Thursday, December 17, 2009

Get Away Day on Strong Dollar, Options Expiration

As is usually the case, foreign markets reacted to Wednesday's Fed statement with more conviction and honesty than US media and economic pundits. Here in the USA, the widely-accepted response to the Fed was that the statement contained nothing new, and that money would continue flowing freely, courtesy of extraordinarily low interest rates fostered by Fed accommodation.

In the Far East, Asia and Europe, the response was vastly different and it had far-ranging effects on US equities. Most foreign currencies - especially the Euro, Pound Sterling and Yen - fell sharply against the US Dollar as leaders and market participants overseas saw the Fed announcement for what it really was: an early warning that accommodative policies would soon end. With the rise of the dollar, those enganged in the risk trade (shot the dollar, long stocks) on Wall Street were stung and forced into selling off a wide swath of positions, sending the markets to their worst one-day slide in over a month.

Contributing to the decline was options expiration on Friday, which raised volatility and exacerbated a descent which really needed little help. In the horse-racing business, they call day's like these "get-away days," as owners sell off unwanted or damaged horse flesh in claiming races or to private parties, raising cash for their next foray. So it was on Wall Street today, with investors exiting unwanted positions and trimming back on strong ones. Some, however, were selling everything to cover their short positions against the US Dollar.

Dow 10,308.26, -132.86 (1.27%)
Nasdaq 2,180.05, -26.86 (1.22%)
S&P 500 1,096.07, -13.11 (1.18%)
NYSE Composite 7,063.75, -117.02 (1.63%)

The decline was broad-based, with declining issues far outpacing advancers, 4851-1780. The relationship of new highs to new lows was flattened, with the highs at 227, to 73 lows. Volume, which was extraordinarily high on the NYSE, is indicating that the selling may only have begun, though there are still enough unhedged bulls about to keep declines in order.

NYSE Volume 6,782,270,000
Nasdaq Volume 1,928,465,625

Commodities were hard hit, as is the usual case with dollar strength. Oil dropped only a penny by the close, though it traded down as much as $1.40 during the day. Gold fell $29.00, to $1,107.20, while silver dipped 49 cents to $17.20.

In general, the day's trade was tied almost exclusively to dollar strength, a counter-trend trade that may have legs. The number of short positions in the dollar is immense, and if there are continuing signs that the US economy is improving rapidly - and there are some - the unwinding of these positions and the corresponding sell-off in stocks could be profound in a classic short-squeeze, likely engineered by a concerted effort by central banks with more at stake than equity positions.

The message may become all-too-clear if central banks work together to promote dollar stability and global strength: Stocks be dammed; whole economies are of far more importance. It's a dicey situation, though a correction may not exceed a 15% in equity values, not a bad haircut, but more of a trim after the robustness during the liquidity-driven rally of the past 9 months.

Overall, the markets are functioning well, and an unwinding of the short dollar - long stocks trade may be just the tonic needed to promote overall prosperity. Wall Street needs to give some heed to Main Street, which is still suffering.

There were a number of positive signs beyond the Fed announcement from Wednesday. After new unemployment claims disappointed with a 7,000 net rise from a week ago, to 480,000, the Philadelphia Fed Index reported a healthy rise, from 16.7 in November to 20.4 in December, and the Conference Board's Index of Leading Economic Indicators posted an increase of 0.9% for November, ahead of expectations (0.7%).

There is no economic data due out tomorrow and options traders must close positions by noon. There was a positive quarterly report by Research in Motion (RIMM) after the bell, which may provide some impetus to the upside in the tech space, though it appears that much of the trading for 2009 has concluded and new highs for the markets are unlikely until January.

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