Old Trade Is Holding—But for How Long?

Ah, it's like February again: dollar weak, commodities up, commodity stocks up....except it's not February anymore.

It's true that the old trade is holding today: short dollar/long commodities, but no one believes it has much power anymore. It's more of a cynical trade than any belief that this will stick around for a long time.

Why? Because things have changed. Stocks have held up well, despite the weak U.S. economy, helped by several factors:

1) QE2 (the Fed's quantitative easing);

2) a dramatically improved balance sheet for corporate America, thanks mostly to aggressive cost cutting which has resulted in improved margins;

3) a weak U.S. dollar which supports exports for U.S. corporations; and

4) emerging market economies that outperform the U.S. and Europe.

But this mix is changing: QE2 is ending, the dollar is showing signs of ending its slide or at least stabilizing, many emerging market economies are raising rates, and while corporate balance sheets are still strong it is now clear that cost cutting can only get us so far.

As a result, May has seen problems. We are starting to see a rotation out of the manufacturing/cyclical trade...the bellwether stock is Caterpillar , down nearly 10 percent this month.

While there has been some handoff to consumer and healthcare stocks in the U.S., we are not handing off to a robust domestic backdrop.

In the U.S., ISM may be peaking...capacity utilization and industrial production is disappointing in April after a great run.

And if your really want to swallow the daily suicide pill, take a look at some of the comments from the Staples executives:
- "Looks Like Economy's Still Stuck In Neutral;"
- "Flat Sales Reflect Little Employment."

We are back to the dilemma of last year: revenue growth is fair but not great, and early signs of a weaker economy is a big problem.

What are we left with? More QE. Gads.

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