David Moenning's Daily State of the Markets: 03/02

Carry Trade Pain

Good morning and TGIF. The bears could be heard singing a happy tune as the market opened down more than 200 points yesterday morning. It looked like the perfect storm that had trapped the bulls so violently on Tuesday was taking a turn for the worse on the back of comments out of Japan regarding the Japanese "carry trade." And with the market’s newfound volatility in full swing, there didn’t appear to be a bottom in sight.

For those of you that don’t invest billions of dollars leveraged at 40 to 1 on the basis of the spread between global interest and currency exchange rates, the idea of the now famous “carry trade” is to borrow money in Japan, where interest rates have been close to zero for years, and then invest the cash in other countries. (Another version of this game is to short the Yen and invest the proceeds in U.S. stocks.)

The topic of Japan has long been a source of worry for the bears. For as long as I can remember, the bears have attempted to make the argument that the U.S. could be in deep trouble if the Japanese ever decided to stop buying our bonds. The argument purported was that if Japan stopped investing in U.S. treasuries (aka lending money to the U.S.) the result would be a global liquidity crisis. If memory serves, stocks tumbled about once a year on this fear.

And while the song has now changed to worries that the unwinding of the “carry trade” will create a global liquidity crisis, the result was the same yesterday. Stocks dove on the idea global liquidity problems and then rebounded as reality set in.

In short, stocks plunged at the open on fears that the Japanese want to rid themselves of the “carry trade.” This was good for a drop of almost 210 points in the first fifteen minutes and it looked like the bulls were in deep trouble.

But just about the time the technicians started screaming about breakdowns on the charts and the possibility of a new bear market, the bulls enjoyed a reversal of fortunes. And while it isn’t likely that one economic report was responsible for stocks reversing from down 200 to up 30, it seems that the sudden and sharp rebound did correspond to the release of the ISM Manufacturing Index, which came in above expectations. The gain in the manufacturing activity index, which was the best in 17 months, seemed to remind investors that the demise of the U.S. economy is not imminent and that earnings are likely to continue to expand.

So, while our horned heroes weren’t able to actually put green numbers up on the board, thanks to what is termed a “reversal day,” they were able to chalk up a W on the session. And if you believe in such things, the techies tell us that a “reversal day” is an indication that we’ve seen the bottom of this move and the short-term trend should soon head the other way.

Turning to this morning, we don't have any economic data to review before the bell. However, a sudden weakening of the Dollar/Yen relationship is causing renewed concern about the “carry trade” this morning. It is reported that the Dollar/Yen weakness is due to traders “unwinding” some “carry trade” positions, which means that those short the Yen are selling U.S. assets (stock in this case) in order to cover the short Yen position. Whether the weakness continues is anybody’s guess, but it’s a safe bet that we haven’t heard the last of the "carry trade."

Running through the pre-game indicators, with the exception of Hong Kong, the major overseas markets are lower once again. Gold futures are also trading lower by $17 this morning to $653.00 right now. In the oil pits, crude futures are off $0.22 this morning and the latest quote is at $61.78. Interest rates are moving lower this morning on a renewed flight to quality move. The yield on the 10-year is currently trading at 4.52%. And finally, with about an hour before the bell, stock futures in the U.S. are continuing to be very volatile right now and are looking to open to the downside once again. The Dow futures are currently down by about 75 points; the S&P’s are about 10 points under water, while the NASDAQ looks to be about 22 points under fair value at the moment. So, buckle up folks, because the ride is about begin again.

Stocks "In Play" This Morning:

American Intl Group (NYSE: AIG) – Reported $1.47 vs. $1.50
Dell Inc (Nasdaq: DELL) – Reported $0.26 vs. $0.28
Fluor Corp (NYSE: FLR) – Reported $0.90 vs. $0.60
Gap Inc (NYSE: GPS) – Reported $0.27 vs. $0.24
Kohl’s Corp (NYSE: KSS) – Reported $1.48 vs. $1.43
Tyco (NYSE: TYC) – Mentioned positively in Business Week
Moodys Corp (NYSE: MCO) – Upgraded at Bear Stearns
TXU Corp (NYSE: TXU) – Downgraded at Bernstein
Freeport McMoRan (NYSE: FCX) – Upgraded at Deutsche Bank
Ciena Corp (Nasdaq: CIEN) – Upgraded at Jefferies
NASDAQ Stock Market (Nasdaq: NDAQ) – Downgraded at JP Morgan
Xilinx Inc (Nasdaq: XLNX) – Upgraded at Merrill Lynch
Deutsche Telekom (NYSE: DT) – Downgraded at Merrill Lynch
Southwest Airlines (NYSE: LUV) – Upgraded at Prudential
AT&T (NYSE: T) – Upgraded at Stifel

Mr. Moenning holds Long positions in stocks mentioned: BSC, MER, FLR, T

Note: All earnings reports compared to Reuter's consensus estimates

** For More of David Moenning’s Market Analysis, Stock Portfolios, and Trading Ideas, visit: www.TopGunsTrading.com

The opinions and forecasts expressed are those of David Moenning, President of Heritage Capital Management and Co-Founder of TopGunsTrading.com and may not actually come to pass. Mr. Moenning’s opinions and viewpoints regarding the future of the markets should not be construed as recommendations of any specific security or Heritage Capital program. No part of this material is intended as an investment recommendation. Neither the information nor any opinion expressed constitutes a solicitation to purchase or sell securities or any of HCM’s programs. Do NOT ever purchase any security without doing sufficient research. There is no guarantee that investment objectives outlined will actually come to pass. Investors should consult an Investment Professional before investing in any investment program. Neither Mr. Moenning or Heritage Capital Management nor any of their employees shall have any liability for any loss sustained by anyone who has relied on the information contained herein. Mr. Moenning and employees of HCM may at times have positions in the securities referred to and may make purchases or sales of these securities while this publication is in circulation. The analysis contained is based on both technical and fundamental research. Although the information contained is derived from sources which are believed to be reliable, they cannot be guaranteed.

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