Author: Michael Arold
Covestor model: Technical Swing
Disclosure: Short LDK, AIG, JOE
Market weakness finally dominated in May. There had been signs of deteriorating sentiment in the prior months and I discussed related factors in earlier reviews.
As a consequence, I engaged in various short sales in order to try to benefit from falling stock prices: LDK Solar (NYSE: LDK), AIG (NYSE: AIG) and St. Joe (NYSE: JOE) were stocks that fell and where I could book gains on the short side. Unfortunately, I had to close various long trades – such as Lululemon Athletica (NASDAQ: LULU), Apple (NASDAQ: AAPL) and Titan Technologies (PINK: TITT) – with a loss.
Going forward, I’m leaning towards the bullish side in the short-term. Investor sentiment has recently been extremely negative, which usually can be taken as a contrarian, supporting factor for the markets.
Also, we have to acknowledge that the U.S. Dollar has been driving equities, and the greenback resumed its decline with the temporary resolution of the Greek debt crisis. Other factors are pressuring the Dollar: weak economic data from the US make it more and more unlikely that the Fed will raise interest rates in the near future. Other central banks are either at the beginning (Europe) or at a later stage (China) of the tightening cycle, which puts the Dollar under more pressure. These developments are supportive of higher stock prices in the US.
Regarding the Dollar, equity correlation shows the emotional state of investors. Throughout the equity rally of the last twelve months or so, negative economic news was taken as a positive for stocks: weak economic numbers nurtured investors’ hope for more quantitative easing and an extended period of very low interest rates, thus pressuring the Dollar and supporting stocks. What if this psychological state changes? What if investors suddenly start to see bad economic news as a negative? The argument in that case would be that a loose Fed policy would be indeed negative for the economy.
“Stagflation” would be a term used in this context. I don’t see stagflation fears in the market yet, but I’m looking out for signs such as an increasingly positive correlation between a weakening Dollar and US equities. In that case, I would become much more defensive in my equity selection.