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Global Financial Markets Melt: Now What?


A crimson tide sweeps the world.


Editor's Note: Todd posts his vibes in real time each day on our Buzz & Banter.

Yesterday, a butterfly flapped his wings in Washington and there was a financial tsunami in Asia.

We can talk about Japan (the Nikkei (INDEXNIKKEI:NI225) was down 2%, or 18% since the May 22 top, following an 84% rally), but the real story may be China, which is down 10% thus far in June.

The People's Bank of China (PBoC) squashed hopes of a liquidity boost, seemingly opting for their banks to take medicine to cure the debt disease rather than drugs to mask the symptoms (unlike some central banks we know), and that has bulls backpedaling around the world.

To get a sense of the carnage in Shanghai, check the long-term chart below; I will warn you: It's not pretty, particularly with stateside proxies a stone's throw from all-time highs.

Commodities, for their part, are also listening to some chin music, with gold and silver both lower to the tune of 6-7% (as I type, gold broke our all-important $1325 level, trading down $72 at $1300).

To get a sense of why this matters for stateside stocks, check out the second chart below, which updates the S&P (INDEXSP:.INX) vs. CRB; that yawning chasm should revert to the mean, if the rising tide lifts and lowers all boats as a matter of course.

The bigger story, perhaps, is the backup in global interest rates at a time when investors are balls-to-the-wall invested in the carry trade (borrowing at cheap rates to invest in risk assets).

In a highly leveraged finance-based global economy, the butterfly-in this case Ben Bernanke-set the stage for the Gorilla, in the form of China, to return volley. The spectators, from India to Brazil and throughout emerging markets, have been whiplashed in the process, hemorrhaging capital as social unrest grips their masses.

In my opener yesterday, The Waning Integrity of US Financial Markets, I closed the missive with the following vibe:

I see a diminishing likelihood of this ending well, at least in the traditional sense. The DNA of this stock market is polluted and the human capital that will be necessary to unbox Pandora is tossing towels left and right. When the music stops, and it will, we'll see just how talented the robots and black boxes are at finding their respective chairs.

In the span of 18 hours, the music didn't fade; it reversed like the Beatles White Album. Adding spice to the mix, the S&P trend line that has been in place since November is in serious jeopardy of breaking today with a move through S&P 1620 (remember, this is an upward sloping technical measure, which is why the rip-cord level continues to rise). Should that happen, past support will morph into future resistance and the bears will have a fresh level to lean against.

Finally, as discussed in 5 Things to Watch on the FOMC Announcement, I entered yesterday's catalyst with a negative bias (short delta; long gamma) and covered that overage into the slippage as a function of discipline (I am long a few individual stocks, including Facebook Inc (NASDAQ:FB) with a tight stop, as well as December SPY (NYSEARCA:SPY) puts). I want to watch the opening-there should be a bounce attempt-and will continue to operate from the short side so long as I can map advantageous risk-reward with defined risk.

To lend some perspective, despite yesterday's price action, the S&P is 3.45% from an all-time high and a 10% correction, from those highs, would place the index in and around S&P 1520.

If every market move is defined by three phases-denial, migration, and panic-I urge investors to pay close attention to their risk profiles, synch them with their time horizon, and remember that there are Ten Trading Commandments that are designed to help us through environments such as this.

Random Thoughts:
  • Remember that June expiration is tomorrow and that typically manifests with volatility in the days preceding the actual expiry.
  • I did a Minyanville Fireside Chat with David Stockman, author of The Great Deformation: The Destruction of Capitalism in America, which will be posted soon on Minyanville. It was an eye-opener, even for me, so give a listen if you have the time, or read the book if you want the full-throttle story.
  • We asked the question on May 23: Can the S&P Trade to 1500? It seemed silly at the time and for many, it still does. Hmm.
  • Watch the financials; a move (lower) through BKX (INDEXDJX:BKX) 60 would break the pennant formation we've been monitoring, and as go the piggies, so goes the poke. Goldman Sachs Group Inc (NYSE:GS) and JPMorgan Chase & Co. (NYSE:JPM) remain stateside tells, while Deutsche Bank AG (USA) (NYSE:DB) and Barclays PLC (ADR) (NYSE:BCS) are overseas proxies.
  • Leave emotions for weddings and funerals; stay lucid when it comes to financial decision-making, and understand that when there are a lot of traders standing in a circle shooting at each other, the goal is to be in a position to prosper when the dust settles.
    There will be better days and easier trades; our goal is to get there, and yes, enjoy the journey (away from the screens) as we do.
  • Good luck today.

Twitter: @todd_harrison

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Position in SPY and FB.
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