What To Do With Stocks Falling

A European rift over Greece and mounting risk aversion weighed most-heavily on EUR and GBP on Friday while JPY, USD and CHF led the gainers. We look at the FX implications of the S&P 500 closing lower for the sixth consecutive week.

Pessimism about the US and global economy continues to rise. On Friday, the S&P 500 fell 18 points, or 1.4%, to 1270. Its the first time the index has fallen in six consecutive weeks since 2002 and its the lowest weekly close of 2011, falling below several important support levels.

Its a weak seasonal time for stocks but its also no surprise the declines are coming as the Fed wraps up QE2. We have heard this market described as a whiny girlfriend or a drug addict; it will kick, scream and throw fits until it gets what it wants (more stimulus from the Fed and/or govt) but more is never enough.

THE KICKING AND SCREAMING IS GOING TO GET WORSE and the Fed appears extremely reluctant to come to the rescue. The pressure is going to mount on the Federal government and it couldnt come at a worse time. VP Biden is working through budget talks aimed at cutting trillions from spending in order to get support for raising the debt ceiling. That is precisely the type of growth-stifling news this market hates.

The question is: how much further do stocks have to fall to get the attention of the Federal govt or the Fed? To 1200? 1100? 1000? Even if stocks fall to last summers lows, the FX trades arent entirely straightforward. The obvious buys are JPY and CHF but how willing are policymakers to allow those currencies to appreciate? There may be some upside in USD but the risk is the story may plays out as US growth slowdown rather than worldwide growth slowdown so that leaves USD vulnerable.

The best trade we see that capitalizes on a fall in stocks is short CAD. CANADA IS LEVERAGED BOTH TO U.S. GROWTH AND POSITIVE RISK SENTIMENT. A decline in both will push CAD lower against virtually everything. A trade that maximizes exposure to risk sentiment is short CAD/CHF (this pair is just above the 2008 low). A trade that minimizes exposure to risk sentiment is long AUD/CAD. Timing it is key. The RSI on the S&P 500 is at the lowest since last summers bottom so its not an opportune time to jump into these positions but they are trades we are watching and will share with premium subscribers.

Ashraf will bring you a weekend version of the Premium analysis to go over Friday's dynamics in FX, energy & equities and the implications for next week.

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