Selling Unwinds as Volatility Abounds

Global central bankers served up a cocktail of coordinated tightening Thursday, leading to dislocations around the world that featured falling commodities markets and a rising dollar. The stock market's late-day rebound took some of the sour taste from traders' mouths. But Thursday's volatile action globally shows the downside of risk rebalancing as several "winning" trades have become losers.

"You have the perfect storm going on," says David Greenwald, partner at Scalene Partners, a currency-focused hedge fund. "The driver here is world interest rates," and people are getting pummeled by positions they put on at the end of May.

The most-damaged positions included being short volatility, going long the euro vs. the dollar, long the yen and long Asian equities. None of those trades are working, as investors watch their other leveraged investments in commodities, emerging-market and high-beta U.S. equities slip away as well. The U.S. stock market's recent gyrations only point to the volatility such unwinding creates.

"That is a bad scenario ... that is a potential 1997 scenario," says Greenwald, referring to the so-called Asian contagion that roiled financial markets until (and definitely including) the Russian debt default and collapse of Long Term Capital management in 1998.

History certainly might not repeat itself, and most emerging markets are in better financial shape now than in 1997-98. And while the "contagion" snowball may be forming, the stock market's late-day rebound may suggest that it hasn't started down the hill. Maybe it never will.

After falling 173 points earlier, the Dow Jones Industrial Average closed up 0.07% to 10,938.82, ending a string of four successive declines. The S&P 500, which fell to its lowest point of the year at 1235 intraday, finished up 0.1%, at 1257.93. The Nasdaq lost 0.3% to 2145.32, but finished well off its intraday low of 2100.

Technically speaking, bulls were calling Thursday's session a "successful retest" of the market's May lows and said the intensity of midday selling was the kind of "climactic action" typically associated with a market bottom, at least short term.

Still, Thursday shows that the markets can approach a tipping point if only a few elements take unpredictable turns.