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Of Myths and Markets


Perception is reality, but perception isn't always true.

"There is a road, no simple highway. Between the dawn and the dark of night."
--Robert Hunter

Investors have finally identified a few lights at the end of the tunnel. It's their sincere hope they're not affixed to the front of a train.

The two most popular myths in the marketplace are that lower crude and a stronger dollar are both equity positive.

Perception is reality, we know, but perception doesn't always prove true.

In fact, the difference between the two-the thin layer that resides between what is and what's perceived to be-is where profitability is found.

Pundits are quick to point to the decline in Texas Tea as the recent upside equity catalyst but few have discussed the demand destruction that is manifesting as a function of slowing global growth.

Looking back, the correlation between the S&P and crude oil is –0.041 over the last ten years.

In other words, arguing that lower crude is a causation of higher stock prices has no historical standing despite the tick-for-tick action we've witnessed in recent months.

It just so happened that the crude bubble popped at precisely the same time stocks bounced from massively oversold levels.

It was a heck of a coincidence.

Then again, maybe it wasn't.

The other widely held conventional wisdom is that a stronger dollar will help stocks sustain a better bid.

Using the last six years as our guide, that's completely backward.

We've spoken about "asset class deflation vs. dollar devaluation" for a long time.

We touched on it as we listened to Thunder and Lightning.

We revisited it when we watched Bullets over Broadway.

We contemplated it as we weighed out Our Wishbone World.

And we drove it home when we explored the Anatomy of the Recession.

The government created massive money supply on the back of the tech bubble to keep balls in the air and bubbles afloat. That crushed the value of the greenback and jacked asset classes-including crude-across the board

Policy makers solved one problem by spurring stocks higher but created another as the debt bubble built. A six-year snapshot of the S&P, commodities and the dollar index illustrates these points.

Click to enlarge

It's dangerous to blindly believe that a stronger dollar will be positive for asset classes but, as we've seen with the knee-jerk equity reaction to lower crude, timing is everything when it comes to navigating financial markets.

I don't profess to know the tipping point but we must remain conscious of the road signs, particularly given that the dollar recently violated the downtrend that's been in place since 2002.

Click to enlarge

The deflationary writing seems to be on the wall.

How we get there is an entirely different discussion.

Setting Up for the Counter-Counter Trend Trade

The last few months have been a wild ride for the world's largest reality show and to understand where we're going, we must appreciate how we got here.

We asked aloud if the big picture blues were priced into the financials as they dangled in the abyss on July 16th.

We monitored the action through multiple time frames, paying particular attention to the potential for a bear market bounce.

We dared ask if Hanky Panky was operating behind the scenes with an agenda of lower oil and higher equities into the election.

And we mused that a perceived recovery could conceivably precede the storm.

As our financial destination pales in comparison to the path that we take to get there-and we're only as good as our last trade-I wanted to update my posture with the following thoughts.

As crude toggles towards $110 and the S&P eyeballs resistance into 1330-1350, we could be setting up for a reversal of recent fortune in both the energy and equity markets, at least for a trade.

The technical construct is seemingly offering serendipitous signs.

Crude has near-term support at $110/barrel.

Click to enlarge

Equities are approaching the downtrend that connects the lower highs in the S&P that have been in place since October.

Click to enlarge

Putting one foot in front of the other, I peeled out of my upside S&P exposure into S&P 1310 on Monday and built a laundry list of potential "counter-counter-trend plays."

They included USO calls (with defined risk under $110), airline puts (such as Continental (CAL) into $20), American Express (AXP) puts (into resistance at $40) and Transocean (RIG) and Weatherford (WFT) calls.

Where you stand is a function of where you sit and to be sure, active trading isn't for everyone. There are powerful agendas in play to get equity markets higher into the election as policy makers attempt to steer a market infected by many years of financial engineering.

Those structural risks are why credit markets continue to flash warning signals that aren't readily apparent in equity markets. You always want to see both sides of every trade and now more than ever, it's incumbent on us to do just that.

We'll get to the other side of this spooky ride as a function of time and price.

When we do, opportunities will be plentiful for those properly positioned and proactively prepared. The goal is to get there with our capital and sanity in tact.

Risk management over reward chasing is the mantra of choice as we find our way.

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Positions in USO, RIG, WFT
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