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Portfolio A and the Mini-Crash

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  • Portfolio A and the Mini-Crash

    Portfolio A and the Mini-Crash

    The May 2006 corrections and yesterday's decline were both associated Yen rallies

    by John R. Serrapere

    Up/Down Vol was nearly 4.2 billion to 44.5 million for a 94:1 ratio (a first). I think the above shows that foreign investors were the prime sellers. They unwound their Yen Carry Trades (see below). Why? Foreign investors hold mostly big names listed on the NYSE, which includes the financials, basic material stocks, and industrials that have been leading the market since 2003. These groups were sold wholesale. The brokerage stocks also broke down technically. They and the emerging market stocks were the only red flags prior to the day's carnage.

    I am speculating that the sellers were foreign because the decline was accompanied with a 1.8% rally in the Yen, making it riskier to hold Dollar assets financed in Yen. I also knew that last Friday, the government reported a reversal in net capital inflows from requisite monthly inflows near $70 billion to an outflow of $11 billion in Dec-2006.

    The above demonstrates that our market is like other liquidity driven markets when too much money chases a small–and shrinking–supply of stocks. As I indicated in my January 24, 2007 issue of Active Indexer, M&A manias do not warn us of the extreme risks that accompany merger binges. Note that all market crashes have been preceded by M&A booms. Stocks rise until the liquidity pump stops.

    Tuesday we got a mini-crash. It is the warning! Soon–in a few days to weeks–the broad USA market may decline about 10% with low quality stocks down 15% and emerging markets down about 20%. It all depends upon the Yen, which is why I favored Japanese stocks with a 10% allocation as of Feb-01-2007 plus an additional 5% short of emerging market stocks on Feb-16-2007 (EEM was shorted at 117. We are short 10% in Portfolio A). Today, Japanese indexes were the best performing equity markets (after factoring in the Yen's rise) while EEM was down over 8%.

    All bets are off if the Yen continues to rally and we get a severe decline in the US Dollar and associated currency displacement. My Consumer Price Index Score (CPIS) has been near 1974 and 1987 highs. An extremely high CPIS warns us that price uncertainties in commodities, producer goods and consumer goods/services are likely to be transferred to commodities, interest rates, bonds, and equity markets (see attachment). If CPIS remains high and/or heads higher, crash risk rises. When it is high, we overweight high quality and go short and/or underweight low quality securities.

    In spite of the Bravado on Wall Street, it is High Noon, which is when high quality kills low quality. Bang!

    Portfolio A is unchanged MTD and up 0.38% YTD.
    Last edited by FRED; 03-01-07, 09:56 AM.