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May 8th, 2010 @ 3:45 pm by Matt "NewstraderFX" Carniol

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*And Maybe For Paper Currency

The New Your Times published a very interesting chart the other day which outlines how deeply in debt the PIIGS (Portugal, Italy, Ireland, Greece and Spain) are: $3.889 trillion or 4.958 trillion euros at Friday’s exchange rate. Of that amount, $2.053 trillion or 2.617 trillion euros, is owed to Germany, France and Britain (or presumably, their commercial banks).

Meanwhile, the absurdity of the Greek “rescue” package will only serve to put the nation further into debt both in absolute terms and in percentage terms of its GDP.  As of 2009, Greece’s GDP was about $345 billion, which means its debt-to-GDP percentage was 68.4%. But with $136 billion of new debt (the EU-IMF rescue package) and with Greek GDP estimated to fall about 4% in 2010, the percentage of debt-to-GDP rises to over 112%.

In other words what we have here is round 2 of the debt crisis, which is defined as “which banks are exposed and by how much.” Round 1, as you’re probably aware of, occurred in September 2008 after Lehman Bros. was allowed to collapse. At that time, as now, no one knew exactly which banks were exposed or by how much (although it was generally known that the exposure was huge). As a result of the uncertainty, inter-bank lending rates (LIBOR) soared as banks refused to lend to each other, which naturally caused financial markets to freeze.

We’re already seeing the beginnings of this same scenario happen right now. On Friday, 3 month LIBOR (the cost of borrowing dollars for 3 months) climbed 5.5 basis points to 0.428%, the highest level since Aug. 17, 2009 and the biggest increase since Jan. 16, 2009. It also was the 13th straight gain in this “fear gauge.”

The spread between three-month Libor and the overnight indexed swap rate rose more than 6 basis points to 18.5 basis points, the most since Aug. 26 2009. The measure at one point ballooned to 364 basis points, or 3.64 percentage points, after the Lehman debacle.

According to Simon Johnson, former chief economist at the IMF and co-author of the new book 13 Bankers, the joint EU-IMF program has only a “small chance of preventing an eventual Greek bankruptcy.”

During the negotiations which occurred prior to the announcement of the Greek plan, The IMF floated an alternative scenario with a debt restructuring, but this was rejected by both the European Union and the Greek authorities. This is not a surprise; leading European policy makers are completely unprepared for broader problems that would follow a Greek “restructuring,” because markets would immediately mark down the debt (i.e. increase the yields) for Portugal, Spain, Ireland and even Italy.

The fear and panic in the face of this would be unparalleled: When the Greeks pay only 50% on the face value of their debt, what should investors expect from the Portuguese and Spanish? It all becomes arbitrary, including which countries are dragged down. Adding to the problems are that European structures are completely unsuited to this kind of tough decision-making under pressure.

So, where do you go as a trader? Certainly, in the face of what’s happening you want to be out of anything that looks risky, which means stocks and commodities. The dollar is likely to continue gaining in this situation because there’s no other paper currency which can serve as an alternative. But there is one other “currency” however: Gold.

In “normal” times, gold trends downward as the dollar gains and it rises when the dollar falls, which is what happened once the dollar began depreciating as stocks rose from Mar. 09 2009. But when panic sets in, as it did after Lehman collapsed on Sept. 15, 2008, gold appreciates along with the dollar. For example, from that day until stocks begin rising, gold went from $779 to $929 while EUR/USD went from 1.4242 to 1.2889.

Gold and the euro peaked in early December as traders first began speculating on European problems. But once the market started to better appreciate the full extent of the European debt crisis in early February, gold rose from a low of $1044 to reach $1207 even as EUR/USD fell from 1.3677 to Friday’s close on 1.2750.

I would look for this trend to continue, because what’s going to happen is either one of two things: Debt restructuring or the far more likely debt monetization by the ECB, which means that Europe’s Central bank will be printing a lot more euros in order to buy the debt of the PIIGS.

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April 18th, 2010 @ 7:04 pm by Matt "NewstraderFX" Carniol

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With Goldman Sachs (ticker: GS) being sued by the Securities and Exchange Commission (SEC) for fraud over subprime CDO’s gone bad, the potential is there to see a measure of risk taken off the table the table over the next few days.

