Quick Thoughts on the Week Ahead

Last week saw some extremely volatile and violent selling pressure hit many high-flying stocks and the broader indexes as well. A sell swing was imminent, but was deeper than most people anticipated.

In the coming week, we have major economic announcements that will help set the tone for the market likely for the rest of the month.

From Yahoo Finance (Investors Brace for More Bad Bank News), here are a few quotes from a recent article:

“Investors are slowly getting a clearer picture of how much in risky and deteriorating debt securities the world’s major financial institutions are holding, and they don’t like what they see.”

“The Nasdaq composite index was hit the hardest last week, as investors’ optimism vanished about the technology sector being isolated from the slowing economy and problems in the financial markets.”

(note, the NASDAQ Index actually declined 6.50% last week)

The next few sentences sum-up the paradox from an inter-market relationship perspective:

“Meanwhile, gold lifted further above $800 an ounce to its highest levels since 1980, and crude-oil briefly breached $98 a barrel, as the dollar plunged.”

(we see key relationships here, with rising inflation and commodity prices being inverse the US Dollar Index)

“The combination of shaky financial markets and inflationary triggers has worried investors that the Fed’s hands are tied. An interest rate cut could send the dollar down even further, but keeping rates where they are might translate to even wider losses for the world’s major financial institutions.”

This is exactly the spot the Federal Reserve does NOT want to be in. Inflationary pressures along with the declining dollar practically compel the Federal Reserve, who seeks to combat inflation, to raise rates to help bring down a bit of the rise in commodities (including near $100 a barrel oil prices), but if the Fed actually raised rates, it would most likely deepen the current credit crisis and potentially curb spending and loans so much as to lurch the US economy into a recession in the months ahead or beyond.

Of course, with the market already shaky and the economy in probable decline due to a variety of factors, the Fed would be most likely to cut rates to help ease the tightening effect of lending policies and help spur the consumer to spend freely again.

It seems like a tenable thing to do until you realize that cutting rates would directly devalue the US Dollar further against other currencies and help spur potential inflationary pressures in the already ‘sky-high’ commodities markets (such as gold and oil).

So what is the Federal Reserve to do?

That’s not our business to make their decisions. We, as traders, anticipate and react accordingly.

Either way you look at it, there are a variety of trends to be followed currently and a variety of trading opportunities and asset diversification to be situated now.

For now, it seems the best strategy has been:

Long gold prices and oil futures (or oil stocks)

Short the US Dollar Index (future, etc) or Long other foreign currencies (for FOREX traders)

Short Financials/Homebuilding Sector

Long Technology stocks (this has been a majorly unexpected outlier, or oddity in the whole cycle, which is now crashing)

And eventually, if things continue to play out, Short the US Equities Market.

Perhaps even long Utilities, Consumer Staples, or other defensive style sectors.

We will learn about current inflationary pressures from the Consumer and Producer Price Indexes, and if they have risen too much, expect a subsequent plunge in the market.

Either way, be safe and cautious in the week ahead.

Bonus:  Check out Bondad’s detailed assessment (from the Bondad Blog) on the week ahead from his post “Houston, We Have a Problem.“