for a long time and there is no rush to get in on them now. Besides, how can we tell if they are currently undervalued or overvalued? Who knows?

Futures contracts for Bitcoin were launched in the US in December and financial regulators in the EU are seeking to regulate crypto-currencies especially since they are very attractive to criminal types. This story is only beginning and it’s not until the market turns sour on cryptos (which is very likely to happen in 2018), that we’ll get an insight to their true value.
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A Photo of a 'Stocks Market' Sign in the City of London (Image: Ian Murphy)

3. Rue Britannia
Brexiteers assume the EU will continue in its current form after the UK leaves and a newly liberated Britain will have the best of both worlds. This view is based on a flawed binary understanding of the EU project – it’s us and them. (The EU will plod on as before and we'll run rings around them). As we saw with the Irish border issue, international politics is never that simple and every country works on the basis of ‘enlightened self-interest’.

If the end result of Brexit improves the lot of UK citizens, we can expect other EU states to follow suit. Why should Germany, France or Italy stay in the EU when they are better off outside? If Brexit is successful, Germxit will be awesome!

The EU will never sign up to a deal where the UK is better off on the outside, because the very future of the EU is at stake. If the first phase of negotiations is anything to go by, we can expect some serious Brexit fireworks in 2018. A general election in the UK is also on the cards, as simplistic Brexit promises come into contact with the reality of 27 countries with individual agendas. Political fireworks create volatility in the markets and traders need volatility to profit.

US based traders looking to profit for Brexit volatility might consider UK stocks and ETF’s. According to Finviz, there are currently 57 UK based stocks trading on US exchanges. There are also some highly liquid ETF’s such as the iShares MSCI United Kingdom ETF (EWU) which tracks large cap UK equities. iShares also offer EWUS which gives exposure to about 270 British small cap stocks.

A word of caution - these stocks and ETF’s tend to gap at the open. This is common for US listed instruments which track markets in a time zone ahead of the US. The London market opens at 08:00 local time (3am ET), so 5½ hours UK trading instantly manifests at the open in New York and the price can gap up or down as a result. This plays havoc with automated orders as the price gaps over them, so these stocks and ETF’s are more suited to longer term traders.
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A Dynamic Yield Curve Courtesy of stockcharts.com

4. Yield Curve
If ‘Brexit’ was the catch phrase in 2017, ‘Flattening yield curve’ will be all the rage in 2018. A flat yield curve occurs when the payout on short term bonds matches long term bonds. When the curve becomes inverted (shorter bonds pay more), it traditionally predicts a recession. There will be much debate about the yield curve in the year ahead.

Globally, interest rates have never been so low for so long and that’s about to end. During its December meeting, the Fed raised rates by a quarter point (0.25%) and forecast three more increases in 2018. Also in December, the Bank of Japan held short-term interest rates at minus 0.1 percent, but their stimulus program is expected to end in 2018. In October, the European Central Bank announced the unwinding of its Quantitative Easing program (ie. printing money to buy government and corporate IOU’s) and markets are predicting an interest rate increase in 2019.

Remember the ‘taper tantrum’, when markets pulled back because they thought the central banks were going to take away the QE punch bowl? The bowl is being withdrawn for real this time.
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Where Wall Street and Broadway Intersect (Image: Oliver Klein, Pixabay)

5. US Equities and the Trump Trade
President Trump has completed his first year in office and US indices continue to make new highs on historic low volatility. The word on Wall Street is for more of the same in 2018. The main driver of equities last year was improved earnings on the back of low interest rates and low unemployment. In addition, we now have a corporate tax rate of 20% and the possibility of repatriated funds being used for share buy backs or increased dividend payouts.

Up next on the White House ‘To Do’ list is infrastructure spending, but the issue of how to fund the much-needed investment is fraught with political difficulty in light of the $1.5tn which has just been added to the national debt over the next ten years.

With an eye on midterm elections, Republicans who were traditionally seen as deficit hawks will be reluctant to increase debt to fund infrastructure spending. According to NBC News, “In every midterm election since the Civil War, the president's party has lost, on average, 32 seats in the House and two in the Senate. In next year's battles, Democrats need only 24 seats to flip the House and two to take the Senate.”

There is talk of buyers remorse among Trump voters, but the polarized nature of politics and media debate in the US makes it difficult to know how accurate that assessment is. The midterm elections will take place in early November 2018 and that will be the first real test of President Trump’s popularity.

Before then, the ongoing investigation by special counsel Robert Mueller into Trump's alleged ties with Russia has the potential to give the market a few surprises.
© Ian Murphy 2018
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