April 27 was a news driven trading day with some scary twists.
The world woke up to the news th at the Swine Flu h
ad spread all over the world and WHO was considering it as a potential pandemic. US Equity futures had been trading down since the market opened on Sunday evening and continued with the down trend till the market open.
If the swines were not enough, we had the surreal scene of a Jumbo Jet being chased by USAF fighter jets as it flew low over Southern Manhattan and the lower Hudson. Traders trading on the Nymex floor at the New York Mercantile Exchange took no chances and bolted from the exchange floor. It was run first instead of sell first.
All that was missing was pigs flying low over lower Manhattan to complete the Scary Movie.
Dollar Strong but Gold Weak: Change in Risk Perceptions
The Dollar was strong today as the flight
to safety trade continued. The dollar was helped by poor economic news from Europe, with the consensus being that Europe will take much longer than the US to emerge from the current economic crisis.
Surprisingly, Gold did not rally. This is an indication of a change in the nature of the risk perceptions driving Gold prices.
Risk it seems is no longer perceived coming from the financial system, which would have led to a flight to hard assets like Gold.
Gold it seems is now increasingly been seen as the reflation trade, a hedge against the risk of a weak dollar and inflation. This change in the risk perception is likely to show up as a negative correlation with the Dollar.
If this trend continues, it also means that Gold is unlikely to see a strong rally, until it is clear that the Fed’s reflation efforts are bearing fruit.
Of course this situation can change quickly if some event triggers the fears of a systemic financial system risk. But given the coordinated efforts of banks worldwide,
the perception of this risk is gradually decreasing.
Gold and Equity Prices: Risk Appetite Improving?
The fact the gold is no longer been driven by the meltdown risk, also means that overall investor risk-appetite is now growing. This is going to be positive for risky assets like equities going forward. The US stock market though did not show the same behavior today with the riskiest small caps, underperforming the large caps, and especially the tech-heavy Nasdaq-100.
The Bulls can take heart that even the fear of a world-wide pandemic did not cause any serious damage to indices. In fact it is likely that some Bulls took the opening gap as an opportunity to add to their positions, with the assumption that unlike SARS in China, there is enough transparency in the situation in Mexico to allow health regulators world-wide to manage the fallout of the swine-flu.
The Russell 2000 is now forming a tight ascending triangle, which is likely to resolve this week.
With the Fed meeting this week (typically bullish), it is going to be a toss-up on which side it will resolve to.
Many indices and sectors are up against strong trend-line or horizontal resistance levels. If the market does break out it is going to be a strong coordinated move. This market has out-foxed most pundits and I will not be surprised if it breaks out over the 875 level on the S&P500 this week. I myself am positioned primarily in cash, and puts on some indices like the commercial real estate (IYR) and small-caps (IWM).
If the dollar continues to strengthen, we might see Gold and Oil pull back. This will be setting up for a giant trade, when the dollar eventually starts to feel the effect of th Fed’s action. That will probably be when the European and the Japanese economy recover.
The 30-day correlation coefficient between the Dollar Index and Morgan Stanley’s MSCI World Index reached negative 0.72 on Feb. 19, the most since July 2006, as the greenback approached a three-year high against its trading partners and global stocks fell. A correlation of minus 1 would mean the dollar gains whenever stocks decline.
Now, the dollar is gaining as stocks rally, signaling investors see the economy bottoming and are putting their money in U.S. assets.
The Dollar Index rose as much as 5.1 percent since March 19 as the MSCI World Index rallied 11 percent. The 30-day correlation coefficient narrowed to minus 0.55 in that period.
“If there’re signs that the U.S. is the first out of the recession, it’s beneficial for the dollar,” said Samarjit Shankar, director of global strategy for the Global Markets group in Boston at Bank of New York Mellon, which administers more than $20 trillion in assets.