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What To Make Of Today's Market Move

A visual summary of today's action...

And a verbal one, courtesy of Peter Tchir from TF Market Advisors:

If not unprecedented moves we are certainly witnessing a rare day in the markets.  The entire energy complex is down 5-10%.  Metals and agriculture are down 2-5% except for silver, down a whopping 11%! The Eur has depreciated 2%.  So far stocks have been largely immune to the move and credit has completely ignored it.

Clearly a combination of crowded trades, margin increases, and surprisingly dovish comments from Trichet sparked this move.  It's clear that the moves down are triggering additional stops and that no one has been willing to step up and play for a big bounce.

Equities have remained fairly calm so far.  Certainly a decrease in commodity prices is helpful and would go a long way to ease one of the main concerns expressed by company after company.  The move in the dollar is a little more troubling as the weak dollar has clearly been a positive for the economy and profits.  But the reality is that the stock market is a little like dear in headlights right now.  Investors aren't used to seeing moves of 10% in a commodity as important as oil.  I think the initial reaction of doing nothing will give way to selling.  Investors taking losses in commodities will take profits in stocks or at least raise some cash to post additional margin on their remaining positions.  The economic data has been weak at best and deteriorating, eroding support for stocks.  None of the major problems in the world have been solved, they have been merely swept under the carpet or ignored, but are still there.  The sovereign debt crisis is not better, if anything it's becoming more clear that default is likely for at least Greece.  Japan is still in the early stages of dealing with the consequences of the earthquake, tsunami, and nuclear disaster.  MENA remains troublesome.  With all the excitement of taking out Osama, no one focused on the fact that the 'No Fly Zone' in Libya has expanded into bombing buildings where Quadaffi is living. 

If the selling starts, the reports show that margin debt and net leverage in the stock market are back to extremely high levels.  Any selling in stocks could trigger margin calls there too.  The housing market remains a mess and fraudclosure hasn't gone away, if anything, it seems a safe bet that DB and MortgageIT are not the only entities in the crosshairs of the government. 

Clearly something is going on in the markets that is not natural.  Liquidity is at a premium.  Stocks have watched it calmly so far, but I expect they will get dragged into this as well and we will see margin liquidations in stocks too.  All indications are that people are pretty fully invested.  As mentioned earlier this week, stocks had lots of excuses to rally early in the week, but couldn't.  The buy the dip mentality is still there, and that could rescue stocks, but since the sell off in other assets does not appear normal, I wouldn't rely on buy the dip to save stocks.

Credit is completely ambivalent right now.  That largely makes sense, but we all know that credit is always liquid until it isn't.  It may be time to start shorting some LQD and HYG.  The carry is low, the markets have been supported by a big influx of cash - HYG has the most shares outstanding ever, and LQD has seen a strong rebound in shares outstanding recently.  I don't think there is anything wrong with the fundamentals in credit.  Companies have generally cleaned up their balance sheet and earnings are fine, but if investors need to raise some cash this market is as likely to get sold as any, and the speed of the sell off could be surprising.  With high yield, only yielding 7.5% I'm assuming many hedge funds have had to use some leverage to get potential returns above 10%.  If any move down remains small, they will grow their positions, but at some point, they will have to cut positions to defend their returns.  Many are relucantly long at these levels, so their willingness to hold on is lower than usual as they are not in love with the market at these prices.

In summary I would be very careful here.  I would be short stocks, light if not short credit, and would be looking for opportunities to go long the energy sector in particular. It will be interesting to see how China reacts overnight and I expect tomorrow's NFP to be a big disappointment - though I'm looking forward to hearing some new creative excuses as to why it was weak.