In the last few weeks I have been studying the markets and reading an unimaginable amount of news from all over the globe.  In my estimation, the recent stock market bounce (that started on 10/5/2011) has been a result of three things:

  1. Until recently, the number of people betting against the market (short interest) was fantastically high. Often this kind of market imbalance ends with what is called a short-squeeze, where the people betting against the market are forced to buy as a result of a rising market. This process then feeds on itself as more people with negative bets have to cover their bets.
  2. The currency markets are the most active and deep markets in the world.  More currency transactions happen in a day than just about any other market (stocks, bonds, commodities etc.).  This is important because throughout the late summer, while the stock market was declining, the Euro currency was getting crushed.  The weaker Euro currency was a result of investors fleeing to the US dollar as a safe haven (in contrast, a stronger dollar pushes down the Euro).  Then, on October 5th, the rumor mill in Europe went into full swing and has not stopped since.  Upon the rumors of the possibility of bank bailouts, confidence started to return to the Euro.  So, in reverse, if the Euro strengthens, then the dollar will weaken.  Nine times out of ten, a weak US dollar will translate into stocks moving up.  Remember, the overwhelming majority of trading is now computer generated, news driven, algorithmic trading.  Computers don’t question; instead, they buy based on programs.  If the program says a weak dollar equals buy, then it buys.
  3. The last element has been a more complex and backward driver.  As well, it relates to the above.  In the midst of this rise in stocks, we saw the biggest bank in Belgium (Dexia Bank) fail.  This is not good news for any currency.  But, what Dexia’s failure did was to hasten European finance ministers to push European banks to start trying to shore up their balance sheets.  Some banks in Europe began selling US dollar based assets to raise cash.  Going back to the above, when a European bank sells US dollar assets, it must turn the proceeds back into Euro (read as buying Euro).  Buying Euro strengthens the Euro, which weakens the US dollar, and a weak dollar…wait for it…means stocks rise.  This is the only explanation I can come up with that would support why stocks were rising into what is bad news out of Europe.  How’s that for a Monday morning headache???!!!

This is the kind of market that will whip-saw advisors endlessly as they try to chase the markets up the “less bad news” trail.  If the end of the trail is a dead end, then the walk back will not be fun.  The sad reality is that many investment advisors will not take the time to gauge the risk in the market.  A 5-10% move up is not worth chasing if there is a high chance of an equal or greater move lower.  I am being patient and waiting for not only my technical indicators but also real fundamentals to be on the table before I commit to adding new RISK positions to portfolios.

Do you have an investment strategy that seeks to protect your portfolio against volatile economic conditions?  Call me to schedule a free review of your current investment portfolio – 913.693.7918.

John P. Chladek, MBA, CFP® is the President of Chladek Wealth Management, LLC, a fee-only financial planning and investment management firm specializing in helping families and couples who are not yet retired realize their financial goals.  For more information, visit https://www.chladekwealth.com.