As has been stated numerous times on this site everything comes down to the currency markets. The US stock market is neither trading on current nor future fundamentals. It is simply moving in reaction to events in the currency markets.This has been the case for at least 3 months now. First as a safety trade, and now as a carry trade that has gotten out of control.

At the beginning and throughout much of the financial crisis the US dollar was a short term ’safety trade’, or in other words a risk aversion parking spot. But, as the value of the US dollar continued to deteriorate it became a carry trade (borrow US dollars cheaply to engage higher risk/cost transactions) much like the Japanese Yen did in 2007 and early 2008.

Carry trades never end well, and with the worlds global currency now being nothing more than a vehicle to borrow cheaply it will (not if) lead to a disastrous outcome if the US Government does not take an active role in stabilizing the currency. But it may be too late, for even if the Fed (or another nation) intervenes in currency valuations it could force a massive liquidation of the carry trade that will force the selling of higher risk assets (stocks as one example) for any rise in the dollar creates a higher pay back of the original borrow (carry trade). This is why the dollar and the equities market have been so tightly intertwined.

Should the US dollar get into a run away downward spiral it will cause a number of situations to unfold. One situation is that it will prompt other nations to raise hell over the currency devaluation and in turn raise substantially the chances of purposeful foreign currency devaluation on the part of other nations in an attempt to stabilize the FX markets. You see, there is a price to pay when your currency is the worlds reserve currency. The second situation will be a currency dislocation event, that is when commodities, bond markets, and even stocks (as stocks are the highest risk asset among investment classes) will suffer as there is a global shift in currency valuations that will propagate globally. Suddenly valuations of stocks becomes increasingly mute as all references becomes tilted.

Right now we are at a cross roads with respect to the global financial situation. As I type this the Japanese Yen / US dollar cross is literally on the line of either staying above a significant support level, or breaking below it which could possibly be the beginnings of a currency market ‘event’. Wondering what will happen with the US stock market? Forget about valuations, forget about better than expected or worse than expected at the moment. All of that is for the most part meaningless at this juncture (and has been in recent months). Right now one only has to turn to the FX markets as it is there that traders, hedge funds, and sovereign wealth funds are watching.

The US stock market is currently over valued on even a basic fundamental basis and over bought on a technical basis. Should the US dollar rise equities will be even further over valued as the reference currency plays havoc on the pricing of equities. Not to mention the rapid selling of higher risk assets to unwind the carry trade.

Should the US dollar go down a dark rabbit hole it will raise the potential significantly of a global currency market storm. That is the risk we face with the dollar being the reserve currency and why so many nations are still considering abandoning the dollar as the reserve.

The risk of holding assets in the equities (stock) market is extremely high. Go ahead and chase those stocks higher and higher if you wish. But don’t say no one warned you of what might happen if the currency market dislocates, or the US dollar carry trade is forced to unwind in a panic.

I remain bearish on US equities. There is more to understanding the market than just the price of Google stock. In general, the older one is the more they see danger in this market for it is us older folk who have witnessed more. As Art Cashin (one of those old timers on Wall Street) stated today there is so much air supporting this market that any upset we could see a fast 1,000 point drop ( Dow Industrial) very quickly.

The entire financial crisis is still playing out. Little has changed, only the names have changed. US stock market prices are indeed floating on air and have been for a considerable amount of time. It remains my opinion that equities should be sold and a safer position be maintained. If there is a severe currency market dislocation there will be no safe investment other than to be out of the market. Once again this is my view and I will continue to trade my own account accordingly. You on the other hand must decide for yourself if you feel safe with your money tied up in the equities market that is being elevated on a devaluing currency, which so happens to also be a global carry trade. Cross your fingers that a massive currency dislocation event does not happen.

Trade at your own will,  but be warned there is danger all around.

Even FOMC member Fisher said on November 16 -

“Carry trade usually ends in tears”