It was going so well. Large-cap stocks were pushing the Dow Jones industrial average and the S&P 500 toward record highs. Stocks like Caterpillar (CAT) were overcoming weakness in the big tech and biotech momentum favorites that pushed the market higher throughout 2013.
And while skeptics like me pointed to warning signs -- such as narrowing buying interest as fewer stocks participated in the uptrend -- investors were content to ignore them and push diminished cash balances and bullish sentiment measures to new extremes.
The fundamentals didn't justify the move, as things like corporate earnings, valuations and the economic data all pointed to caution. But what did was the dominance of currency carry trades and the hope of new stimulus measures out of Japan, China, and Europe. This explains why stocks, especially emerging market issues, have been melting up to such an extent over the last few weeks.
But today, it's all unraveling as those currency carry trades -- which I recently discussed here -- move against traders. (We also had the March jobs report release this morning that slightly missed expectations.)
The catalyst were rumors out of the German press early this morning that the European Central Bank was modeling the market impact of a 1 trillion euro bond-buying stimulus program. They wanted to see if it would reverse the slide in inflation and credit growth that is plaguing Europe at the moment.
While on the surface this would appear to be good news for the bulls (more cheap money!), it pinched yen carry-trade positions that relied on a relatively more aggressive Bank of Japan and a more stringent ECB. That, in turn, would result in a steady drop in the value of the Japanese yen against the euro.
The possible shift in the relative policy stances of these two major central banks upset these pair trades, forcing hedge-fund types to scramble to close their positions by selling stocks and other risky assets, selling euros and buying yen. That worsened the moves for others with the same exposure -- selling begat more selling.
Another factor has been the rise of damaging food and fuel price inflation in Japan, which is hurting consumer confidence and is a nasty side effect of the currency devaluation strategy being used -- as a last gasp effort -- by policymakers in Tokyo trying to reverse the country's decades long stagnation. That lessens the odds that the Bank of Japan will look to weaken the yen with more cheap money stimulus in the near term.
A similar dynamic with yen carry trades played out in the market's rush to the last bull market peak in 2007. So we could be seeing history repeating itself here.
Some significant technical support is at risk. The Nasdaq 100 hasn't closed below its 20-week moving average since late 2012. With Friday's decline, it looks like that winning streak -- which spanned three years -- is about to be broken.
Plus, we cannot discount the hit to sentiment coming from this week's revelations surrounding high-frequency trading and potential for rigged markets -- which I discussed here.
I continue to recommend investors embrace a more defensive positioning, raising cash were possible and looking at safe haven assets like U.S. Treasury bonds and precious metals. Examples include the Direxion 3x Treasury Bond Bull (TMF), a leveraged play on T-bonds, which is up more than 3 percent since I added it to my Edge Letter Sample Portfolio.
For the more aggressive, I've recommended put option positions against big tech stocks like Facebook (FB). The April $65 puts added on March 21 are up nearly 350 percent -- a sign that for the nimble, market shakeouts like we're seeing now can be quite profitable.
Disclosure: Anthony has recommended TMF and FB puts to his clients.