And as we’ve seen, when risk comes off the dollar gets bought.

We certainly saw that on Friday as the greenback advanced against the better-yielding euro, pound, Australian and New Zealand dollars while the S&P declined by 1.6%. Meanwhile, GS lost over $10 billion of market cap and financial shares declined an aggregate 3.8%. As always, commodities like oil fell and Treasuries advanced while traders grew more skittish.

Going forward, there’s now an element of uncertainty which didn’t exist prior to the disclosure. For one thing, it’s doubtful that this particular transaction was the only one of its kind that Goldman was involved with. Indeed, the British and German governments gave early indications that they plan to do a bit of digging themselves, and we already know that Goldman helped Greece hid the extent of its deficits with interest rate and currency swaps.

As a trader, it’s always important to look at what happened to the markets under similar circumstances. The problem here is that basically, as far as I can tell, no one has ever traded through an SEC fraud allegation of one of the world’s biggest investment banks while the global economy is at the early stages of recovering from a devastating credit crisis.

That’s why a simplification of the situation sometimes the best approach. To my way of thinking, if it looks like garbage and it smells like garbage then it must be garbage, which means that we’re likely to see a continuation of what happened last Friday at least over the next few days.

The problems related to GS aren’t the only ones which could cause stocks to take a tumble (and cause the dollar to advance). For one, China is making some moves to pressure its growing real estate bubble by requiring higher down payments and limiting loan amounts for non owner-occupied homes and apartments. Prices in the big city coastal areas are already several multiples above what even a two income household can afford to carry.

Still, in the longer term, there’s every reason to believe that investors will go long once they spot a bargain. It’s highly unlikely that Goldman is going to come out of this with anything more than a few bruises and some blows to its pride. People are not going to permanently stop doing business with them.  It does look bad now, and it is, but Goldman is not going out of business and the banking system is not going to seize up as it did after Lehman collapsed.

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August 11th, 2009 @ 10:32 pm by Matt "NewstraderFX" Carniol

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Fed heads like me will be parsing the FOMC statement on Wednesday for clues regarding the future of monetary policy, which naturally will affect the valuations of all asset classes including currencies, stocks, and commodities. The first thing that any Fed watcher does is to look for changes from the previous statement, so let’s break it down to the three main areas of interest.

Interest Rates

No one expects interest rates to change on Wednesday, but it will be important to see if the language regarding the need for “exceptionally low levels of the federal funds rate for an extended period” is retained. The odds are that it will be however, expect to see the dollar gain as traders in Fed Funds Futures price in a rate hike perhaps as soon as December if it isn’t. One of the world’s great Fed watchers, Bill Gross of PIMCO, is of the belief that the Fed won’t be making a move on rates until well into 2010, if then.


Because of the output gap, the difference between potential and actual GDP, the Fed is of the belief that “substantial resource slack is likely to dampen cost pressures,” and that “inflation will remain subdued for some time.”  (By “resource slack,” the FOMC is referring to the amount of workers who are unemployed).

Be aware that when the Fed talks about inflation what they really are most concerned about is the potential for a wage-price spiral as seen during the 1970’s. The reality is that there’s very little chance of seeing that occur anytime over the next several years. For one thing, there are much fewer unionized workers. Second, and even more important, there obviously is an oversupply of workers relative to the amount of jobs available which means there’s little pricing power among employees. Third, companies don’t need to hire more workers because contrary to what usually happens when companies eliminate jobs, productivity (worker output per hour) is rising (6.4% in Q2 on an annualized basis according to Tuesday’s report). Aside from that, the report also indicated that labor costs fell the most in eight years over the period.

Economic Growth

Most economists, including such luminaries as Paul Krugman and Nouriel Roubini, believe the economy has bottomed although in the case of Roubini the opinion is that the economy will remain in recession through the end of the year. The Fed itself was fairly sanguine about the prospects for economic growth in June, saying that “policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will contribute to a gradual resumption of sustainable economic growth in a context of price stability.” Nothing has really happened since June 24 to change that outlook given the improvements seen in the ISM’s, housing, Q2 GDP along with the July jobs report and unemployment rate, so expect to see a similar opinion expressed in Wednesday’s statement.

