View From the Turret: The Aftermath
The bears were out in full force as we wrapped up last week. You could almost smell the fear as investors lightened exposure and bailed out of positions, and short-sellers stepped up to the plate.
While the selling got started midway through the week, the intensity really picked up following the April jobs report which was a major disappointment. For the month, payrolls rose by 115,000 – well below the 165,000 that economists had expected. April marked the third month of decelerating job growth…
In the ‘lies, damned lies, and statistics’ category, the official unemployment rate actually dropped from 8.2% to 8.1% as the US workforce shrank for the second month. According to the BLS, 342,000 people left the labor force last month. Apparently, the market saw through the government charade as the S&P dropped 1.6%, the Nasdaq Composite lost 2.2%, and every single Dow component traded lower.
With the majority of recent global economic reports showing weakness (particularly in manufacturing, employment, housing, and consumer measurements), bullish investors are finding fewer data points to support their posture.
First quarter corporate earnings reports have held up as one of the last remaining bullish areas – thanks to the majority of companies beating expectations. But according to Bespoke Investment Group the rate at which individual companies are beating expectations has declined steadily throughout the season.
It’s becoming harder to justify bullish positions as the market rolls over, and we’ve been methodically adding bearish exposure to our trading book. With plenty of economic land mines still threatening investors, we’re growing more confident in methodically adding more exposure while still carefully managing our risk.
Below are a few of the specific opportunities that we are tracking this week…
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The Australian Connection
While fielding questions from a group of traders last week, I was asked about my thoughts on the US dollar. I responded by saying that the US dollar has plenty of problems – and ultimately may lose a significant amount of purchasing power… but today, the US dollar remains stable versus the other major currencies whose problems are much WORSE!
My suggestion was to consider short positions in currencies that were tied directly to natural resources, as current weakness in emerging markets has the potential to shift the supply / demand balance - which in turn affects the currency of resource-rich countries such as Australia and Canada.
In fact, the Mercenary Live Feed took a short position in the Australian dollar (via AUDUSD currency pair) last week as the currency resumed weakness after a brief consolidating drift.
Last week, the Australian central bank cut their current economic forecast from 3.5% to 3.0%, as an indirect result of weakening demand for resources. The lower expectation gives policymakers more leeway to cut interest rates – which would be a natural headwind for the aussie.
Austerity measures in Europe add insult to injury as now both emerging markets AND a major portion of the developed world are running into constraints for manufacturing and building. Now that the bearish Aussie trend has been confirmed, the pair could fall a significant way before running into a legitimate support area.
Speaking of Resources…
US equities weren’t the only group of securities that were under pressure last week. Oil prices took it on the chin as well, dropping well below the $100 per barrel mark for the first time in months.
Spring is typically a bullish month for oil prices as traders anticipate a pickup in demand with the summer driving season. This year, the supply side of the equation is getting more attention…
Oil inventories rose for the 6th straight week last week – hitting their highest levels ever for this time of year. Couple that statistic with weakening manufacturing, employment and consumer spending, and you don’t need much of a catalyst for prices to start backing down.
The big question now is how investors will treat the oil producers… If the commodity prices soften significantly, it will certainly cut into profit margins and lead to earnings disappointments. The political environment is already heavily weighted against these firms, and yet any contraction in production would be viewed as “price fixing” – leading to more backlash.
The E&P (Exploration & Production) majors have been hitting key resistance areas on their charts lately – see weekly charts for Exxon Mobil (XOM), Chevron Corporation (CVX), BP P.L.C. (BP) as examples – and a breakdown for the group would likely set up some very attractive reward-to-risk short opportunities.
Another Technical Failure?
Technology stocks have not been immune to the broad market selloff. Last month we took a look at a group of networking stocks – identifying a handful of vulnerable stocks worth watching.
In keeping with that overall theme, take a look at the current chart for the S&P Technology Fund (XLK)…
If the pattern looks familiar, simply pull up a chart of Apple Corp. (AAPL) and you’ll see why. According to Morningstar, Apple makes up 18.31% of the ETF’s holdings – and of course Apple has been showing signs of breaking down since it topped in early April.
Technology stocks as a group are widely regarded as speculative positions – and while it’s not fair to paint such a diverse group with such a broad brush, the truth is that as institutional investors adjust their exposure to a more bearish environment, they will be active sellers of high-beta liquid stocks.
The technology group is also vulnerable to reduced corporate spending as companies back off on growth initiatives until the economic picture becomes more clear. We’re isolating breakdowns in this area and watching for consolidation periods to set up better reward-to-risk entry points.
This week, traders will continue to focus on a full slate of earnings reports, the results of European elections, along with a few key inflation measures at the end of the week.
Greece is the major fly in the ointment Sunday night as pro-austerity parties received 32% of the vote (see Business Insider). This makes it more challenging for current bailout deals to be pushed through (no austerity, no bailouts) and raises even more uncertainty.
Overnight futures show oil near $97, US equities down another 95 basis points, and the aussie dollar hitting new lows.
The trading environment still favors nimble participants – as there is still plenty of uncertainty. The bearish action gives the fed more ammunition for additional liquidity measures – so don’t be surprised if the bulls try to pull that out of their hat.
Overall, the picture is turning decidedly bearish and we continue to be comfortable building short exposure as equities break down.
Trade ‘em well this week!