As fears of sovereign debt problems mount following the Dubai World default and the downgrade of Greece’s credit rating, the Dollar looks to be in the process of a trend change. Looking at the US Dollar ETF, we can see plenty of volume coming in as price breaks up and above a six month trendline.

Looking at the EUR/USD, we can see a similar trend break. While the chart argues for further downside over the longer term, it is short-term oversold and sitting just above the 200 day moving average.

During this period of Dollar strength and debt worries, equities have been remarkably resilient overall. SPY remains above a rising 50 day moving average, and near its yearly high.

At DailyFX, John Kicklighter comments that risk appetite has yet to break despite the Dollar’s rally.

All that is needed to tip risk trends into a tailspin is a definitive catalyst. We have plenty of potential threats to global, financial stability; but optimism or greed for greater returns has helped the markets weather most of tremors. This likely means that we need a market-based event. A particularly large withdrawal of capital from the speculative arena or the seizure of a critical node in the broader financial market could certainly spark a panic that leads to a cascade selling event. Ironically enough, the best opportunity to force the Dow below 10,250 or pitch the carry interest into a bleak bear trend is during the low liquidity-period that is approaching. While there is not enough market depth to maintain and develop a reversal; the low liquidity means it will be easier to unbalance sentiment. Therefore, we need only keep a vigilance on the already incubating fundamental troubles that have developed over the past few months and be ready for a new shock to catalyze price action itself. Among the key trends to watch, the threat of defaults on a corporate and national level is particularly troublesome. Not long ago, the IMF warned that the world’s banks have only accounted for half of the losses they will ultimately suffer from following the worst financial crisis since the Great Depression. Now, we are seeing downgrades on sovereign credit ratings that is further taxing an already fragile market that is now seeing some of its ‘safe’ assets degrading. Investors could weather this if the government maintained its support of the global economy and markets; but this safety net is already being rolled in. As stimulus and emergency aid is rolled back, the markets will increasingly have to support its own weight. And, considering how high valuations have run and the lack of true fundamentals to support recent heights; the outlook is fragile indeed.

Aside from the Dollar, financial stocks are also signaling that risk trends may be changing. The past three days has seen Citigroup (C) break down on heavy volume.

Europe’s troubles are weighing on the continent’s banks.

- Lloyd’s Banking Group (LYG)

- Barclays

- Credit Suisse (CS)

And some more US banks with bearish charts:

- Zions Bancorporation (ZION)

- State Street Corp. (STT)

- Principal Financial Group (PFG)

Given high equity valuations and the likelihood of additional crisis events in the debt markets, odds would favor a bearish orientation for stocks.

Last night I discussed the possibility of a Dollar bottom, and implications for the equity markets. This morning the EUR/USD is breaking a major trendline. In early trading, European stocks are lower, as is gold. Here is the EUR/USD chart:

The 200 day moving average seems like a logical target for now. I had an alert which woke me up this morning, and I entered a short position, which I plan to hold for a swing trade.

The AUD/USD currency pair also looks like it may have topped. I entered a smaller short position in this one:

Given the Dollar action, the odds are not good for being long equities here. I posted some charts last night, but doubt I will be touching any of them today.

Over at Zero Hedge, John Bougearel discusses last week’s employment report, and its impact on gold, currencies, and the carry trade:

A client emailed me back to say “I thought the Fed already has stated that it plans to keep interest rates low throughout 2010.”

Yes, I replied, that is the Fed’s basic monetary policy for the next 12 months. And most market participants believe that is a credible statement. So, why should market participants in gold and currency carry trades have been nervous at all? Simply because the economic data pointing to the jobs market stabilizing may not entirely support all of the Fed’s economic policies. It’s not just Fed’s monetary policy that is accommodative. It’s also that trillion dollars of excess liquidity that they have injected into the insolvent big banks. On that score, the Fed has been much more stringent. They promise us that they have the tools to remove the excess liquidity through “reverse repos” and possibly by issuing their own debt, if push come to shove. Moreover, they are telling market participants that they will remove that excess liquidity when the day comes to remove that liquidity becomes self-evident. The idea is a strong recovery will require a shift in Fed policy to remove that excess liquidity sooner than later. And just last week, the Fed was “testing” its ability to do reverse repos with primary dealers. This is an indication that they might be inclined to suck some of that liquidity out of the big banks.

