Thursday Roundup: Sell the U.S.

 |  Includes: FXE, SPY, TLT, UDN, UUP
by: Vikram Saxena

The world markets got a shock Thursday when the S&P lowered its outlook on Britain to negative from stable, a signal that the sovereign AAA ratings may be cut. The primary reason cited was the debt/GDP ratio passed 100%. The market soon acknowledged that the US also has the same risk. This resulted in a sell-off across all US assets. The USD fell across all currencies by almost 1%. The long treasury bonds fell by 2% and the equity indices shedding 1.5-2% across the board.

Fed Intervention leads to Treasury Collapse

The Treasury bond prices collapsed after the Fed came to the market to buy US treasuries under its Quantitative Easing policy. However, the market was disappointed by the amount of bonds purchased; bonds worth $45B were offered but the Fed purchased only $7B.

Government Interference and Unstable Markets

This is another indication of how government interference leads to unstable markets. The expectation of Fed intervention has led to many (including me) to buy bonds, under the assumption that the Fed will try its best to allow the green shoots to grow by keeping the cost of borrowing low. However, once the natural balance of the market is interfered with, any unexpected event can result in a rush to the exits. Yesterday, the ratings challenge led many to sell to the Fed and when the Fed could not buy it all, prices just collapsed.

Equity Markets: Range Bound Trading Continues

As I had alluded to, the market seems to have found a trading range between 875 and 930 on the SPX. After being repelled by the upper end of the range Wednesday, the market found support at the lower end Thursday, nicely rebounding into the close.

Thursday morning’s job loss numbers came better than expected but continuing claims did not pause. This disappointed some bulls who were hoping to see a further drop in jobless claims. Coupled with the weaker dollar theme, the market was under pressure throughout the day. Gold was up on weaker dollar and is enjoying a nice bull run.

My Portfolio

I continue to day-trade without opening any new positions long or short. Yesterday the IYR traded in a wide range, and I sold some of my puts during the weakness, only to buy them back on market strength. The debacle in the TLT yesterday reaffirmed my decision to close out the bulk of my position last Friday; better to be lucky sometime.

Short the Euro

After the Euro breached 1.390 mark against the USD, I opened a small position going short the Euro and long the USD. This is a contra-trend trade, where I will keep tight stops (< 1.0%). I do believe that the four day collapse in the dollar is over-done to some extent, and there is likely to be some profit-taking and risk reduction before the long weekend.

On a more fundamental basis, I believe that the Euro zone is in a much tougher situation than the US, and the ECB does not have the sovereign power to respond appropriately. The Euro-Zone will have to follow policies similar to the US Fed. They will just do it later than needed, when the situation is even worse. So even though I am bearish on the US Dollar versus the commodity currencies (AUD, CAD, NOK), I am even more bearish when it comes to the Euro versus the rest.

Friday’s Outlook

I continue to expect equity markets to trade range bound, with a slightly bullish bias. We had two days of strong price losses, and we are due for a rebound, especially going into a holiday weekend. I expect a pause in the dollar’s slide and the treasuries to get some bid.