Either Tuesday’s election or Wednesday’s Fed announcement could trigger a major market move in either direction. However, overall, we are experiencing one of the most extraordinary events in financial history. There has been an unprecedented effort to inject liquidity into the markets. The central bankers are intent in preventing the current “Great Recession” from becoming the “Second Great Depression” and have launched a Herculean battle against deflation.The weapon of choice is the US dollar, the international currency for commodities–the basis for life and the raw materials for economic activity.
As the dollar gradually declines, commodities rally providing a stabilizing effect for the economies of emerging nations. Of course, the dollars’ decline also creates rallies in silly things like gold, which as no intrinsic value except jewelry. The spillover for the stock market is that as more and more traders grasp this declining dollar/massive liquidity injection, the more embolden they become. When traders puff up, they slowly take on risk and their willingness to take on risk is the key element to pushing banks to lend, deals to get made, companies to hire, people to spend, and eventually to pull the world’s economy back from the brink of deflation and despair, first to stabilization, then slowly to growth.
Currently, it looks like we’re in the stabilization phase of the world’s economy. It also looks like the US Fed and Bernanke have decided to push down hard again on the liquidity injection/dollar decline lever with a new round of easing. Probably, this is being done with the agreement of the G-20, since the central bankers appear to be working together against deflation. As traders we need to understand the dynamic, focus on the best vehicles to exploit the dynamic, and make logical, calculated trades. In this current scenario, we should be looking for stocks or ETFs that best react to the declining dollar/rising commodity dynamic.
The first chart I’m posting shows the SPY’s rally (lead by stocks like FCX) and the rally in commodities (RJA) moving in the opposite direction of the dollar (UUP ETF). The movement has been almost in lock step since September. We are most likely at a pivot point in the market, depending on how the market handles next week’s events. October’s market was strong enough to break price out of the symmetrical triangle on the SPY’s monthly chart. Coupled with a monthly MACD that is gaining momentum (this is an old, and venerable market indicator that still works), it would be reasonable to conclude that we have entered a new bull phase.
Some suggestions: For those looking to hedge long positions going into the election, the VXX is the ETN of the VIX or Volatility Index. Volatility tends to rise when the market has a sharp decline and this ETN is highly leveraged. Of course, index puts are also an idea. Personally, I drop my trading load to the bare minimum at times like these. If the dollar continues to decline, there are numerous ETFs available that track commodities, or mining stocks. GDX, XME, GLD are a few. Also, a declining dollar is good for emerging markets like so ETFs like EWZ, ECH, FXI are all worth a look.