Putting these three together really indicates that a sweet spot exists for stocks, because the economy is set to improve while policy looks to remain expansionary as inflation remains low. The latter point is especially important because it means that in real terms (taking inflation into account), any percentage gains will be that much higher, i.e. that the purchasing power of the dollars you receive when you cash in your investments will not have eroded to an appreciable degree.

Those factors certainly have been great for stock investors; the S&P has gained nearly 12% since the FOMC met on June 24. The problem is that for forex traders, the concurrent movement in the dollar (short) against the euro, pound and A$ hasn’t been quite as pronounced during that period although those currencies did make significant moves against the yen (they have made significant gains on the USD overall since March). Also of note is that USD/JPY, which basically mirrored S&P movements for several years, hasn’t done anything of note since the March rally although it the yen does gain rather dependably on days when stocks retreat.

The Fed may also make a decision regarding whether to extend its $300B program to purchase Treasuries. If they choose not to continuing purchasing U.S. debt it could cause interest rates to rise, which will tend to put downward pressure on the dollar. Also, Congress wants the Fed to extend its program to purchase commercial mortgage backed securities for another year, so look for the FOMC to comment on that.

Commercial real estate is likely to present the biggest obstacle to economic growth over the medium term. There’s a crisis looming there because of the inability of property owners to refinance debt which is coming due. Rents and property values have fallen dramatically, which means that there will be less income available to service the debt and that banks will require any loans they do make to have lower loan to value ratios.  Property values are forecast to remain depressed which means that many owners are underwater on their mortgages, another recipe for rising foreclosure rates.

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July 30th, 2009 @ 1:33 pm by Matt "NewstraderFX" Carniol

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I’ve been thinking about this for a while and while I can’t say that I’ve read through every trading strategy, what I have found through my years of experience is that in order to make real and lasting profits you need to attune yourself to the Major Fundamental Events (MFE’s) that set the trends-and then get in when price is most advantageous.

When I refer to Major Fundamental Events I’m not just referring to the monthly reports, although those can be used along the way. I’m talking about something that can cause a radical shift, which I’ll explain.

One thing before we start though-these MFE’s may only happen a couple times per year, if that. That’s OK though, because these trades are going to yield 1000’s of pips. One trade may last for weeks or months.

Also, we’re not at the start of an MFE now, at least in my opinion.

As you might have guessed, an MFE can be (and usually is) initiated by the Fed although certain earth-shaking events (the Lehman bankruptcy for example) can certainly do the job. Sometimes several MFE’s can occur simultaneously which is great because those tend to build on each other, strengthening the trend.

The 2 keys for profiting from this are as follows:

1. You have to recognize when an MFE has occurred.

2. You have to understand how markets will be affected after the MFE has occurred and the correlations between the different asset classes (currencies, stocks, bonds and commodities).

The most recent MFE began on March 15, the day of Bernanke’s 60 Minutes interview in which he said the Fed was “electronically” printing money. Go to this page:…um=4&ct=title# and see the “The Chairman Part 1” video at about 8 minutes in.

It’s true that economists and commentators were talking about the Fed printing money before the interview because everyone was well aware that the Fed had already expanded its balance sheet (quantitative or credit easing = money creation).  But the Federal Reserve admitting it on national television was a whole different matter in my opinion. The dollar bear market began in earnest from there while stocks, commodities and Treasury yields rose.

In other words, Bernanke created a rally in risky assets because he convinced investors that the value of the so-called safe assets (the dollar and Treasuries) would depreciate.  What also was interesting about this MFE was that none of the so-called experts, including the financial press, picked up on it.

Then again, none of the so-called experts said anything about what would happen to the dollar after Lehman went bust either, including such luminaries as Jim Rogers who’s been a commodity bull forever (and who got crushed in the 2008 commodity collapse) as well as Peter Schiff who also lost his shirt because he didn’t recognize that a dollar-boosting flight to safety would occur after Lehman’s bankruptcy.

