I believe that the global stock markets are today at a critical juncture where a call has to be taken whether the US dollar will collapse and fall big time over the next few weeks or will it bounce back from its extremely oversold levels and along with it cause a significant sell off in equities and commodities.
Although i have been on the side of caution over the last few weeks with the base case view that there will be a dollar and vix bounce which will cause the much awaited correction there is another possibility that exists where the dollar instead of bouncing from its immediate strong supports could actually fall off and thus lead to an explosive near term upmove which will then be followed by a strong sell off.
The other factor supporting this hypothesis is that technically most stock markets, both emerging and developed are looking at forming patterns which are very similar to that of September 2003, at the time of the start of the last big bull impulse. Subsequent to that formation after a period of brief consolidation the markets moved up substantially before they corrected by nearly 25% when the results of the elections came out in May 2004. The only difference is that at that time the markets took nearly 14-15 months to double from their bottoms of early 2003 and this time they have doubled in just four months.
After a phase of consolidation over the last few weeks this formation, if not taken out over the next few days can cause a big bull impulse which is the part of every breakout pattern. This can potentially lead to the markets moving up by another 10-15% before any meaningful correction fructifies.
What should one play for, boy its a crazy position today. I think the market movement over the current week will clearly show the way. All investors are jittery after the big upmove, monsoon situation, swine flu impact etc, however the short term direction clearly lies in the dollar move. A dollar upmove will cause a 10-15% selloff, a dollar collapse a 10-15% upmove.
I would still keep some cash on the sidelines and also take hedged positions for the short run.
However given that the long term trend is that of a big upmove its important to remember that –
“The genius of investing is recognizing the direction of the trend -not catching the highs and lows”