Trading a Moving Global Outlook

Several debates rage. In financial markets and boardrooms, decisions are made and assets repositioned based on opinion regarding the presence or absence of recession. These debates are interlinked as recession fears emerged from U.S. weakness and created growing trepidation about contagion. If the U.S. is in, or headed to recession, how deep and how long will it be? How broadly will it be shared? We see such debates driving Hang Seng swoons, Bombay Sensex gyrations, Nasdaq nosedives and global financial stock sell-offs.

Given the protracted nature of the debate on a series of correlated targets, the sure thing is volatility. Economic data flow, earnings announcements and headline risk rules the roost. Traders have taken home much more than investors over the last few months. Asset price movements reflect oscillation between deep fears and rebound plays. The trading ranges- long and short- on financial ETFs, emerging markets index ETFs and U.S. and European ETFs make this very clear. Moves of greater than 3% per day are commonplace with moves greater than 5% not uncommon.

The Long Play ETFs: emerging markets (EEM), U.S. financials (UYG), China (FXI) and the Nasdaq (QLD).

The Short Play ETFs: emerging markets (EUM), U.S. financials (SKF), China (FXP) and the Nasdaq (QID).

The swings are created by recession and contagion debate and data flow. A significant group arguing for no or minor coming U.S. weakness tends to focus on the relatively particular areas of trouble. These include the automotive sector, housing, financial and credit markets. Overall employment and economic growth data- while far from strong- are not yet definitely recessionary. Personal earnings numbers have not radically turned down and neither has employment.

I believe that our post-2001 economic boom was uniquely and imprudently based on consumer credit and asset inflation. Equities rebounded and performed well- particularly outside the U.S.- since 2003. American home prices surged. All of this was based on consumer credit. Employment and personal earnings growth was weak across the last few years. Thus, it would not be shocking to see less profound earnings and employment downturn as recession begins. If you boom on house price inflation and consumer credit, you bust when they bust. They are busting now.

This is not a U.S.-only story. America's asset bubbles spilled over and fed foreign asset bubbles. The sheer volume of American equity purchases overseas suggests the level of correlation will continue to be high. The last full year covered by U.S. Treasury International Capital System data is 2006. U.S. holdings of foreign securities increased by almost 30 percent, or approximately $1.4 trillion, during 2006, reaching almost $6 trillion. Generous global credit terms, booming markets, outperformance of foreign equities and currencies created the global upward contagion that all have been celebrating and buying.

These factors are creating a disorderly unwind and a trader's markets with upside returns to short bias. Of course this won't last forever. It will last as long as we under-report and fail to acknowledge the recessionary trajectory of the U.S. and the very low chance of international equity market de-coupling. American housing, financials and macro outlook will retain downward leadership so long as weakness is denied. A look at housing and financials suggests this will take a while longer.

Disclosure: Short global markets