Market Week in Review: May 17-21, 2010

Friday’s close ended the third consecutive week of exceptionally high volatility in the financial markets, with the Dow and S&P 500 giving up over 4% and the NASDAQ dropping 5%, as investors fled risk in all forms.  International stocks, high yield bonds, and commodities all found themselves out of favor. Even gold, in prior weeks the beneficiary of safe haven buying, shed 4.5%, as gold mining stocks lost even more ground. US Treasury bonds were the winners for the week.

We revisited the February low on Friday and bounced off it, which should be considered a positive sign for US stocks, though we should remember it was an options expiration day. The Euro also found support in what looked like a short squeeze.

Looking ahead, with politicians – not only in Europe – challenging the financial markets to a fight of sorts, it’s difficult to make forecasts based on market internals only. Last week, Germany unexpectedly banned certain types of trading activity. While the merits of that position could be debated, the markets were spooked and asked: if they won’t let us short these banks, what is wrong with them that we can’t see? In the environment of tightening liquidity conditions in interbank money markets, nobody wanted to hang around and find out.

With stocks and oil both appearing oversold even after Friday’s bounce, a case could be made for going long on Monday in trading accounts. Just keep them on a very short leash. Conversely, Treasuries and the dollar seem to have had their run for now, and I exited my positions in both last week with a tidy profit. In longer term accounts, defense still seems to me the best positioning. My general bias is not to underestimate the US economy, but when such a luminary as Richard Russell breaks the glass and hits the red button, you have to stop and think about it carefully.

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