A major selloff for financial markets, save Treasuries, this week raises a classic "chicken or egg" conundrum: Did the stock and corporate bond markets tumble because the yen rallied, prompting an unwinding of the carry trade? Or did the yen strengthen because speculators rushed to unwind those "short-yen/long-
insert riskier asset here" bets amid a sense that the global liquidity boom is waning?
Late Friday, the dollar was trading at 118.97 yen, its lowest level since April, even as the greenback posted its biggest weekly gains vs. the euro and British pound since January. As
detailed here, a stronger dollar could hamper earnings for U.S. multinationals, which led the market's recent run to record levels.
But "Dow 14,000" now seems a distant memory, and whether the yen's rally was the cause or effect of the selloff is academic to most investors, whose portfolios were decimated. After another sharp selloff Friday, the
Dow Jones Industrial Average
fell 4.2% for the week, while the
lost 4.9%, and the
shed 4.6%. The weekly declines were the worst since September 2002 for the S&P and since March 2003 for the Dow.
Beyond currency concerns, reasons proffered for the selloff include disappointing earnings and/or guidance from corporate giants such as
But housing and credit-related issues were at the epicenter of the decline, as embodied by
. The nation's largest mortgage lender posted lackluster second-quarter earnings Tuesday and offered
dismal guidance, which featured CEO Angelo Mozilo saying that problems in subprime are spilling into prime loans and that the current housing environment is the worst since the Great Depression.
Concerns about housing were exacerbated by weak new- and existing-home sales data, as well as shocking losses from homebuilders
Related worries about mortgage-backed securities continued to pressure financial stocks, including -- but certainly not limited to --
Big brokers and money center banks also are reeling from problems in the credit and leverage loan markets, evident this week as
failed to find buyers for $20 billion of loans to pay for previously announced private equity buyouts. A consortium led by
was left holding the debt on its balance sheets until the deals can get done, presumably at less favorable terms.
and Russia's Gazprom were among the more than 40 other firms
reports either postponed or canceled debt offerings this week.
There is a rising fear that more debt offerings to finance previously announced LBOs will face similar fates, thus curtailing future private equity deals, hurting financial sector earnings and removing the "takeover premium" from the stock market. This week's notable losers included companies previously speculated as takeover targets, including
Further prompting the selling this week was weakness in energy stocks, despite crude's surge to $77 per barrel. In addition to Exxon's disappointing profits and production data,
took a much larger-than-expected charge related to Venezuela's expropriation of its projects. Reflecting the sector's changing fortunes,
shares slid 2.6% Friday, despite the firm's stronger-than-expected second-quarter results.
Finally, some trades attributed the ferocity of this week's decline to the recent end of the "plus tick test," which dictated that investors could only short stocks on an uptick, as discussed on Friday's
The Real Story podcast with veteran NYSE trader Teddy Weisberg of Seaport Securities.
The Tide Turns
Regular listeners of my podcast know I've been steadfastly bullish since beginning the show on Sept. 1, 2006 (save for a few days in late February). But this week's decline featured heavy-volume selling and a decided break of support for the S&P at 1490. The action suggests that the S&P is likely to test its 200-day moving average at 1448, at a minimum, before this decline ends.
The good news -- for the bulls -- is that 1448 is a mere 0.8% away and that the S&P is already down 6.2% from its July 16 all-time high. If the recent pattern of 5% to 7% declines holds, the selloff should therefore be nearing its conclusion soon. Furthermore, robust gains this week for names such as
show that the bulls still have firepower and that "good news" is being rewarded.
However, it should be noted the Russell 2000 is now down more than 10% from its recent high -- a true technical correction -- and there's also a lot of "remain calm, all is well"-type chatter coming from the talking heads on television, despite a 42.5% spike this week in the CBOE Market Volatility Index (VIX). Further anecdotal evidence of the absence of fear comes from some favorite Wall Street gurus.
"There are many feared catalysts for a substantive market correction, yet the evidence does not support the likelihood of a sustained downturn," Citigroup's Tobias Levkovich wrote Thursday. "While risks are always present, it is difficult to position a portfolio for the remote chance that they surface."
Friday morning, Bank of America's Tom McManus writes: "The market's sharp sell-off has stoked investor concern, and a surge of put buying at significantly higher prices indicates the slide may soon provide a short-covering bounce," especially in recently battered sectors such as banks and utilities.
It should be noted that McManus is talking short-term and that Levkovich's call is based on his long-term bullishness. Also, Levkovich has generally been more upbeat in recent months than McManus, so those biases play a role here, too. (On a semirelated note, uber-bull Don Hays remains undeterred by this week's action.)
But after issuing a short-term sell signal last Friday, Lowry's Reports issued an intermediate-term sell signal Thursday night, its first since moving to a buy recommendation on Aug. 30, 2006.
"The quick succession of 90% downside days suggests selling may be at or close to an exhaustion phase at least on a short term basis," Lowry's wrote. "Any rebound rally in the days ahead though is likely to be selective and serve largely as an opportunity to reduce equity exposure."
In other words, the "buy the dip" mantra is being replaced by a "sell the rallies" mentality.
Aaron L. Task is editor at large of TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in TheStreet.com. He also doesn't invest in hedge funds or other private investment partnerships. He appreciates your feedback;
to send him an email.