Wednesday Roundup: Markets Get a Reality Check

The equity markets finally reacted to the broader economic picture after the large gains of the past few days.

The ADP employment report which included a steep correction to April’s number, coup led with weaker ISM index of non-manufacturing activity

led to a large gap down open in equity markets. News of disagreement about the policies of the ECB in tackling the financial crisis strengthened the dollar.

A larger than expected build-up of oil inventories added to the sell-off in crude oil. To top it all off, Fed Chairman Ben Bernanke warned about the risk posed by rising deficits, affirming that any talk of inflation is rather premature.

This also led to a sell-off in Gold and a bid in treasury bonds.

Inflation and the Anti-Dollar Play
In yesterday’s review I had written that the anti-dollar trade was going beyond what the macro-fundamentals suggest.

The problems plaguing the financial system stretch to most of the developed world, and the effect of Fed’s monetary policies are being exaggerated.

The Euro specifically is the default beneficiary of the anti-dollar trade, even though the schisms created by multiple political stake-holders tugging the ECB are hindering appropriate policy response. The trade reversed today, with the Euro taking a significant tumble along with oil. Though this is certainly not the end of the bullish run, it does highlight how chasing a crowded trade can hurt investors.

Bullish Sentiment Intact: 200 Day SMA Holds
In yesterday’s roundup, I had expected the SPX to test its 200 Day SMA from the upside, and

it did so today.

The bulls will take heart th at buyers emerged when the SPX approached the 200 Day SMA

at 923, and equities finished strong, wiping out a significant portion of the intra-day losses at the close.

It is fairly common for instruments to straddle the 200 Day SMA for many days, as the market tries to resolve its future direction.

This average is sloping downwards and the average will continue to decline for some time to come. As a result the market can continue to remain about the technical level, even when it moves sideways or downwards.

Ever since the market closed above the 875 level on May 1, it has not fallen below it.

As long as that level holds the bullish sentiment will remain intact.

My Portfolio: No New Positions

Though I had planned to open new long positions when the market tested the 200 Day SMA, I did not do so. This w as bec

ause the strongest sectors so far, energy and materials showed a strong pull-back today. The anti-dollar trade is likely to be unwound further, and these sectors will continue to remain under pressure. As I had written yesterday, the chart of oil last year should be a reminder to anyone who wants to chase commodities, when the global macro picture is clouded.

Refiners Sell Off

Unfortunately, my long call position on the refiner TSO, took a big beating today as the entire sector was sold off due to concerns about capital needs and earnings. VLO has suffered from refinery shut-downs leading to a loss, which they pre-announced today, prior to a secondary equity offering to meet some urgent capital requirements. Refiners continue to trade at attractive valuations to their book value. However their earnings continue to remain volatile.

They are great take out candidates for larger integrated oil companies but until that becomes a reality their share price will continue to be volatile. TSO closed below its 50 Day SMA today (15.78) and is likely to test its 200 Day SMA currently just above $14. That may provide a good longer term entry point for long positions.

Tomorrow’s Outlook
I expect cautious range bound trading tomorrow in front of the non-farm payroll report due on Friday. The market will likely consolidate it gains around the 200 Day SMA, perhaps retesting it.

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