Dow loses critical support as selling intensifies

Global markets drop as the yen carry trade collapses and ends the cheap-money dream.

By Anthony Mirhaydari Jun 6, 2013 2:32PM

Arrow Down copyright Photodisc SuperStockThe dream that cheap money can solve all was coming down around the bulls' heads Thursday as markets worldwide were in turmoil. Japanese stock futures have fallen into bear market territory. European stocks and sovereign bonds are dropping, pushing borrowing costs and reminding everyone the eurozone crisis is far from solved.


And here at home, the Dow Jones Industrial Average has just scythed below its 50-day moving average for the first in seven months -- proving the fundamentals still matter and that the concept of mean reversion, to the frustration of momentum traders, is still in play. At the same time, repressed defensive plays like Treasury bonds and gold are surging.


How long will the selling last? And where are the profits to be made along the way?


The catalyst for all this is the reversal of the yen carry trade that has fueled this market, single handedly, since the marcoeconomic data started rolling over months ago and executives started marking down Q2 earnings. That encouraged the X factor in all markets -- emotion -- to come into play, pushing NYSE margin debt to record highs, boosting consumer confidence and pushing investor sentiment gauges into bull market topping territory.


Now that the yen carry is collapsing, panic is setting in as the emotional tailwind fades.



You can see this in the chart above, which I first showed in a blog post Wednesday, illustrating the relationship between the U.S. dollar and the Japanese yen. For hedge funds putting on the yen carry, they would short the yen and buy stocks -- profiting from the trade on both sides as this chart climbed and stocks rose.


Now they are being squeezed on two sides as the yen carry falls and stocks melt. Without strong support from the fundamentals, selling will only encourage more selling until sentiment has fully reversed from myopic optimism to haggard indifference.


When will that be? Wednesday, I mused that a test of the S&P 500's 200-day moving average near 1,500 would, at the bare minimum, qualify as a cathartic enough event to clear the air of overconfidence. The S&P 500 is about 100 points away from there, which would be worth a 6.3% drop from current levels and take us back to the January-February trading range.


At that point, a short-term bounce would be likely as the market waits to see what the impact of its drop on the real economy will be. Remember, a higher stock market is one of the few bright spots in the economy right now, as manufacturing activity is contracting at a pace not seen since the recession ended.


We'll also need to find out if the eurozone can handle higher borrowing costs (unlikely) or the export damaging impact of a stronger euro (also unlikely as Germany's economy starts contracting). And we will need to see how the market reacts to the failure of Japan's efforts to inflate a stock market bubble by destroying its currency and shaking its huge government bond market.


For conservative investors, in situations like this cash is king. But also consider that beaten down defensive assets like precious metals and Treasury bonds are showing signs of life for the first time in months. Gold and silver, in particular, have been heavily shorted and are vulnerable to a short squeeze -- which could send prices up quickly.


Plays include the iShares 20+ Year Treasury Bond (TLT), the Gold Trust SPDR (GLD), and the iShares Silver (SLV).


More aggressive traders can follow the same logic, only use more leverage via the Direxion 3x Treasury Bond (TMF) and the Velocity Shares 3x Silver (USLV), both of which I've added to my Edge Letter Sample Portfolio.


For individual stock ideas, precious metal mining stocks are forming would what be an inverse head-and-shoulders reversal pattern and could be pushing higher soon. I've recommended AuRico Gold (AUQ) previously and it still looks good.



For short ideas, emerging market inverse ETFs such as ProShares UltraShort China (FXP) have performed well but might be too extended for new money. Consider the UltraShort Nasdaq QQQ (QID) instead. European financials are looking weak, including the short in ING Group (ING) I've added to my holdings.


And finally, for the risk takers, the CBOE Volatility Index (VIX) is surging as options traders scramble for put option protection against further losses, pushing up the iPath VIX (VXX) and the VelocityShares 2x VIX (TVIX).


If this is, in fact, as high as stocks will go this cycle the VXX and the TVIX are going to surge in a huge way as the bull market regime of lower and lower volatility is replaced by a bear market regime of higher volatility. I'm not saying that's what's happening right now, only to be aware of it.



Update 5:00 PM ET


The bull managed to stick save the situation by pushing the S&P 500 and the Dow back above their 50-day moving averages. For regular folks catching the closing prices on the nightly news, everything will seem tranquil. But it's not.


While U.S. equities stepped back from the edge of the cliff, the massive decline in the yen carry trade stuck. Let's see how the Japanese markets respond when they open in a few hours.


