Potential Other Asset Class Trades To Watch During Bear Market

Potential other asset class trades to watch during bear market

In last week's article we talked about the market transitioning from a 2-way market where select longs against select shorts was an appropriate strategy, to a more bearish biased one that was more difficult.  We suggested that "shorts, shorting weak groups versus the market, or buying defensive groups versus the market short should be the primary ways of playing this market in such a phase - and with less allocation than even earlier, as this is the most dangerous phase of the market."  So far this scenario of a more dangerous bearish biased bear market developing looks like it is accurate, although a sharp bear market rally could develop at any time and would likely favor the laggards in a short-covering play. 

However there are other asset classes that are now accessible by stock investors as never before.  Let's take a look at some that might offer good trading opportunities in the period ahead.

As the US economy weakens relative to other economies, its currency is still likely to weaken further, especially versus the strongest global economies.  The Fed is stuck and cannot raise rates because doing so would hit housing and banks even harder than they are already being hit.  This means the dollar could still move lower, despite Fed and Treasury rhetoric aimed at propping it up.  Relative interest rates and relative economic strength will likely dwarf rhetoric.  However the dollar is getting quite undervalued versus most developed market currencies, including the Euro.  Fortunately, stock investors can now look elsewhere for ways to play a declining dollar, if indeed the dollar index breaks below 71.80 to signal a renewed downleg is likely underway.

As chart 1 shows, the dollar index is currently in a rectangle pattern.  The dollar is likely to get resistance at the top trendline and a breakdown under the lower trendline and below 71.80 would signal a likely renewed leg down for the buck.  This signal, along with others mentioned below will be important to potentially initiate a host of possible currency trades we will discuss below.  The outlook for the dollar is therefore critical to watch.

 
Chart 1:  Dollar index still in rectangle though decline under 71.80 would signal renewed decline.  Crtsy Bloomberg

 
Chart 2:  CNY recovering nicely and moving higher after breakout - could add on dollar breakdown.  Crtsy Bloomberg

One of our long-time favorite trades has been buying the Chinese currency against the dollar.  We've suggested shorting CNY NDF's on the forex market for those able to do so, and, if this cannot be done, considering buying ETF's CNY or CYB which attempt to replicate the Chinese currency against the dollar.  CNY has continued moving higher after its head-&-shoulder breakout we highlighted and could be added to on positive technical action after a dollar breakdown as well.

 
Chart 3:  Brazilian Real ETF is also a favorite of ours if the dollar index breaks down clearly.  Courtesy Bloomberg

Another favorite currency that is still undervalued in PPP terms against the dollar is the Brazilian Real, which is benefiting from high relative yields and strong terms of trades gains because it is a primary commodity producer.  Here too, we would buy this on a breakdown by the dollar index, and look to potentially buy it if the dollar tests resistance at the rectangle upper trendline.

PGD is a new Barclays ETN that is very interesting, particularly if the dollar index does breakdown in the period ahead.  This is an equal portfolio consisting of the Chinese RMB (CNY), the Hong Kong Dollar (HKD), the Singapore Dollar (SGD), the Saudi Arabian Riyal (SAR), and the UAE Dirham (AED).  The Singapore dollar and the Chinese RMB are two favorite Asian currencies.  But the Hong Kong Dollar, the UAE Dirham, and the Saudi Riyal are all dollar linked currencies.  The SAR and AED have stayed tied to a dollar linked exchange rate recently even though this has caused internal inflation rates to flare substantially.  Many Middle Eastern countries facing a similar problem have had to de-link their currency to the dollar, which causes instant and substantial appreciation of their currency when such de-linking is announced.   If the dollar undergoes yet another leg down, it is likely that the SAR and AED, and even possibly the HKD will have to de-link their currencies from being tied to the dollar or face huge inflation.  In the forex market our favorite Middle East currency plays are the Saudi Riyal and Egyptian Pound, but for those without exotic forex access, this ETN is a great way to have fairly low risk with good upside potential if a de-linking or two must evolve in the case of a renewed dollar downleg. 

 
Chart 4:  PGD is a play on the dollar's decline in Asia and Middle East - buy on dollar breakdown.  Crtsy Bloomberg

The Canadian Dollar has been stuck in a broad trading range since November, bounded by the January lows and the February highs, with par nearly in the middle of the range.  The Canadian dollar (which has an ETF with the symbol FXC) got overdone on the upside as it appreciated even faster than the terms of trade gains Canada experienced in its run-up from August to November last year.  But over the last six months, terms of trade gains have caught up and surpassed currency gains and our models suggest that an eventual upside breakout of the current trading range is likely, and would signal a new wave up in FXC.  We would buy on a close over 103.25 w/ a 96.75 ops.
 
