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The devastating tornado that wiped out Joplin Missouri this weekend may have been a bit of foreshadowing for what lies ahead for the financial markets in the next few days and weeks.
Indeed, the key to the whole market right now may be the action in the U.S. Dollar, which is rallying as fears of sovereign debt problems in Europe are again on the rise. The U.S. Dollar Index (USD) closed above 75 last week, as well as above its 20 and 50-day moving averages. This is a reversal of the short and intermediate term trend. And the action early Monday morning says that the up trend for the greenback is gaining ground.
A stronger dollar is viewed by Wall Street as a negative for U.S. multinational corporations, such as the ones in the Dow Jones Industrial Average and the S & P 500. Thus dollar strength likely means weakness in large cap stocks. And if there are enough margin calls on large cap stocks, traders will sell other things to raise money.
Chart Courtesy of StockCharts.com
The S & P 500 (SPX) failed to close above 1340 on Friday. Now it looks ready to test the 1328 support area near its 50-day moving average. A move below 1320 would likely lead to further selling.
Chart Courtesy of StockCharts.com
Over the last few days, we’ve been looking at the market’s breadth. We’ve focused on the Nasdaq Advance Decline Line (NAAD). That’s because there are fewer ETFs, preferred stocks, and closed end funds that trade on the Nasdaq.
That means that the picture of the number of actual stocks that are advancing and declining provided by this instrument is much clearer than that provided by the NYSE advance decline line (NYAD).
And last week’s action in NAAD got worse as the week went on, with the line making lower highs and lower lows, clearly showing a market where sellers had the upper hand.
Chart Courtesy of StockCharts.com
More interesting, though, is that the NYSE A-D line, despite all the distortions that it contains, also turned lower last week, in essence confirming the weakness that was being documented by NAAD.
Chart Courtesy of StockCharts.com
When you add the wild and woolly sentiment from Investor’s Intelligence where the ratio of bulls/bulls + bears was over 69% skewed to the bulls, a correction in the stock market should come as no surprise.
Here’s it where it gets interesting, though. Traders have been bundling commodity, stock and currency trades into one package, now known as the “risk” trade. That means buying stocks, foreign currencies and commodities, and selling dollars at the same time. The rally in the dollar is making the “risk” trade too risky.
That means that traders now have to unwind stock, commodity, and currency positions at the same time.
And that means volatility and margin calls in all three areas of the market.
Tales from The Road: Florida Gulf Coast Shows Signs Of Recent Weakness
We spent several days in the Tampa, Sarasota, Bradenton area of Florida this weekend. As always we looked around and see what the business climate was like, and we asked everyday working people about their jobs, the general outlook of things in their area, and what came up was familiar.
First, we start with the airport. It was packed, and much of it looked as if was vacation and necessary travel. There just weren’t that many families with large numbers of kids on their way to Disneyworld there. To be sure, we didn’t get to Orlando, so we can’t vouch for the Disney related traffic. What we saw were a lot of people that didn’t want to pay their luggage fees to the airlines. And many of them were getting turned back with large carry on bags to pay the fees. At $30 per bag, you can see how the airlines make up the revenues lost via discounted tickets. Nice.
Freeway traffic, though, was not very busy, given the number of people that were getting off airplanes and renting cars. Maybe we just went the wrong way.
Our driver, a married father and self employed businessman was very concerned about the school system, taxes, and the lack of any reasonable political alternative to what is already available. His take on real estate was that there were too many houses for sale and not enough people willing to buy them.
Restaurants had business, but there were no lines for lunch or dinner. The sit down casual diners had more business than the fast food places. And the local mom and pop restaurants were busier than the chains. The chains had their bargain specials prominently featured on the menus. Alcohol prices were higher at all restaurants, though, following a national trend in order to make up for loss revenues due to bargain meals.
Our hotel, a privately owned franchised Hilton property was full. Employees were happy, but noted that if it wasn’t for the weekend convention business, and a local college graduation, business wouldn’t have been as brisk, although they noticed that it was better this year than last year and were hopeful for a continued recovery.
Finally, the rise in “Bank owned” signs at commercial real estate sites was higher than we’ve seen in other places. We didn’t see much residential real estate so we couldn’t say much about it.
Conclusion
The risk trade is being unwound. And that’s likely to make life difficult for anyone on the other side. We have kept our portfolios hedged via ETFs that sell stocks short (SH and RWM). We have also positioned our commodity portfolios to profit from a fall in commodity prices.
Our trip to Florida this week was also an eye opener since we hadn’t been in that area of the country for some time. And the amount of “bank owned” commercial real estate was impressive. Not just empty buildings were “bank owned” but also empty lots and businesses that seemed to have closed recently were quite numerous, suggesting that conditions are actually worsening.
What’s our point? We may be headed for a significant correction on Wall Street and on Main Street.
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