Market Oddities Abound in This Era of Globalization

Includes: ERO, EU, EWA, FXA, FXY, UDN, UUP
by: Dr. Duru

This is a guest post written by “Chenzo” of

If any lesson was clear during the past few turbulent weeks of trading, it was that our markets are more closely entwined than ever. Perhaps this is a sign of our continuing globalization path, but the waves created by any financial event are traveling across the globe at Internet speed defying any attempt at a Tsunami-type warning system. A crisis is one fundamental that jerks the volatility cord of every market and sends paranoid traders rushing back to their screens to unwind unprofitable positions where hedges were never put in place. Traditional trends reverse, and new trends evolve, but will they last?

As volatility lessens and everyone catches their collective breaths, it is a time to step back, observe the carnage on the battlefield, and regroup our forces for the new battles to come. Oversold conditions persist in the U.S. stock market, but are dependable momentum indicators to be believed or are VIX readings to be trusted? We have become accustomed to low volatility in our markets, but although a lessening has been witnessed, levels are still at March highs of a year ago. Confused traders are not sure if they should short or buy apparent bargains. Corporate earnings are present. A recovery seems to be occurring, but lagging unemployment and consumers with “diminished capacity” related to disposable income could prevent our consumer-driven economy from recovering quickly.

On the other side of the pond, the European Union has yet to propose any major infrastructure changes that markets want to hear. Forex real time quotes tell the story of a weakening Euro in full detail. The Euro began to weaken versus the Dollar back in February when news of problems in Greece and other member states began to surface in the headlines. The Euro has recently pierced the 1.24 resistance level, and after one “dead cat” bounce, it is back testing new bottoms. The Dollar has continued to strengthen, along side of Gold, which is a break with tradition. Safe haven or not, nothing fundamentally has changed regarding debt and deficit issues surrounding our Dollar, but the beat goes on.

On the other side of the planet, more “strangeness” is the rule in Australia. The Australian economy has outperformed many around the globe. GDP was up 2.7% in 2009, unemployment is half of what other countries are experiencing, machinery and equipment spending is also up, and China’s demand for resource exports remains unabated. The Central Bank has raised interest rates, and it appears that Australia may have skirted the global recession that has gripped Europe and America. Yet the Aussie Dollar has weakened of late versus the Greenback. A traditional “double top” has formed over the past six months, signaling an impending decline, which has been validated by trends during the past week.

Much of the recent market turmoil and related “oddities” have been attributed to normal speculation during times of high volatility and to massive “carry trade” exposures. Many hedge funds and traders have used the Dollar and Yen as the “base” currency and invested where rates were higher, typically in Australia and New Zealand or even India this time around. Although figures are difficult to obtain, concerned financial officials have estimated the recent “overhang” to be $2 trillion. The degree to which this figure has been hedged is anyone’s guess, but a strengthening Dollar would cause havoc to reign and create nightmares for highly leveraged and un-hedged currency traders.

We have become so accustomed to a weak Dollar for the past few years that it is difficult to assess its effect on individual company stock values. Pundits on national financial news channels debate endlessly the flows of multinational companies and how a material change in the Dollar will impact the net earnings of these companies. The answer is that we do not know.

We do know that we import more than we export to the tune of $40 billion a day. The U.S. Treasury must cover this net-deficit in our Current Account with CD’s, thereby increasing the Dollars in foreign hands and weakening our relative currency value. A stronger Dollar should have a favorable impact as the value of imports declines over time. If this net-trade deficit begins to drop and consumer purchasing power improves, then real fundamentals should take hold again, sanity should return to our markets, and “oddities” will finally exit stage left.

Disclosure: No positions