Financial Stocks And US Dollar Warn Of Tough Times Ahead

Scott Johnson
updated | Author's Website

As fears of sovereign debt problems mount following the Dubai World default and the downgrade of Greece’s credit rating, the Dollar looks to be in the process of a trend change. Looking at the US Dollar ETF, we can see plenty of volume coming in as price breaks up and above a six month trendline.

Looking at the EUR/USD, we can see a similar trend break. While the chart argues for further downside over the longer term, it is short-term oversold and sitting just above the 200 day moving average.

During this period of Dollar strength and debt worries, equities have been remarkably resilient overall. SPY (SPY) remains above a rising 50 day moving average, and near its yearly high.

At DailyFX, John Kicklighter comments that risk appetite has yet to break despite the Dollar’s rally.

All that is needed to tip risk trends into a tailspin is a definitive catalyst. We have plenty of potential threats to global, financial stability; but optimism or greed for greater returns has helped the markets weather most of tremors. This likely means that we need a market-based event. A particularly large withdrawal of capital from the speculative arena or the seizure of a critical node in the broader financial market could certainly spark a panic that leads to a cascade selling event. Ironically enough, the best opportunity to force the Dow below 10,250 or pitch the carry interest into a bleak bear trend is during the low liquidity-period that is approaching. While there is not enough market depth to maintain and develop a reversal; the low liquidity means it will be easier to unbalance sentiment. Therefore, we need only keep a vigilance on the already incubating fundamental troubles that have developed over the past few months and be ready for a new shock to catalyze price action itself. Among the key trends to watch, the threat of defaults on a corporate and national level is particularly troublesome. Not long ago, the IMF warned that the world’s banks have only accounted for half of the losses they will ultimately suffer from following the worst financial crisis since the Great Depression. Now, we are seeing downgrades on sovereign credit ratings that is further taxing an already fragile market that is now seeing some of its ‘safe’ assets degrading. Investors could weather this if the government maintained its support of the global economy and markets; but this safety net is already being rolled in. As stimulus and emergency aid is rolled back, the markets will increasingly have to support its own weight. And, considering how high valuations have run and the lack of true fundamentals to support recent heights; the outlook is fragile indeed.

Aside from the Dollar, financial stocks are also signaling that risk trends may be changing. The past three days has seen Citigroup (NYSE:C) break down on heavy volume.

Europe’s troubles are weighing on the continent’s banks.

- Lloyd’s Banking Group (NYSE:LYG)

- Barclays (NYSE:BCS)

- Credit Suisse (NYSE:CS)

And some more US banks with bearish charts:

- Zions Bancorporation (NASDAQ:ZION)

- State Street Corp. (NYSE:STT)

- Principal Financial Group (NYSE:PFG)

Given high equity valuations and the likelihood of additional crisis events in the debt markets, odds would favor a bearish orientation for stocks.

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