So, the huge selloff might have been sparked by big banks worrying that their might be a little less liquidity to play with in the not too distant future. Now here is where we must judge and question the Fed’s credibility and resolve to remove the excess liquidity on the balance sheets of the big banks. Because the Fed has also reassured us that they would provide as much liquidity to the zombie banks as required to keep them zombified. The stabilization of the jobs report drives a wedge between the two Fed promises to provide as much liquidity to the big banks as required, but also to remove that liquidity quickly and efficiently when conditions warrant.

In short, a stabilization in the jobs market does nothing to improve the balance sheets of zombie banks. An improvement in the big bank balance sheets is the prerequisite which would allow the Fed to mop up the excess liquidity, not am improvement in the jobs market. So, in short, the Gold market has probably overreacted a bit, and may continue to trade lower into the next jobs report. When market participants are reassured that the Fed is in a box and that the excess liquidity must stay in the system for the foreseeable future, gold prices will resume its trend higher and currency carry trades will be put back on.

Going into Monday’s session, much attention will be focused on the Dollar. On Friday, the Dollar index rallied nearly 1.5% on very heavy volume following a much better-than-expected employment report. Looking at the UUP daily chart, we can see increased trading volume since late October, and a potential double bottom.

The EUR/USD currency pair remains in an ascending channel, but if very close to violating the lower trendline.

At DailyFX, John Kicklighter suggests that risk appetite is on the verge of collapse:

The scenario for a market-founded correction isn’t a complicated one. As funds have been invested back into the capital markets at near the same pace that they were withdrawn; the benchmarks have reported record-breaking advances. However, the recapitalizing of the financial system comes with a number of drawbacks. One indisputable fact is that total global wealth has been severely reduced by the 2007-2008 financial crisis and economic recession. A more elemental issue is sentiment as it relates to true fundamentals. Investors have put their capital back into a market that produces very low levels of natural return; and rates of return are not expected to significantly rise in the near future. This means much of the influx to this point has been founded on speculative returns through capital gains. Recovering from the losses of last year, money managers would likely prefer booking some of their profits for the year, rather than hold out through a correction that could ultimately kill the abnormally bullish pace that has been enjoyed to this point. Another concern that is gaining more traction in recent months is the withdrawal of government support. Trillions of dollars worth of guarantees, bail outs and toxic asset purchases have been spent to prevent a financial collapse. Now that it looks like the markets are back on an even keel, the world’s governments will look to reign in this stimulus to work down deficits and further stabilize the private sector. We can already see this take place with the ECB ending its stimulus injections, the Fed testing repos to drain cash and China looking for ways to curb lending. However, this will be an extremely delicate procedure as an exit that is too early can spark another panic; while staying too long can fix to deflation or hyper inflation. It is now a matter of ‘when’ not ‘if’ sentiment will buckle.

Looking at the SPY chart, we can see price has failed to close above the trading range that started in mid-November. It is worth noting that the market has confounded the bears time and again since March. Still, odds will not favor the bulls until we can get a close above the 112.00 area.

Looking at the monthly chart, we can see price approaching resistance in the form of the 200 period moving average.

First thing tomorrow morning I will be checking Dollar activity in Asian and European trading. If we see Dollar strength overnight, expect a rocky session for US equities.

We could simply see the opposite, of course. I’m not ready to commit much to the short side yet, and am still finding some charts that look good for long trades. I am not likely to hold much overnight in this environment, but here are some charts that might make significant moves if the market resumes its rally.

- REXX

- AIXG

- VISN

- CATM

- ECPG

- YONG

- VMED

- DEER

Friday saw some crazy trading, as investors reacted to a surprisingly good employment number. Price gapped up to start the day, proceeded to fall sharply, before gaining traction late in the day to close slightly positive on very heavy volume. The dollar also saw a strong rally, as traders considered the possibility that a stronger economy may result in higher interest rates. Here’s a look at the 2 minute chart of SPY, showing two days of trading:

Monday will be a very important day, as traders take the weekend to consider some confusing crosscurrents. We are also in the midst of the holiday shopping season, one week after Black Friday. Certainly the improving employment situation is good news for retailers. However, it is instructive to look at the charts of retailers who rely heavily on the Christmas season.

