Friday, January 13, 2012

Deleveraging continues...

Today, as evidenced by the action in the Dollar, the markets continued their deleveraging. Ironically, as is par the course these days - equities complied and then rebounded. I want to pay some attention to this action because I have on these pages, been explaining why this is occurring. That reason, of course, is DELEVERAGING.

With the breakout to new highs in the dollar and with the various new stresses being announced to the markets - not the least of which is the continuation of downright unethical and fraudulent reporting by big US commercial banks like JP Morgan - over leveraged market participants  have been forced to pair down positions. When ever this happens one need only look at the biggest markets and watch the smaller ones for effects.

So, we are finding many large and stressed market participants who hold size positions in many other instruments and larger markets than equities. For these participants it is a common practice to attempt to hedge this exposure with short positions equities or equity indexes. Specifically, in the current case, the new stresses in the markets are causing large sales of assets that most people are not watching or seeing requiring their corresponding equity short hedges to be covered. This is why whenever we see action that would usually indicate that there should be downside in equities - such as a dollar breakout or treasury breakout - that the result is that any equity weakness is often bought to close short positions as longs in corresponding and usually much larger markets are being closed. What is absolutely amazing is that despite a lot of selling activity, treasuries are constantly bid. The other thing I think people need to get over is the idea that equities are a barometer for anything fundamentally changed or bullish in our current market conditions. What we have to remember is equities are a relatively small market/asset class compared to the ones being accessed to raise cash by bankrupt or stressed institutions.

So, while the deleveraging is in play, I would expect the weird and seemingly uncorrelated behavior of the various markets to remain in play. However, if and more importantly when the deleveraging activity is   reduced the equity markets are prone and very likely of closing the aberration in rather abrupt fashion. That moment is coming soon.
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