Why did Bernanke make the radical decision to allow himself to be interviewed on 60 Minutes? I think that it was because despite all of its previous balance sheet expansion, the Fed to that point had been totally unable to accomplish its goal of boosting stocks and creating some measure of inflation (making commodities more expensive) by weakening the dollar in order to counter the far more dangerous deflationary pressure of the financial crisis. The S&P had made a fresh low just one week before and had declined nearly 58%. No question they were concerned that all of the actions taken to that time could potentially fail, sending the global economy deep into a depression.

By the first week in June, the S&P had gained about 40% from the March low. The dollar had lost thousands of pips to the euro, pound and A$, oil was threatening $70 and yield on the benchmark 10 year Treasury was up near 4%. That created another set of problems for the Fed however, because of the detrimental effect that rising energy prices and interest rates naturally would have on consumer spending and housing (because of rising mortgage rates).

From that point, the Fed began a serious effort to talk up the risks of deflation (while talking down the risks of inflation) and from there, the markets basically went sideways. In other words, just as his efforts to convince investors that the dollar would depreciate helped boost markets, his deflationary concerns helped throw cold water on the rally he created with his printing-dollars comments.

Market correlations are pretty straightforward once you realize something:

When you trade spot forex, you’re trading pairs-GBP/USD for example. When you buy the pound you are simultaneously selling the dollar. When you’re trading currency futures, the contract is listed in euros or pounds or A$’s-there’s no “pair” in futures. However, despite that you’re still “selling” the dollar when for example you buy the euro contract because you are trading in dollars and your contract moves against the dollar.

It’s the same thing for any instrument which is priced in dollars no matter what the asset class is. So when for example you’re buying a stock, for all intents and purposes you are “selling” dollars-your bet is that your stock is going to appreciate against the dollar.

Think of it this way-if an asset class priced in dollars goes up, what does it go up against? The dollar of course. So when all of these asset classes are appreciating, it tends to put downward pressure on the dollar.

It’s the same for the S&P-the S&P is priced in dollars so for all intents and purposes if you are long the S&P you are short dollars.

So think of it this way:


Or just:


How about bonds (Treasuries)?

First, by convention, when people say bonds are up or down they are talking about price.

Second, bond prices and yields move in opposite directions for a very simple reason: If you buy a bond today for $1 that yields 2% and yields go up tomorrow, of course the bond you just bought is going to be worth less simply because it yields less.

Stocks and commodities are risky assets while Treasury bonds (and notes and bills) are “risk free.” They’re risk free because if held to maturity your principle and interest are guaranteed by the full faith and credit of the U.S. government. So when the market is “risk averse” (like it was after the Lehman collapse, another MFE)), stocks are sold and bonds are bought.

So in general, stocks and Treasuries are inversely correlated. We saw that after Lehman and we saw it happen again after Bernanke’s little interview.

It all comes down to investors appetite (or lack thereof) for risk, which obviously is heavily influenced by what I call Major Fundamental Events. “Risk aversion” places tremendous upward pressure on the dollar while the acceptance of risk has the exact opposite effect.

That’s why you want an MFE to occur-things can only move one way after one happens and when you recognize it early, you can absolutely make a killing.

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July 15th, 2009 @ 2:13 pm by Matt "NewstraderFX" Carniol

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There are  times when deciding not to trade is the best trade you can make and right now appears to be one of those times. I know, I know, there are a certain number of you guys out there who claim to be very nimble when the market is moving sideways (as it has been over the past 6 weeks or so) but for the vast majority of traders (me included), sideways movement is just too hard to deal with. The problem is that staying on the sidelines is difficult for many to do because they develop a syndrome I call ‘trader’s finger,’ which means your finger gets itchy to push the buy or sell button.

It’s very important to resist the urge to trade just for trading’s sake or because you feel you have to “do something” like earn a certain amount of pips each week.  I haven’t taken a trade since I saw the markets moving sideways weeks ago and I’m feeling better about my decision every day.

I can’t feel comfortable in a trade if I don’t have a clear idea of where the market will be in a few weeks or months and what’s even more important is that I’ve avoided putting myself through the mental anguish of making bad trading decisions and losing money, which I hate to do and which I know is inevitable when markets get choppy.