First, let’s take a look at the retail and consumer ETFs. RTH gapped higher at the open today, and then actually closed negative on increasing volume. This is a short-term bearish signal, although price is still trading in a rising trend above the 50 day moving average. This is not a place to buy RTH, but nor would I get overly bearish unless it breaches the 89.00 level.

XLY, the consumer discretionary ETF, fared better, closing positive on increased volume. Still, I wouldn’t call the action today particularly bullish as price failed to make a new high despite the positive news, and would wait to see how things move on Monday.

Over at TradeKing, bigdog comments that Black Friday sales were sluggish, and Cyber Monday sales were much better. The charts are supporting this evaluation, as stocks like BBY and AMZN look relatively strong.

- BBY recently broke above a 7 month trading range, and is trending higher.

- AMZN reported blowout numbers for the last quarter. Price appears to be in the process of pulling back after a strong run. I would prefer to see a base form before starting a position in this stock.

Looking at some other retailers, we see a mixed picture. Macy’s is one of my favorite short setups, as I’ve mentioned in a few prior posts. Price recently broke down from a head and shoulders pattern with high volume. This is still a good entry on the short side.

- GPS held up well today, but has been on my watchlist short. A break below 21.12 would indicate lower prices going forward.

- AAPL also reported some great numbers for last quarter. However, two of the last three days have seen selling on heavy volume, with price breaking below the 50 day moving average today. I think this is a great company, but it looks to be going lower from here.

Video games appear to be out of favor with investors. TTWO lowered outlook and received a 29% haircut today.

ATVI also moved lower in sympathy, but the chart wasn’t looking great before today’s news.

- Retailer GME also looks ill.

At any rate, now is a good time to wait and watch. Some select retailers may be good buys going forward, but after today it is prudent to wait for pullbacks.

Stocks sold off late in the day today in advance of tomorrow morning’s employment number. Odds favor the bears going into tomorrow, unless something particularly surprising and positive comes out of the employment report. Looking at the SPY 60 minute chart, we can see that price has failed to close above the trading range of the past few weeks, and today started heading back down.

The longer term look is still essentially bullish, with price trading above the rising 50 day moving average.

Here are some of my current short positions, followed by some others on watch for tomorrow:

- M

- HOT

- MCO

- FDML

- FISV

On watch

- NFX

- JNY

- JPM

- PACW

- WFC

Here are some more long setups for today:

- EPIC

- ECPG

- VISN

- NUAN

- NEU

After a brief flurry of selling late last week, world market appear to be shrugging off events in Dubai. Nonetheless, investors should take time to consider the significance of Dubai World’s debt default. The global economic crisis is, at its roots, a story of overleveraging. While the Dubai debt is not of a scale to cause systemic risk, it should remind us that the world economy is still dangerously overleveraged. Furthermore, new questions arise related to sovereign debt. This morning, Nouriel Roubini sent out a useful summary of the situation:

Last week, state-owned Dubai World requested a six month standstill on its debts, calling into question the emirate’s ability and more importantly willingness to service the debt of its state-owned enterprises. While the debt in question, including a US$3.5 billion bond issued by a property development subsidiary, was not sovereign-guaranteed, investors had treated it as such, relying on the fact that the size of Dubai World and the profile of the underlying projects would imply a government rescue. Uncertainty was heightened by illiquidity and poor price action from the holiday period while the lack of information and communication at the time of the request added to concerns about the complete scale of Dubai’s implicit and explicit obligations—with on and off balance sheet debts by some estimates as high as $200 billion, or over 400% of GDP. Despite capital support that makes an outright default of Dubai World’s debt unlikely, the ongoing restructuring implies that the creditors will take a share of the pain for the most distressed assets in the holding company’s portfolio. The Dubai property development model in particular needs to be reassessed in a lower-leverage world.

