Trader Talk

Risk Aversion is Back -- Big Problem is Oil

Risk aversion is definitely back today. You can see it in the dollar/yen, where the yen has really strengthened today.

The AIG news (down 8 percent) told us that a lot of the bad news is still not priced in. Big momentum stocks like Visa , Mastercard , Nucor , US Steel , Anadarko Petroleum , Apache , , Apple , and Google all saw profit-taking today.

But here's the big problem: oil closing up five straight days, closing at a new high. Last week, a small group of traders began to try to unwind the "long commodities/short dollar" trade, betting that the economy would improve in the second half of the year and oil would moderate.

It is not working out quite that way, and so those bulls have been unable to suck in fence sitters who would move the market up. Most traders are sticking with the long-commodity story.

This is a big problem for the bulls: For most of the bullish economists, the second half recovery is contingent on crude dropping. If that doesn't happen, the most likely scenario involves grinding sideways for several months on low volume.

What to do in the meantime? If you believe in the "grind sideways" scenario, you will clearly do better if you can make a few good bets than own the broad market. That is why so many people are sticking with their long commodity position: because it is still working.

Globally, that continues to support Brazil and Asia as an investment thesis; the Brazilian Bovespa hit a new high this week.

Will anything reverse this trend, i.e., strengthen the dollar, weaken commodities? The ECB could be key. Germany has been the strong spot in Europe, but there are signs it too is weakening. There is growing pressure on the ECB to cut.

Bottom line: it will take a lot for the market to really break down, because it has been through so much. But the skepticism is still high, with a notable lack of visibility. That's why many are coming to believe the "grind sideways" scenario. In the meantime, the bulls pray for oil to come down.

For the week: Dow down 2.4 percent, S&P down 1.9 percent, Nasdaq down 1.3 percent, Russell 2000 down 0.8 percent.

Questions?  Comments?