By Martin Tillier
If you go bullish on Position A with $5,000 and...
if you go bearish on Position B with $5,000 and...
therefore have a $10,000 position...
(Here's a link to the archived version with the correction.)
And what a year it has been...
From the lows last November to where we are now, the S&P 500 has climbed an incredible 26% and is up 18.6% this calendar year. I have several times fought off the nagging feeling that trouble may be just around the corner, but am finding it harder to do this time.
My concern started with a simple forex guy's observation that overall the US Dollar index is up around 4% on the year, with a couple of dramatic spikes over the last 2 months.
This set me wondering about the effects of those spikes on stocks. Allow me to explain.
Forex has a self regulating function when it comes to individual nations’ economies. As the domestic economy strengthens, so the assets denominated in US Dollars, and therefore the Dollars themselves become more attractive, pushing the price up.
As the Dollar moves higher, the relationship between imports and exports changes. Imports become relatively cheaper at home and exports become more expensive in overseas markets. This slows the growth in the domestic market and balance is resumed.
It amazes me to what extent it is possible to ignore the rest of the world from here in my adopted country. From a purely practical point of view, the US contains everything you need, with a great diversity of climate, culture and resources.
Of course, from an investor’s point of view, ignoring the rest of the world is a recipe for disaster. The S&P 500 companies with full reporting and breakdown of their business reported around 46% of sales going overseas in 2011. For the companies that make up the index as a whole this number is likely to be lower, as the bigger multinationals are more likely to have full reporting, but the number is still high.
The effects of the higher Dollar have been seen this year in a gradually worsening Balance of Payments figure for the US, a worrying trend that has received little attention. This so-so earnings season, particularly on the top line, would seem to indicate that some of those effects are being felt.
As I said, this was the genesis of an uneasy feeling, one that was confirmed by even a cursory glance at that first chart of the S&P. It doesn’t take a genius to see that the move up has stalled. The longer we go without resuming the march up, the more that lower becomes the path of least resistance.
Those slightly disappointing earnings numbers are likely to have a negative effect over the next few weeks too. For some reason, Wall Street analysts always feel that they should underestimate earnings significantly. I guess nobody wants to be the next “AAPL at $1150” guy. The overall narrow beat, therefore, is likely to lead to a series of downgraded forecasts, and history shows us that that can be a powerful downward force.
That tendency is likely to be exaggerated by the very fact that we have had a good year. Even traders in charge of huge institutional funds are human, and anybody who has ever traded knows what they are feeling right now. When you are looking at a decent profit, the fear of giving it all back begins to dominate. Any hint of a retracement produces itchy fingers hovered over the sell button.
Let me get this straight. I’m not saying that the market will collapse tomorrow. It could, of course, but the more general point is that I am now a lot more cautious than I was before.
I believe that, for several reasons, any beginning of a downward move could become exaggerated pretty quickly. When the next correction comes, and it will, I believe it will be hard and fast.
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Martin Tillier has a wealth of experience in Foreign Exchange. He started working for a major interbank Forex broker in London in the 1980s, rapidly acquiring more responsibility and the authority to run larger positions. After several years, he was asked to go to Tokyo to develop the cable (USD/GBP) desk there. He returned to London at a time of turmoil in European currency markets and helped build the company's Sterling Mark (GBP/DEM) desk into the world's most profitable, in the years leading up to the Euro. Highlights included a 36 hour unbroken stint at the desk during black Wednesday, when the Pound was forced out of the European Monetary System. Because of his success in London and his ability to teach new recruits the complex world of Forex trading, Martin was asked to establish Spot FX desks in new markets for the company, first in Moscow, Russia, then in Warsaw, Poland. He left the market in 2002 and moved to the US, following the loss of a family member in the tragic events of September 11th 2001. He spent some time out of the markets, starting and running a successful wine store, but the lure of the financial world was still strong, leading to him selling that business and accepting a position as a financial advisor with a major firm. The frustration he felt while there is what led him to his current position as a writer and educator on markets, particularly Foreign Exchange. The markets were more accessible than ever, but it seemed Wall Street was still doing fine. It was obvious that the retail trader and investor were at a disadvantage, and education could close that gap. Martin now writes regularly for Nasdaq.com and other financial sites, trades Forex and other markets successfully and, in his spare time, plays golf badly. |
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