Despite yesterday’s rally, the stock market is officially in free fall as the major averages violate their seven-month uptrend and drop into the abyss. The PowerShares QQQ Trust (NASDAQ: QQQQ) returned to levels first reached last December. And shares in market stalwart Apple (NASDAQ: AAPL) have fallen at a pace not seen in more than a year.
After months of believing that all ailments could be solved by cheap cash courtesy of the Federal Reserve’s $600 billion monetary injection — or “QE2” for short — it’s becoming clear that the negatives facing the stock market are huge. These range from Japan’s nuclear disaster to violence in Bahrain. What’s more, rising inflationary pressure, with the Producer Price Index increasing 1.6% in February alone, means that another round of money printing will just make the problem worse. When QE2 was teased last August and started in November, these pressures didn’t exist.
As a result, no risky asset class is being spared as commodities, oil, corporate bonds, and even gold and silver follow stocks lower. All indications suggest the downtrend is far from over. Here’s why.
Various technical, breadth, and momentum indicators are deep in sell-signal territory. One that’s caught my eye is the percentage of NYSE stocks above their 50-day moving average, which is shown in the chart above. The indicator measures the number of stocks in established up trends. And it’s fallen to levels that prevailed during last May’s “flash crash” event. The measure has dropped out of its lower Bollinger Band, a measure of volatility. Violent down moves like this are associated with market sell-offs.
Also, two market stress points are rising fast — the CBOE Volatility Index (CBOE: VIX) and the Japanese yen.
The rise in the VIX reflects a rush by traders to buy put option protection against continued market declines. It’s crossed its 200-day moving average in a big way for the first time since May 2.
The rise in the yen reflects repatriation inflows as insurers buy the currency to pay off claimants. The yen is a key component of the global “carry trade,” where investors borrow cheaply in Japan and use the cash to invest in high-yield countries like Brazil or in commodities like gold. So a rise in the yen acts like a punch in the stomach for hedge fund types. As a result, carry trade investments are being sold heavily to repay short yen positions.
I’ve been recommending a new short position to my newsletter subscribers for weeks now with a focus on short positions against semiconductor and financial stocks. Two of our holdings, the ProShares UltraShort Semiconductors (NYSE: SSG) and the Direxion 3x Financial Bear (NYSE: FAZ), were posting gains of 4.6% and 6% during Wednesday’s sell off.
If you’re just now looking to lower risk, or are a conservative investor, I would recommend increasing your cash holdings and dumping risky, cyclical “high beta” stocks. I would also recommend increasing exposure to long-term Treasury bonds, which is one of the few assets enjoying safe haven inflows. Be sure to check out the iShares Barclays 20+ Year Treasury Bond Fund (NYSE: TLT). Risk takers should look at the Direxion Daily 30-Year Treasury Bull 3x Shares (NYSE: TMF).
Disclosure: Anthony has recommend SSG, FAZ, and TMF to his newsletter subscribers.
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