Tuesday, March 13, 2007

Equity Index Update

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Brad Sullivan

The index markets are called to open at or near their respective low trading zones over the past 3 trading sessions. A combination of the sub-prime lending blowup, a weak retail sales report and – most importantly – whispers of INFLATION out of the BOJ last night has produced another big leg of unwinding in the YEN carry trade. On the flip side, GS produced blow out numbers on its quarterly earnings report released this morning…keep a close eye on this stock as it has been our proxy over the last several months.

One of the concerns behind yesterday’s small move higher was the complete lack of volume. It seemed as though it was a holiday trade yesterday as players were on the sidelines…this morning it appears players have awoken from their collective slumber and appear ready to monitor their collective portfolio risk. One key aspect of the trade that few have discussed is the expiration week that we are currently 1/5th of the way through.

Since our massive selling 2 weeks ago today, the indices have been able to hold at higher, but rather uninspired levels. There is little question that this move has been propped by large demand amongst the funds as they try and protect their favorite trade of selling options. If there were to be an unwinding this week of the YEN/DOLLAR it would have dramatic ramifications on the index market. Players are holding their breadth that this does not turn out to be the case, but, if they must let their positioning go due to the risk department LOOK OUT. Certainly the odds of such an event are outlier by definition. However, when looking at such events in a historical context there is always a trigger. The index markets are faced with a POTENTIAL trigger of a YEN carry unwinding that forces index positions out of portfolios creating a vacuum of selling. If this scenario plays out – I would suspect the SPX would fall roughly -4% by Friday’s close from current levels. Keep in mind that the probability of such a happening is small – perhaps as little as 5% to 10% so any plays on this theory should be done with ample speculative cash.

Finally, keep a close eye on GS…a reversal below 200 would put the overall market in jeopardy.

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