Why big market bounces are becoming the norm

Get out the Dramamine, because Wall Street's ups-and-downs are getting serious now. Since the wipeout in big tech and biotech stocks knocked the Nasdaq Composite below the 4,000 level late last week, the market has been doing nothing but churning. It's enough to induce a little motion sickness.

Tuesday morning, an initial pop higher was heavily sold into the early afternoon on reports of bloodshed out of Ukraine after Kiev sent military units to remove, by force, armed pro-Russian protesters (accompanied, according to Ukrainian officials, by Russian airborne troops) from an airfield in the country's east.

The result was a test of the 200-day moving averages for both the Nasdaq and the Russell 2000. This is a big deal because this key medium-term trendline -- which both professionals and retail traders alike monitor -- hasn't come under threat by these two indices since late 2012. A violation of this level, if sustained, would suggest that the three-year-old uptrend is in its terminal phase.

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As if on cue, as soon as the Nasdaq hit this level, buyers rushed in to protect it. The index gracefully pirouetted off the line in the sand at 3,950. The momentum tech favorites that have been so hammered lately launched higher as if powered by rocket fuel: Twitter (TWTR) gained 11.4 percent for its best one-day gain since it IPO'd back in November.

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The catalyst for the turnaround, ironically, was a story in the Japanese press that the Tokyo government is planning on lowering its assessment of Japan's economy in its monthly report to be released in two days. This would be the first such downgrade since November 2012.

Ostensibly, this is coming in response to the harrowing drop in Japanese retail sales following the imposition of the first sales tax hike since the late 1990s earlier this month (from five percent to eight percent). Other drags include higher food and fuel inflation, stagnant wages and a drop in business confidence.

The bulls interpreted this as meaning more cheap-money stimulus would soon start flowing out of the Bank of Japan -- weakening the yen further.

Why does this matter? As I discussed last month, a weaker yen has been one of the main supports for this market over the last two years due to what's known as the "yen carry trade." That's a trading strategy where people sell the yen short and use the proceeds to buy stocks and bonds in the U.S., Europe and elsewhere.

As long as the yen is weakening against the U.S. dollar and the euro, the trade works.

Much of the reason stocks have been so weak this month has been the strengthening in the yen, which has pinched yen carry trade positions and resulted in forced selling of popular stocks -- such as Twitter -- in order to close the trades. This has been caused in part by the combination of higher inflation in Japan (which limits the efficacy of any new monetary stimulus efforts) as well as hints that the Europeans are moving towards unleashing new stimulus measures of their own.

So what does this all mean for the average investor?

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We could be on the cusp of a short-term rebound off these 200-day support lines. Indeed, I recommended my clients book profits today in put option positions against those big tech stocks that have weakened so much. Examples include a 338 percent gain in the April $350 puts against Amazon (AMZN), which we added to the Edge Pro portfolio on March 26.

But I don't think any bounce will be long-lived. The volatility, unfortunately, looks like it's here to stay this year with major hurdles including the midterm congressional elections, end of the Federal Reserve's bond-buying stimulus and the Ukrainian tensions all on the horizon -- and all unresolved.

Plus, Japan is looking like it's tipping into a dangerous bout of "stagflation" -- higher inflation causing economic stagnation as consumers pull back. And we're seeing early signs of a possible currency war with China and Europe both looking to weaken their currencies to boost their economies. That means the "yen will stay weak" meme behind the yen carry trade is looking more and more vulnerable.

So, we could soon see a return of that forced selling pressure that has pushed stocks down so hard over the last few weeks. Keep the seasick pills handy.

Anthony Mirhaydari is founder of the Edge and Edge Pro investment advisory newsletters, as well as Mirhaydari Capital Management, a registered investment advisory firm.

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