At the heart of the saga is a clarification that investors shouldn’t assume implicit government support. Credit ratings for Dubai-owned companies now reflect this lesson, based on a fundamental credit outlook, not an implicit government backstop. Dubai World’s request for a standstill follows months of the emirate reassuring creditors and issuing over US$15 billion in sovereign debt. The debt standstill suggests the emirate had run out of options for a preemptive comprehensive bail-out from the well-resourced region. Apparently, things had to get worse before they got better. Or rather the severity of the situation had to be impressed on bond holders. Although the risk from Dubai is not systemically important on a global level, it is significant on a UAE and GCC level, underscoring the central bank’s response to support domestic financial institutions. Beyond the UAE, the reassessment of government support could draw further attention to other countries where state support is murkier, with obligors pricing in the real likelihood of support.

…Lessons for the global economy and financial markets are mixed. Firstly, the Dubai debacle reminded investors that all is not yet well in the global financial system. Although exposures to Dubai World were relatively diffuse and containable, despite some concentrations in UK and UAE banks, they are a reminder of the remaining losses stemming from the credit boom, some of which have been obscured by the removal of mark-to-market accounting. Finally, the episode underscores the fact that despite a liquidity glut, some countries and companies will find it difficult to access credit. Not all countries have even the prospect of even partial support from a richer neighbor.

In this video, Marc Faber discusses the broader implications of Dubai. Faber has been giving warnings on future sovereign debt defaults for quite some time, and considers the US to be on the road to bankruptcy. Faber discusses the conventional wisdom of the markets, that certain debts have implicit government guarantees, and also that governments can step in to print cash or create stimulus programs as circumstances require. Faber’s conclusion, correct in my view, is that such programs are not really solutions, but rather ways to delay the consequences of overleveraging.

One of the central difficulties in predicting the course of the crisis relates to assessing the amount of bad debt in the system, and who holds it. Moreover, good debt today can always turn into bad debt tomorrow, especially when the default of Entity A results in the failure of Entity B. This was the lesson of the Lehman Brothers failure, which was followed soon afterward by the failure of AIG, which was followed by a massive government bailout. In this and other cases, the government has simply moved the bad debt from Wall Street to the US taxpayer, for payment some time in the future.

Questions remain, however, as to where we stand in this process. The optimistic scenario, the one the markets seem to be embracing, is that we are largely past the crisis point. Although we may have isolated cases of large-scale default, the systemic risk has been resolved, and world governments have the resources to transition us from crisis to sustained economic growth.

The pessimistic scenario holds that the system is still awash in bad debt, companies and governments have simply done a good job of moving to new places and otherwise hiding it for the time being. My opinion is closer to the latter. However, the scenario is likely to play out for quite a few years, and the Dubai default does not appear to be the catalyst for a market crash.

Investors should put the maximum focus on finding companies with strong financial fundamentals, in markets that are most likely to withstand adversity. Companies with significant debt or negative earnings should be avoided. It is noteworthy that many companies in the latter category are up over 1000% since March. As I’ve mentioned, I think the current rally is losing steam, and we are long overdue for a major correction. For long-term investors, this is a place to be highly selective, or to wait for better opportunities at lower price points.

Looking at 60 minute index charts, we can see that the bulls appear to be losing momentum. First, let’s take a look at QQQQ. Price last made a new closing high in mid-November, and has been making lower highs and lower lows since then. A move over 44.40 would at least end that mini-trend, and give the bulls some confidence.

SPY is in reasonably good shape, but has been range-bound since mid-November. Today price made an attempt at new highs, but then started moving lower in the last hour of trading. A move over the November high would trigger buying. However, price is currently near the top of the range, so best to wait and watch for clearer signals.

The small caps continue to be relatively weak. IWM formed a double-top in October, and has a bearish orientation. When we look at the three index charts together, the odds would appear to favor the bears going into Wednesday.

Even so, there are some decent-looking charts to be found. I will be watching SPY particularly closely, along with action in the Dollar. If the bulls can break us up out of SPY’s trading range, here are a few charts I will be watching (also check out Sunday’s post for more setups). I am already long GXDX, NEWN, DRWI, MSPD, CBAK, and NANO, and short M, HTZ, HOT, FDML, and MCO.

- NANO

- MSPD

- GNK

- DRWI

- GXDX

- NEWN

-

-YONG

On the short side, my favorite chart is M, which broke down out of a head and shoulders pattern on Monday, with volume.

An orderly pullback here would set up a lot of charts for the long side, so overall this is a good place to hold a large cash position.