Currency volatility is a sign that the tailwinds that have gently pushed markets higher over the last few months have turned into gusty headwinds.


Now, all eyes turn to Friday's payroll report. The bulls better hope it's strong enough to bring back the fundamental case to own equities -- A strengthening economy -- as liquidity from a falling yen disappears.


Disclosure: Anthony has recommended FXP, TVIX, TMF, AUQ, and USLV to his clients.


Check out Anthony's new investment newsletter, the Edge, and his money management service, Mirhaydari Capital Management. A two-week free trial has been extended to MSN Money readers. Click the link above to sign up. Mirhaydari can be contacted at anthony@edgeletter.c​​​​​​​​​​​​​​​​​​om and followed on Twitter at @EdgeLetter. You can view his current stock picks here. Feel free to comment below.

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Jun 6, 2013 2:55PM

Some of you know this.   For some it remains a mystery.


"You cannot create wealth by printing money."

Jun 6, 2013 3:11PM
The carry trade is just another of many evil and worthless scams by which wall street skims money off the people who actually work and produce things for a living.
Jun 6, 2013 3:11PM
When the FED stops so will the markets
Jun 6, 2013 3:35PM
Thanks for predicting 200 of the last 2 corrections.
Jun 6, 2013 2:59PM

Traders started to buy again and now it going backup. Broken arm a couple second ago and now it healthy again, wow! We have an economy that was great a couple week ago and now it not because the stock price goes up and down everyday. Stop fooling the public.


Jun 6, 2013 3:09PM
Oh he predicted it, except for when he predicted it wouldn't happen, right before he predicted it would...... or was that after?
His charts look pretty....... all nice and cherry picked.
Jun 6, 2013 3:25PM
WOLF!!!! WOLF!!!<<<< oops it's just a bunny wabbit
Jun 6, 2013 3:53PM
Jun 6, 2013 4:07PM
I think the market waits for Anthony to come out with an article, then the entire stock market does the opposite. Yes, Anthony is that powerful of a force.
Jun 6, 2013 4:11PM
The Dow lost Anthony's support many months ago, obviously that wasn't critical support.
Jun 6, 2013 4:34PM
Obviously this article was written and submitted before the markets turned... Ooops.
Jun 6, 2013 4:29PM

Why is this a big surprise to anyone?  The market was up like 18% through May.    Let's see a nice little 10% correction and move higher baby!!



Jun 6, 2013 3:48PM
"O's" spend all plan to save the Chicago way of life has failed. 
Jun 6, 2013 6:27PM
Chicken Little, the Boogie Man, Mr. Sell everything.

My god man, do you ever have a good day?

One day you will say " I told you so " , then what ?

Once it goes south , what do you say then, ?
Jun 6, 2013 6:57PM
I get you're bearish and at some point you will be correct, but you've been saying the same things since the Dow was trading 1500 points lower!

Jun 6, 2013 7:39PM
Well, congratulations.  MSN finally let Mr. Mirhaydari write an article on an "up" day....although maybe not, because it appears that the first part of the article appeared before the markets closed, before today's little late rally.  And thanks to the author for the little caveat:  "I'm not saying that's what's happening now, only to be aware of it."  Some of us want to read for awareness of the possibilities (I know, I know, they're seemingly endless...) in this volatile market.  And most of us know that any "one size fits all" investment paradigm really only fits one size, not all, as we all come to this blog with various financial needs, goals, and capacity for risk.  So it is good to consider a variety of viewpoints and perspectives outside of one's personal macroeconomic ideology, which is more likely when the author grants the possibility of a different outcome than the one posited in his article.  For this, thank you Mr. Mirhaydari. 
Jun 6, 2013 6:57PM
Another "reproduction" of utter and total BS.  No one can not know this by now.  Our "markets" are a complete and total disgrace.....yet, not one regulatory agency does a thing.  This will come back to haunt all with little more than 401K's and pension plans.  Check your 401K this coming quarter and see how this "works".  What a farcical system!
Jun 6, 2013 4:28PM
Now the World's Economy just does the opposite of what is good for it.
Jun 6, 2013 6:46PM
I and anyone else would take a chunk of all that Printed Money in a Heart beat. And yes, it would create a huge Wealth Effect.
Jun 6, 2013 6:36PM

This is just the beginning, Wait till all the stock falls.

I think a lot of people knew what was going to happen,

Hold on to your hat,Because this is something that you have never seen before.


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