The Dow Jones Industrial Average registered a very rare “Monthly Key Reversal Down” in July…this may signal the beginning of the BIG reversal we’ve been expecting. In June, when we saw that the “smart money” was getting defensive we got long the US dollar and in late July, short the stock market. We will be looking to add to these positions in the weeks and months ahead.

We expected the reversal in Market Psychology would be caused by:

1)  A realization that the Fed was going to raise rates higher and faster than the market wanted to believe, and/or,

2)  Geo-political stress.

In the past few weeks mainstream analysts have begun to share our views on interest rates…and that change of sentiment has had a big impact on credit spreads and currencies…but geo-political events seem to have had limited impact on Market Psychology…witness WTI below $100 and gold down $50 from its early July highs.

But we are having second thoughts about the “limited impact” of geo-political stress…we wonder if the “fallout” from the Ukraine crisis was the “straw that broke the back” of the Euro…which had remained puzzlingly strong until early May…we wonder if the increasing geo-political stress was what convinced the “smart money” to start getting defensive in June.    

We have expected a reversal in Market Psychology to produce:

     1) A rising US Dollar,

     2) Widening credit spreads,

      3) A falling stock market.

When Market Psychology is bullish buyers are more aggressive than sellers. When buyers are aggressive they buy riskier markets…and they are more willing to use leverage. When Market Psychology reverses buyers dump riskier markets and reduce leverage…voluntarily or otherwise. We think that the “mood swings” in Market Psychology  “show up” in the use of leverage…and that is key to understanding price changes.

We love the expression, “Risk Happens Fast.”

1)  Eight trading days ago the DJIA closed 6 points off its All Time Highs…today it traded more than 600 points lower,

2)  Credit spreads started to widened in early July…then collapsed into the end of the month as junk went “no bid” and Treasuries were steady/better,

3)  The US Dollar Index  “turned on a dime” at the beginning of July and rallied to 10 month highs by the end of the month,

4)  Volatility across asset classes was near All Time lows at the beginning of July…by the end of the month the VIX…the Fear index…had jumped ~70%.

For the past few months we have maintained that the market was “priced for perfection” creating the seeds of its own destruction…markets get “way over-bought” and then reverse sharply…“risk would happen fast” and, like the game musical chairs…there are never enough chairs when the music stops.

Trading:

We remain long the US Dollar Index…this is a “core” longer term trade. We’ve taken profits on our short CAD and AUD positions. We remain short the US stock market…we’re up the equivalent of 500 DJIA points…but (in a risk management move) we wrote short-dated OTM puts against our position at the end of the week…as put prices soared on skyrocketing option volatility. We will be looking to make more US Dollar bullish/stock market bearish trades in the weeks ahead.

Chart section:

The classic “Monthly Key Reversal Down” from All Time Highs registered by the DJIA in July is RARE…we think it signals the beginning of at least a meaningful correction ahead in the stock market.

The Dow Jones Utilities Index topped out ahead of the DJIA as worries about rising interest rates hit this index first. In the first week of July it registered a “Weekly Key Reversal Down” from All Time Highs…then had another WKRD last week.

The Russell Index of 2000 stocks turned down from a double top in early July as the DJIA went on to make new All Time Highs (the smart money was dumping riskier assets and getting defensive.)

Last week the Toronto Index registered a Weekly Key Reversal Down from All Time Highs.We think it goes down from here.

The principle German share index was trading at All Time Highs at the beginning of July…but sold off harder than the American market throughout the month…perhaps on geo-political stress and/or rising interest rate premiums in America. (Our core view is that capital flows “back to the center” when markets shift to risk off.)

The US Dollar Index traded to 10 month highs at the end of July. This Index has a heavy weighting of European currencies…which we expect to weaken Vs. the Dollar. We look for the US Dollar to trade above last year’s highs (8475) in the months ahead.

The NZD registered its All Time Highs in August 2011…around the same time that gold topped out. We think it is “way-too-high” at current levels and could easily fall 5 – 10% in the months ahead.

The CAD has been in a downtrend (from 106) since the commodity markets peaked in 2011. It hit a 5 year low in March 2014…bounced (with a big assist from short-covering) to 9400 and then rolled over in early July. We expect it to take out the March lows before the end of 2014