Basically, I have the same goal in trading that I have when I get in my car, which is to not get into an accident. The way I look at it, as long as I avoid crashing, the odds are a lot higher that I’ll eventually get to my destination.

What’s interesting is that over the past few weeks I’ve seen so many “professional” opinions on Bloomberg or wherever turn out to be totally wrong. Even good ‘ole Marc Faber, one of my favorite people, appears to have gotten things incorrect when he said 2 weeks again that the dollar was set to gain over the next two months or so. Since then, he might be ahead a little bit but what’s more likely is that all the back and forth movement has caused him a lot of aggravation.

Now, Marc Faber is probably one of the world’s great traders but even he looked to be suffering from trader’s finger during his last Bloomberg interview. Back in March when markets were really crashing, he seemed to go out of his way to say that stocks were set to rally-and that turned out to be one of the year’s great calls. He didn’t have quite the same confidence 2 weeks ago however-in fact, it looked more like he was saying something in order to justify being interviewed. After all, it’s hard to get in front of the cameras and advise people to stay on the sidelines!

But when you think about it, why should that be so? I know that I put just as much effort into making a judgment not to trade as I did when I called a 1000 pip short trade on the pound last summer (my “Four Figure Trade” article), or when I went long on GBP/JPY and AUD/JPY in May (see twitter) and made about 900 pips over 4 days, or when I made about 400% on some A$ options (twitter again) between April and May.

Now, what am I looking for that could start a trend? Simple really if you use some logic. Let me ask you a question.

Is it not true that all of the fiscal and monetary policies have been put in place because the economy is in an emergency situation? Of course it is. So then doesn’t it follow that if and when the signs are given that these extraordinary policies can begin to be withdrawn it indicates that conditions are improving and will continue to do so? I would think so. In fact, I was hoping against hope that the G8 might signal just that last week but unfortunately, they did just the opposite when they said that now is not the time to begin withdrawing liquidity. Apparently, they weren’t in a “green shoots’ mood in Italy (although we did learn that Obama has a preference for satin-clad booty…lol).

Likewise, when economists like Paul Krugman are talking about the need for a second stimulus, that doesn’t exactly instill much confidence in me that the economy is set to improve in a meaningful way any time soon. And when I hear Nouriel Roubini talking about unemployment going to 11%, an anemic recovery and the chance of a double dip recession along with housing prices falling another 20%, somehow it just doesn’t put me in the mood to buy and hold for the long term.

In fact, I think that professor Roubini helped put the kibosh on the spring rally, so what we need to see is some data proving his opinions on the economy are wrong (a tall order, I know). So, it would be great to see new unemployment claims fall below 500K per week and for the number of continuing claims to stop making fresh records with each report. Stabilization of housing prices as measured by the S&P/Case-Schiller Home Price Index would be helpful. The ISM’s above 50 would be very significant.

Obviously it’s going to take some time to see these data points materialize but what I’m also going to be looking for are any surprises like Bernanke announcing the Fed was “electronically” printing dollars. Listening to what’s being said at Jackson Hole next month could prove to be valuable.

Also, check the Fed’s H.4.1 report each week, specifically the line regarding the amount of deposits commercial banks are holding at the Fed banks under liabilities. In normal times there’s about $14B or so on deposit being kept there because of reserve requirements but at the height of the crisis banks were hoarding nearly $1T .

All that money sitting at the Fed means  the banks aren’t lending (or doing very little lending). We need to see that trend towards normalization because as the amount on deposit decreases, the velocity of money increases as banks make more and more loans.  The amount kept on deposit decreased to about $625B just before stocks took in March but increased to about $900B during the stress tests, so I would like to see it get at least to that level (and decrease further) again.

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July 10th, 2009 @ 3:29 am by Matt "NewstraderFX" Carniol

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Fed Chairman Bernanke’s little stock rally, which was initiated when he announced on 60 Minutes that the Fed was “electronically’ printing dollars, has apparently come to an end (at least for now). As a currency trader and market observer, you’ll want to know why and the reason has to do with the most famous currency pair you’ve never heard of. Ready? It’s called…


That the dollar moves inversely to riskier assets like stocks (and commodities as well) isn’t a matter of some kind of mystical correlation that can somehow “break.” The key to knowing this is to understand what really is happening when stocks (or commodities) appreciate, which is easy to see once you accept the existence of S&P/USD.

