The Scariest Thing on Wall Street

The Scariest Thing on Wall Street
By Jeff Clark
November 3, 2009

While ghouls, ghosts, and goblins were gearing up to haunt neighborhoods across America, something else was spooking Wall Street last Friday. It was the threat of a rising dollar and the potential end of the dollar "carry trade."

The ability to short dollars at virtually zero cost and then use the proceeds to buy other assets – like stocks, bonds, gold, and oil – has been a winning trade since the dollar peaked and the stock market bottomed back in March. But now that trade is getting a little long in the tooth and the markets are getting nervous. With good reason...

You see, never before has the dollar been so despised as a currency. It seems as though everyone is riding the "dollar is doomed" bandwagon. And this rampant dollar pessimism is occurring at a time when everyone is falling in love with stocks and commodities.

So we have a beaten-down currency being used to prop up other assets, which have already inflated considerably in just a few months. It's the exact opposite of what we had in March, when everyone was selling assets at rock bottom prices and rushing toward the safety of the U.S. dollar.

Have economic conditions really changed so much?

Things have improved somewhat. We are no longer on the brink of a financial meltdown, and there are signs of modest growth in the U.S. economy.

But income-tax receipts are still declining, foreclosures are still on the rise, banks still haven't written down the value of bad loans, and the consumer is still not spending. In other words, we still don't have the economic foundation to support rapidly rising asset prices.

The gains of the past several months are principally the result of a falling dollar causing asset price inflation. Traders who have been short the dollar and long riskier assets have profited on both sides as the carry trade bungee cord has stretched far beyond its normal limits.

What happens when the bungee cord snaps back? What happens when the carry trade begins to unwind?

If you've ever been on the wrong side of a short squeeze, then you know the answer. When heavily shorted stocks stop falling, traders step in to cover their positions. The ensuing rallies can be spectacular.

Consider the case of Fannie Mae (FNM). FNM is a worthless company, and the stock really has no equity value behind it. But FNM rallied more than 140% in just four days back in August when short sellers panicked and rushed to cover their shares.

Imagine that those traders used FNM short-sale proceeds to buy other stocks. And then they had to sell those other stocks in order to buy back FNM shares.

Not only would they have gotten crushed when trying to cover their short FNM positions. But they'd also suffer as their other stocks cascaded lower amidst a flurry of sell orders.

Speculating Just Got Cheaper

One of the Only Value Plays Left

That is the risk of an unwinding carry trade. As soon as there's a sustained uptick in the dollar, traders will need to sell their other assets in order to buy back their short dollar positions.

Given the overwhelming short interest in the dollar, a small rally in the greenback could lead to a truly frightening correction in stocks.

Best regards and good trading,

Jeff Clark

12 places to go if the world goes to hell
Interesting list of safe havens... Marc Faber's top pick included.

"Dr. Doom" Roubini: Fed policy will produce biggest asset bust ever
If this doesn't make you buy A LOT of gold and silver, nothing will.

Stansberry's follow up to the Detroit socialist disaster piece
Responds to scathing reader feedback...

•	Collectibles grading company Collectors Universe shoots to new 52-week high.
•	Insurance giant MetLife suffers big selloff... trading at lowest low since July.
•	Novartis reaches new 52-week high... the Big Pharma company rallies 50% from lows.
•	Earnings today... Archer Daniels, Hartford, Kraft, Marathon Oil, MasterCard, Polo.

	Last	Change	52-Wk
S&P 500	1097.91	+0.94%	+16.73%
Oil (USO)	40.76	+0.77%	-31.35%
Gold (GLD)	104.23	+1.02%	+35.00%
Silver (SLV)	14.44	+1.51%	+88.95%
U.S. Dollar	75.28	-0.01%	-9.39%
Euro	1.50	+0.11%	+12.20%
VIX	21.49	+0.28%	-69.44%
HUI	448.69	+0.60%	+120.38%
10-Year Yield	3.40%	-0.02	-0.47

Advertisement

Company	Sym	Industry
Perrigo	PRGO	pharma
Protalix	PLX	biotech
MV Oil Trust	MVO	oil & gas drilling
Perot Systems	PER	outsourcing
Insituform	INSU	construction
Spreadtrum	SPRD	semiconductors
Dr. Reddy's Labs	RDY	pharma
TeleTech	TTEC	customer mgmt
Insulet	PODD	medical devices
Ventas	VTR	health REIT
Domtar	UFS	paper products
NutriSystem	NTRI	weight loss
Vertex Pharma	VRTX	pharma
Williams Partners	WPZ	gas drilling
infoGROUP	IUSA	marketing svcs
Diageo	DEO	liquor
Encore Acq	EAC	oil & gas drilling
Tyler Tech	TYL	outsourcing
Human Genome	HGSI	biotech
Williams Pipeline	WMZ	pipelines
Collectors Universe	CLCT	collectibles

Company	Sym	Industry
OpenTable	OPEN	reservations
CardioNet	BEAT	medical devices
TranS1	TSON	medical supplies
American Public	APEI	online education
First Bancorp	FBP	bank
Hansen Medical	HNSN	medical devices
Emdeon	EM	health IT
Osiris	OSIR	biotech
ZST Digital	ZSTN	telecom
Capitol Federal	CFFN	bank
GTX	GTXI	biotech
Progenics	PGNX	biotech
Comm Bancorp	CCBP	bank
MetroPCS	PCS	wireless telecom
CIT Group	CIT	business lending
USA Truck	USAK	trucking
Matrixx Initiatives	MTXX	cold medicine
Banco Santander	BSBR	bank
Privatebancorp	PVTB	bank
Cheniere Energy	LNG	oil & gas drilling
Pacific Capital	PCBC	bank
EPIQ Systems	EPIQ	IT systems
First Busey	BUSE	bank
Old Point	OPOF	bank

The Headline All Great Traders Hunt For
November 2, 2009

Weekend Edition: You Won't Be Able to Get into Gold at any Reasonable Price
October 31, 2009

This Could Be the Biggest Biotech Trade of 2010
October 30, 2009

Good News for Gold Buyers
October 29, 2009

Commodity Q&A: The Worst Idea for Gold Stock Investors
October 28, 2009