Are the Sellers Done?

So far this year, the S&P 500 has dropped 3% or more in one session 3 different times. The two previous times, it clawed back some of the losses over the following week. We’ll have to wait and see of there is any upside after yesterday’s big drop.   

 

The S&P 500 is now testing the lows from the “flash crash” on May 6. This is interesting because it was assumed that trading that day was something of a fluke as computer trading programs went haywire. But now that stocks are back to those levels, we must consider that the drop may not have been a fluke.  

 

The question now is: can stocks find some strength? Or perhaps a better way to ask the question is: are the sellers done?   

 

Investors have sold stocks, euros, oil, commodities, even gold. And where investors are selling assets, there is also a portion of the market that is selling assets short: that is, they are buying what they do not own and selling in order to profit by buying the borrowed assets back at lower prices.  

 

Of course, that buying is known as “short-covering.” I think it’s safe to say that short-covering is responsible for the strength in the euro we’re seeing today. And there will come a time soon, where stocks rally as short positions are covered.   

 

It’s reasonable to ask why any trader might cover a euro short. After all, there aren’t many traders who will say that the euro has any upside. It would seem that covering a euro short would simply be giving away potential profits.   

 

But there’s more to it than that. The euro trade is very one-sided right now. And any trader or investor should know that one-sided trades are dangerous. It’s analogous to all the passengers on a boat rushing to one side at once, and the boat tipping over. 

 

When you’re short a currency, there’s really one thing you fear: central bank intervention. Central banks often have a lot of ready cash, and can enter the currency market and buy their own currency to support its value.    

 

Intervention is a dangerous game for all involved. A trader can sustain heavy losses fighting a central bank’s actions. On the other hand, if a central bank’s intervention is perceived as weak, it can be overwhelmed by sellers. George Soros once famously beat the UK central bank and made $1 billion in a day.   

 

Reuter’s is reporting that Eurogroup Chairman Jean-Claude Juncker said “…he did not see the need to take immediate action on the euro’s decline…”  

 

Yes, this is the same guy who said the markets were acting irrationally yesterday.   

 

Such a statement isn’t likely to instill much fear of intervention in the euro bears. And it probably reflects another important question: can the EU afford to defend its currency?   

 

While we’re at it, let’s ask: can the EU afford NOT to defend its currency?  

 

It’s clear we are getting to a critical point in the ongoing EU saga. It seems that investors are wondering if we are seeing the end of Europe as we know it. It reminds me of when investors were wondering if we were seeing the end of America as we know it during the financial crisis of 2008.   

 

In the past, I’ve discussed how relentless market declines take on the flavor of a “global margin call”, where assets have to be sold to raise cash to offset other obligations.   

 

I’d say there’s no doubt that a “global margin call” is part of the reason we’ve seen such steep declines. In the current low interest rate environment, many traders have entered into “carry trades.” They borrow at a low rate, and then invest in an asset that will give them a higher return.   

 

Japan has openly supported the yen carry trade for years. You can borrow yen at virtually 0% and then buy something like oil, or stocks or even Treasuries and make money.   

 

But when the yen rallies, suddenly the yen carry trade becomes less profitable, or even a losing position. And if the asset you’ve bought as the other side of your carry trade falls in value, well, hello margin call.   

 

I understand that “slower growth” angle of lower oil prices. But I’m sure some of oil’s decline, and the yen’s strength, is being cause by the unwinding of carry trades.  

 

TradeMaster Daily Stock Alerts Jason Cimpl advised his readers to cover a few short positions yesterday. They made money on downside moves from Microsoft (Nasdaq:MSFT) and Baidu (Nasdaq:BIDU).   

 

Jason is also advising his readers that there should be some upside for U.S. stocks coming over the next couple of sessions. Be he also cautions that we are not in a bull trend anymore.   

 

I have scheduled a special video investment conference to discuss the current market situation and advise readers how they can use the current volatility to add top companies to their portfolios at attractive prices.   

 

The Profiting from Crisis in Europe video conference is free to attend, and will air on Thursday June 4, at 6 pm.   

 

You can sign up for this critical event HERE.