Look at it this way; when stocks go up, what are they going up against? The dollar of course. The same for goes for commodities because those are priced in dollars all over the world. Well, if these riskier assets have gone up, isn’t it than also true to say the dollar has depreciated. Absolutely. So when the market is buying risk, the dollar will tend to fall as a matter of due course.

What’s really interesting is that in the rare instance (like now) when the Fed is actively trying to devalue the dollar (because the economy is faced was the more serious threat of deflation), the Fed can create a stock rally just as Bernanke intended to do by admitting to the electronic printing of dollars on national television. Why? Because if you are convinced the dollar is going to depreciate, doesn’t that also mean that anything you can buy with it is going to be more expensive? Of course. And the convinced you become that the prices of liquid assets (like stocks and commodities) are going to rise, the more inclined you will be to buy them.

So what’s really happening in the current environment is that the Fed, through its actions and comments on the dollar (and on deflation/inflation which is the same thing) is pushing the market for riskier asset classes up and down. Let’s look at some recent action.

Bernanke’s rally pretty much fizzled out in the middle of May, but it got a temporary boost (about 4%) in the week following the last meeting on June 24 when members removed the deflationary concerns which had appeared in the April 29th statement. But then something interesting happened.

On June 30, San Francisco Federal Reserve Bank President Janet Yellen expressed some deep concerns about deflation. “I’ll put my cards on the table right away,” she said. “I think the predominant risk is that inflation will be too low, not too high, over the next several years.”

Now, remember what we said; if the market is convinced the Fed is depreciating (creating inflation), riskier assets are going to be bought because inflation means their prices are going to rise (at least nominally). No one wants to hold cash if the potential for inflation is on the horizon, because cash is guaranteed to lose value in an inflationary environment.

Conversely, if inflation really isn’t a threat and the possibility of deflation exists, there’s no reason whatsoever to buy riskier assets. Afterall, your cash is guaranteed to increase in value in a deflationary environment because prices are going down!

In fact, in a deflationary environment you make more money simply by being a “lender” (keeping for money in the bank or in Treasuries). A little arithmetic will show you how this works.

Your real (inflation adjusted) rate of interest is equal to the nominal rate (what the bank is paying you) minus the rate of inflation or R = N – i.

Let’s say inflation is 3% and your bank is paying you a nominal 4% on your deposit. Your real (R) interest rate is the Nominal (N) rate minus inflation or R = 4% – 3% which equals 1%. In real terms you’ve only earned 1% on the money you have in the bank

Now, let’s say there’s deflation (negative inflation) of -2% for the year and your bank is paying you a nominal rate of 3% on your deposit. What’s the real rate of interest you’ve earned?

R = N – I or R = 3 – (-2) = 5%. In real terms, you’ve earned 5% on your deposit!

Now, if I’m guaranteed to earn a risk-free return of say 5%, and I think prices are going down, why in the world would I buy a riskier asset? In the hope that someday its price might go up? Hope is a bad rational for making a trade.

So, Ms. Yellen, with her deflationary concerns, helped kill the rally. She wasn’t alone however; the Fed, with its expert manipulation of the media via the pundits seen all over Bloomberg, started so make plenty of deflationary noises around the middle of May.

As a trader, there are times when you can put this to very good use for longer term trends (which really is where the money is made). If the Fed does start talking about inflation and making noises like it might raise interest rates, do yourself a favor and sell the dollar as you buy riskier assets like stocks and commodities.  But if they continue to talk about the risks of deflation, there’s little reason to sell the dollar or to buy riskier assets. Buy the dollar at that point because it will be in demand.

BTW, Thursday’s weak market action off the surprisingly good unemployment numbers, along with the subsequent decline of S&P futures overnight, bodes very poorly for stocks and very good for the dollar. I can hardly think of a more bearish sign for stocks than the market failing to rally on good news. Afterall, it the market can’t rise when the news is good…

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