Chart 5:  FXC in trading range and breakout would be buy signal.  Courtesy Bloomberg

 
Chart 6:  Gold would be a favorite to buy on a dollar breakdown as well.  Courtesy Bloomberg
We are also continuing to watch for a move by GDX over 51.5, confirmed by the dollar index DXY falling below 71.80, confirmed by the Gold ETF GLD closing over 94.15 to signal that the next wave down in the dollar has begun and the next wave up in gold and gold stocks is underway.  Such should be taken as a buy signal in gold or gold stocks. 

Crude oil is becoming increasingly critical to the outlook for a number of markets, including the dollar and stocks.  A substantial correction in oil would help take away one of the pressures forcing the dollar lower.  It would also take away one pressure pushing down stocks.  Commodities would likely correct in sympathy with a large oil correction.  Oil is approaching a critical technical juncture that investors should watch carefully.  The first significant support is in the 105-107 level basis USO, the oil ETF.  Should USO close weakly and on strong volume below 105, oil will likely be embarking upon at least an intermediate-term correction.

 
Chart 7:  USO under 105 would likely lead to a more intermediate-term correction in oil.  Courtesy Bloomberg

The market is starting to grow in downside intensity.  We did get 5 days in a row of Bottom EPS/RS New Lows being 40 or more over Top EPS/RS New Highs (see www.midasresourcegroup.com< /a>), something we use as a signal of a bear dominated market environment.  Today's breadth and volume was 82% downside, meaning this was still not a 90% down day despite today's erasing virtually all of the reversal from yesterday.  The failure of the market to rally and today's continued downside pressure in the face of oversold readings probably indicates that the market will need additional capitulation pressure and one or more additional 90% down days before a tradable rally can take form.  The Fed remains stuck in a box where it cannot raise rates because that would kill banks that are already on the ropes, but it cannot lower rates because inflation is flaring from higher oil and food prices.   Until either oil and food prices correct sharply or the economy and stocks soften significantly further, all the Fed can do is try and jawbone the dollar higher while doing nothing - and that is unlikely to calm nervous markets smelling a deeper recession than previously imagined. 

 
Chart 8:  Lower trailing stops to 42 to lock in more profits on wildly profitable short sale in LVS.  Courtesy Bloomberg

Our long/short strategy since our last update did well because our lone short-sale LVS continued to drop sharply (now use 42 trailing stop to lock in big profits).  Since our last update we did not get close calls on either the short or long side.  Check out www.midasresourcegroup.com for daily listings of Top EPS/RS New Highs and Bottom EPS/RS New Lows to make sure you catch all these.  As the chart at the bottom of the page illustrates, bottom relative strength new lows are now strongly dominant over top relative strength new highs here, in what we would describe as a downward dominated market already experiencing some capitulation.  This is often the most dangerous and tricky phase of a bear market.

For those not familiar with our long/short strategies, we suggest you
review my book "The Hedge Fund Edge," my course "The Science of Trading," my video seminar, where I discuss many new techniques, and my latest educational product, the interactive training module. Basically, we have rigorous criteria for potential long stocks that we call "upfuel," as well as rigorous criteria for potential short
 stocks that we call "down-fuel." Each day we review the list of new highs on our "Top RS and EPS New High List" published
on www.midasresourcegroup.com for breakouts of four-week or longer flags, or of valid cup-and handles of more than four weeks. Buy trades are taken only on valid breakouts of stocks that also meet our up-fuel criteria. Shorts are similarly taken only in stocks meeting our
down-fuel criteria that have valid breakdowns of four-plus-week flags
 or cup and handles on the downside. In the U.S. market, continue to only buy or short stocks in leading or lagging industries according to our group and sub-group new high and low lists. We continue to buy new long signals and sell short new short signals until our portfolio is
100% long and 100% short (less aggressive investors stop at 50% long
 and 50% short).

The chart below shows that Top RS new highs (available on www.midasresourcegroup.com) stayed above Bottom EPS/RS New Lows by more than 40 for five days last week and this week.  This suggests a downward dominated market environment.  Shorts and defense should be utilized!