Daily State Of The Markets: 1 And Done? Or ...

Includes: DIA, SPY
by: David Moenning

Good morning. The price action in the stock market was indeed a little u-g-l-y on Wednesday. However, I ended my day with a smile as I definitely got a chuckle out of the bear camp's response after the close. Although our furry friends have had their heads handed to them on a platter for nearly three straight months, suddenly there was hope yesterday.

"This is it!" I was told. "This is the day that we've been waiting for... the day that proves the recent rally has been nothing but central bank-induced smoke and mirrors - you'll see! The economy is sagging again. The housing rebound is over. The Fed is going to pull the punch bowl. The consumer is going to go back into their cave. The sequester is coming. The charts are breaking down. And as a result (insert dramatic pause here) ... All of you dim witted bulls are doomed!"

Okay, I might be guilty of embellishing the comments made yesterday afternoon by my bearish colleagues just a bit. But frankly, I just can't resist poking a little fun at them. You see, while we've made some nice gains in nearly all of our strategies so far this year, the glass-is-always-empty crowd has been on the wrong side of a very nice trend (the S&P is still up +6.01% year-to-date and has risen nearly +12% since November 15th). And by being on the wrong side, I mean to say that they've either been in cash or worse yet, short. Either way, gains have been missed. Oops.

I attempted to make this point to my friends dressed in their bear costumes yesterday (you'd think it would get hot in there at some point), but they would hear nothing of it. I suggested that like February 4th, one day does not a trend make. But to these guys, it's as if making money on the downside is the only "pure" way to play the market or that riding an uptrend in the stock market is an unacceptable proposition. I tried to point out that there is still a very nice uptrend on the daily and weekly charts. But again, I was quickly rebuffed with talk of support and ma breaks, key reversal days, and 2 consecutive weak housing numbers.

To be sure, the current rally will end at some point. And okay, yes, there is a chance that it ended yesterday. However, I think there is a lot more to the story of yesterday's decline than the idea that suddenly a sea of investors (and/or their computers) suddenly decided that the jig was up.

Remember, my primary goal is to stay in tune with the overall market environment. And the bottom line is the Fed didn't say or hint at anything that would normally lead to a decline of more than 1% in the stock market. No, I believe that there were other factors at work as well.

First and foremost was the movement in the dollar/metals trade. The greenback enjoyed its biggest one-day gain in some time while gold, silver, copper, and steel got crushed. And in the case of gold, the key word here is again. At least part of the reason behind the dance to the downside in the metals was the spike in the dollar. But another part - perhaps a major part - was word that a large commodities hedge fund was "blowing up" (being forced to liquidate).

To review, when word gets out that a large fund is liquidating its holdings, the street goes into hyper drive because there is soon to be blood in the streets - as well as easy money to be made. Other managers quickly figure out what the fund in question holds and starts to sell those holdings. Why, you ask? In short, if you know that somebody is going to sell a boatload of gold and silver positions, it is a safe bet that prices are going to go down. So, why not front-run the move with some selling of your own?

While I don't have any particulars, I do know that when funds liquidate they also sell the most liquid positions first. And this usually means S&P futures or ETF's. So, from the cheap seats in my office, this might help explain why stocks started to dive in earnest yesterday morning.

Next, let's talk a little more about the dollar. IF (a big if) the Fed does indeed decide to pull the punch bowl sooner rather than later, rates will undoubtedly rise. This, in turn, pushes the dollar higher. And if you recall your "risk on/risk off" trade rules, you know that if the dollar rises, risk assets are sold at the same time. So, all this talk about the Fed stopping short of their QE goals likely put that trade in motion yesterday afternoon.

Then there is the calendar. There is worry about the sequester, the elections in Europe, and a boatload of economic data to be released today. So, with concerns about the two straight housing reports coming in below expectations leading to fear that the economy's momentum might be starting to fade again, it makes sense to me that buyers may have decided to simply stand aside yesterday.

In sum, I'm of the mind that although there was really no news to speak of yesterday, the chatter in the market about a fund blowing up, gold breaking down, the economy slowing, the Fed acting prematurely, etc. wound up being a heavenly environment for the quants and their algos. So now we will have wait and see whether Wednesday was another one-and-done effort by the bears, or the start of something more meaningful.

Turning to this morning ... Overnight markets followed Wall Street's lead and are all lower. Suddenly everything is negative and the overriding fear is that the Fed will begin to back away from their QE programs and "remove the punch bowl" from the stock market party. In addition, the Flash PMI's in Europe were weaker than expected, which puts the global recovery theme in question. So, with a market that remains overbought, the bears appear to be in charge again in the early going.

Pre-Game Indicators
Here are the Pre-Market indicators we review each morning before the opening bell ...
Major Foreign Markets:
- Shanghai: -2.97%
- Hong Kong: -1.72%
- Japan: -1.39%
- France: -1.83%
- Germany: -1.86%
- Italy: -2.82%
- Spain: -1.48%
- London: -1.66%
Crude Oil Futures: -$1.51 to $93.71
Gold: -$8.80 to $1569.20
Dollar: higher against the yen and euro, lower vs. pound
10-Year Bond Yield: Currently trading at 1.990%
Stock Futures Ahead of Open in U.S. (relative to fair value):
- S&P 500: -5.85
- Dow Jones Industrial Average: -41
- NASDAQ Composite: -11.81
Thought For The Day ...

"Give me six hours to chop down a tree and I will spend the first four sharpening the axe" - Abraham Lincoln

Positions in stocks mentioned: none