The Markets

Last week’s roller coaster cum bloodbath on Wall Street gives us a beautiful case study in the art of macrotrading and the importance of economic factors shaping market trends. The case study started last Wednesday with Fed Chairman Ben Bernanke’s professint not only rising concern with inflation but also a desire to shore up the dollar. Of course, it has been Bernanke debasing ye olde greenback through his over-aggressive rate cutting. With Bernanke now drawing a line in the shifting sands of fortunes of the dollar – a marked policy shift for the Fed -- the markets reacted just like the macrotrading text book indicates:
In particular, the dollar strengthened on the prospects of higher U.S. interest rates. This, in turn, sent oil and commodities prices, which are priced in dollars, down the chute. The U.S. stock market then rallied on the prospect that the oil bubble might be now burst, and the contractionary effects of high oil prices would be moderated.
Ah, but what a difference a day or two – and one horrific economic report – make. On Thursday, the ECB President warned of a possible rate hike. This gave a boost to the euro at the dollar’s expense. Then, on Friday, the jobs report came in with recession written all over it – with the unemployment rate jumping to 5.5% from 5%. With this single report slaying expectations of a Fed rate hike coming soon to fight inflation, the dollar fall was accentuated. Oil prices, in turn, spiked not only on the weak dollar news but also some saber-rattling by Israel over Iran’s nuclear program. The end result was a Friday bearish trifecta of 3% drops for the Dow, S&P, and Nazz.
So here’s where we stand. In the ongoing battle between our three possible economic scenarios – U.S. recession drags world down, global decoupling, and stagflation -- the clear winner last week for the second week in a row was stagflation. As I have previously lamented, this is the worst possible scenario for bulls because it is impossible to cure with discretionary policy fixes. Rate cuts exacerbate inflation and rate hikes exacerbate recession.
In fact, it is becoming increasingly obvious that Bernanke is being backed into a stagflationary corner. Last week’s desperate save the greenback gambit perfectly illustrates this point. No doubt, Greenspan’s favorite fall guy, AKA Helicopter Ben, was likely quite positive that his support for the dollar would make all things rights. Pity the fool – except when we are his victims.
As for next week, if you are really superstitious, then you don’t want to be long on Friday the 13th ahead of the CPI report. It is the most likely market mover next week in terms of economic reports and the risks to the downside outweigh those to the upside.
My market trend bottom line is this : My “sell in May and go away” warning in this newsletter on May 23rd remains in effect. This is not a market I want to be long