Stocks fall, regain ground but still close in the red

Thursday, May 28, 2015 -

There was no follow-through of yesterday’s rebound rally as stocked opened in the red and stayed there all day, though well off the lows of the day by the close.

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Before the markets opened the futures predicted a hard slog in early trading – and it was. Stocks moved strongly to the downside and they stayed there for an hour or two before gently coming back, closing well off the early lows but still firmly in negative territory.

The Dow slipped 37 points (-0.2%) to 18,126, the Nasdaq edged down 9 points (-0.2%) to 5,098 and the S&P 500 dipped 3 points (-0.1%) to 2,121. The NYSE finished at -0.10% and the small cap Russell 2000 also at -0.10%.

The markets recoiled today despite another nice report on housing. And in typical bad news is good news and vice versa –we see fairly good economic data and the market shudders, fearing a Federal Reserve attempt to normalize monetary policy.

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Rising Dollar Risk

If you have read our newsletter for years you will know that we regularly warn our readers whenever we see a strong move in the US Dollar – mostly because crude oil is traded in dollars and any move in the dollar also means a global move in energy prices.

Well, the dollar is once again rebounding into a strong rally, having broken above its 50-day moving average, acting as resistance, over the last three days.

Take a look at the last few strong advances in the dollar and what happened to the stock market over the last six months:

50528SP500vsDollar

Note how the strong advance from mid-December through February was accompanied by a choppy decline in stock prices. And when there was a sudden advance in March, stock prices took another tumble.

As we are moving into the summer months the dollar is once again on a tear – and stock prices are beginning to roll over.

For reference purposes, I want you to look at what happened to the dollar and stocks during the last of 2008 through the first part of 2009:

50528SP500vsDollar2008

The greatest advances in the dollar during the 2008 crash we met with corresponding collapses in stock prices. This is why it is important to keep your eye on the dollar. It tells us a lot about the risk of correction in the broader market whenever the dollar makes a strong advance.

Don’t think because the Federal Reserve is no longer in QE mode that the dollar has been driven to the ground and will stay there. We continue to see global unrest and currency debasement in the Eurozone, the Japanese economy and even in China – all which will strengthen the dollar and make US exports too expensive compared to similar products from other countries.

Consequently, US manufacturers will be in a profit pinch and eventually their bottom lines will be reflected in equity prices, particularly when we have lower currency debasement from our own central bank.

Just consider the strengthening of the dollar as a risk to US equity prices, making true value determinations more difficult.

Helping to confirm that global equity prices are at risk heading into the summer we learned today that several brokers in China have begun to tighten even more on their margin financing ahead of an influx of IPOs next week. The Shanghai Composite Index plummeted 6.5% on the tightening steps.

Even the Eurozone saw further declines as most European stocks moved to the downside on the day, although the U.K.’s FTSE 100 Index edged up by 0.1 percent. The German DAX Index and the French CAC 40 Index dropped by 0.8 percent and 0.9 percent, respectively.

All fundamental and technical indicators continue to point toward a correction this summer or early in the fall.

Tenuous Greece Debt Deal

I suspect that ongoing uncertainty about the situation in Greece will also continue to un-nerve traders until their creditors have signed on the dotted line and the world knows that Greece will remain in the Eurozone and the euro currency will remain viable and strong.

Unfortunately, the more you investigate Greek finances the more tenuous the deal with creditors appears. It didn’t help when today International Monetary Fund Managing Director Christine Lagarde told a German newspaper it is “very unlikely” a comprehensive solution will be reached in the coming days.

Lagarde also acknowledged that a Greek exit from the Eurozone is a “possibility” but said it would “probably not be an end to the euro.”

In a bi-annual Financial Stability Review report from the ECB, released today, the ECB did not lend much confidence to the Greek situation, reading:

Sovereign risks emanating from Greece, in particular, have increased sharply owing to heightened political uncertainty over the past six months, while the banking sector in Greece has witnessed substantial deposit outflows, a loss of access to the wholesale funding market and deteriorating asset quality.”

Financial market reactions to the developments in Greece have been muted to date, but in the absence of a quick agreement on structural implementation needs, the risk of an upward adjustment of the risk premia demanded on vulnerable euro area sovereigns could materialize.”

Traders Sell on Good Housing Data

A report from the National Association of Realtors today showed a jump in pending home sales. With continued concerns about the outlook for interest rates, the successful completed financing of these pending sales may be in question.

NAR said its pending home sales index surged up 3.4 percent to 112.4 in April from a slightly upwardly revised 108.7 in March. Economists had expected the index to increase by about 0.8 percent.

A pending home sale is one in which a contract was signed but not yet closed. Normally, it takes four to six weeks to close a contracted sale. With the bigger than expected increase, the pending home sales index reached its highest level since hitting 112.5 in May of 2006.

The caveat with this improvement in housing data is that normally an increase in pending sales is also accompanied by an increase in actual sales. However, last month we saw a steep decline in actual sales while pending sales rose.

I suspect we are seeing a lot of hopeful home buyers going into the renter market because they simply can’t afford the financing terms and steep down payments. Around here the rental units are springing up like mushrooms after a long rainstorm. Small, affordable homes . . . not so much.

Some suggest that cancellations are on the rise. Perhaps the reason pending sales are up so strongly is because there have been too many cancellations, where these homes have been put back on the market and have attracted new lookers, resulting in a rising inventory.

The big question ahead: Will all the home lookers finally turn into buyers or are we going to see a bunch of new cancellations?

Looking Ahead

Trading on Friday may be impacted by the release of some key U.S. economic data, including reports on first quarter GDP, consumer sentiment, and Chicago-area business activity.

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