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Financial Markets: The Good, Bad and Ugly


Taking a tour of a wild week.

Go figure; the financial media dutifully explained all week why this month's payroll data was poised to disappoint on a few fronts. With the S&P having closed yesterday below the all-important 1340 level, the stage was set for collective fret.

So what shot does the BLS up and pull? Better than expected job growth in April (thanks, in some ways, to McDonald's (MCD) which hired 62,000 folks in one day) and upward revisions in March which have alleviated, at least for the time being, concerns that higher fuel prices served as an implicit tax on the consumer (these readings were taken prior to the commodity carnage).

While it's long been our view that these numbers are "massaged," the on-the-surface takeaway is the biggest monthly gain since May 2010, which should play well in the weekend press.

Consistent with the A.D.D. mindset on Wall Street, that was then and this is now, and profitability resides in the ride ahead. To understand where we are, we must appreciate how we got here and this week offered a healthy dose of perspective, context, and lessons.

Let's take stock of some of the fun.

The Good

Reaction to news is always more important to the news itself. We share that in good times and bad and as it stands, despite tremendous anxiety across the asset class spectrum, the S&P is again trading above critical support at 1340.

That, along with the action in the transports, offers the best technical elements in the current construct, along with the alleviation of the heretofore persistent overbought condition.

And of course, the credit markets continue to impress and while they're not a predictive panacea, they remain the single biggest positive in global financial markets. (Watch Risk On, Risk Off: Is the Rally Over?)

The Bad

Deterioration under the hood, or the action in previous leadership equities and sectors, must be noted. Stocks like Goldman Sachs (GS), Google (GOOG), Apple (AAPL), and General Electric (GE) are all tracing out patterns of "lower highs" which is traditionally a cause for pause.

I would also note the inability of the financials to push through the BKX 52 as an overt negative. While the leaders coming out of a crisis are rarely the same as those who enter them, this complex continues to encapsulate our finance-based global economy.

The Ugly

In a word, commodities. The key takeaways, -- regardless of how you're positioned -- are that this magnitude of volatility, in any asset class, is rarely if ever bullish and that's been proven in, which effectively crashed this week (I wonder if anyone in Washington is taking notes on the impact of margin requirements as a "tool" in their forward arsenal?).

I will also note that commodity volatility typically precedes equity movement; while the VXO traded 40% higher, trough to peak since last week, it continues to trade in a teenage wasteland. (Watch: Silver Volatility Implies Trouble for Stocks.)

The Swing Factor

There has been a lot of chatter about how the end of QE2 might impact financial markets. I've said on numerous occasions that the primary purpose of this program was to "reflate risk" and allow financial institutions to roll their debt and issue equity (read: transfer the risk to the taxpaying public), which we saw long ago (corporate balance sheets effectively bought themselves time). I also noted that commodities could bear the brunt of that dynamic, which may have contributed to the carnage this week.

That's not the swing factor, however; in my view, the second derivative of the QE2 closure could be a rally in the US dollar, which may have put in an important bottom yesterday. Given the universal hatred of the dollar (sentiment was massively lopsided as of last week), the prevalence of the carry trade and the correlation risk in the marketplace, a greenback rally could disrupt markets on numerous levels, few of which would be positive. Watch it please, and respect the leverage behind each and every tick.

Good luck today and more importantly, have a fantastic weekend!


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