Dollar surge puts Q4 earnings at risk and two-year stock uptrend in peril
Stocks opened this week with solid gains across the board, but sellers moved in on cat feet and began pawing at the highs until they unraveled like a ball of string. The net result has been losses across the board, with the small caps once again taking the brunt of the attack.
Headlines have been mostly driven by corporate actions rather than economic data or geopolitical events. Hewlett Packard (HPQ) confirmed plans to split into two bad companies -- why just have one? -- as the antiquated enterprise technology infrastructure side of the business would be separated from the antiquated PC and printer business by the end of next year. HPQ today is like a museum run by docents.
The market loved this idea for a day because, well, the market loves when things happen. I mean, break-ups, spin-offs, mergers, it doesn't care. The idea is just to do something that generates investment banking fees, right? But the attention span only lasts a few minutes sometimes. Remember when eBay (EBAY) ripped higher last week on announcing that it would split off its PayPal unit? That excitement lasted, oh, about 12 hours, and ever since eBay has cascaded back into the abyss from which it crawled. The HPQ excitement lasted even less long.
Another deal announced this week was Becton Dickinson (BDX) acquiring CareFusion (CFN) in a $12.2 billion transaction. Execs said it would add double-digit earnings growth to BDX and save $250 million. (Prediction: Six years from now, BDX will split off CareFusion, citing costs savings and looking for a way to better attract value for the unit.)
Overseas the main news was an election, which was a nice break from mayhem. We learned that the Brazilian incumbent president, Dilma Roussef, received 42% of the vote in the election and will face a formerly little known challenger named Aecio Neves, who had been polling in third place. Brazilian stocks reacted positively because Neves performed better than expected; they really don't like Roussef.
In response to all this and more, the Dow Jones Industrials have slumped 300 points and the Russell 2000 is in danger of losing one of its zeros. Nobody respects the little guy on Wall Street anymore.
The fact that there was no follow-through to the Friday rally this week is disconcerting, as the other major rebounds off the 125-day average (the blue line in the chart above) saw stocks scooped up by bargain hunters for several days straight. If there is no rebound Wednesday, Â technicians who specialize in identifying cycles are looking for a big turn lower. that has the potential to send stocks down to the mid-1800s at least, and possibly in an extreme case down as much as 12% to touch the long-term trendline at 1700.
The catalyst for such an event could be the unexpected surge of the dollar, which will have companies scrambling to determine its impact on their foreign earnings. It was just that kind of assessment of the dual trouble of weaker eurozone and emerging market sales plus unfavorable currency translations that sent Ford (F) skidding out of control last week.
Another hidden problem that could unsettle markets over the next couple of months is Calpers announcement last week that it was pulling out of all hedge fund investments. The California Public Employees' Retirement System is considered the gold standard of pension funds.
Other funds are following its lead. The recent out-of-the-blue decline in stocks could have come about by something so simple as a redemption request from top pension funds to hedge funds. That would explain the chart shown above, which comes from ISI Group. It shows a steep plunge in recent weeks of hedge funds' market exposure.
Add it all up and the past two weeks' setback certainly gives you pause. The fourth quarter could still end higher as would be typical following midterm elections, but there could be a big -12% divot first. The next few days are critical for determining if that will happen; time for bulls to step up and show that the threat of global economic contagion doesn't scare them.
