Thursday, May 28, 2009

It Doesn't Want to Go Lower

Did you really think that the Fed would allow today’s Treasury Auction to fail?

The money they threw at the market was pretty remarkable. The auction was for $26 billion in 7-year Treasuries and the rumor is that the Fed bought $10 billion of it! We’ll know the facts when the Fed displays today’s purchases tomorrow.

Here is a chart with the 20-year US Treasury ETF (TLT), the S&P 500 ETF (SPY) and the 30-year US Treasury Yield x 10 ($TYX).

You can see that the TLT gapped higher overnight by about 1.2%, driving the S&P to open up by about 0.8%. Bonds got sold off hard over the first few hours of trading and then at 10am, the auction was a “success” so yields collapsed and the prices of stocks and bonds were vertical.

This is pretty much the Line of Death for bond prices. A break from here and the Dollar is toast. Everybody knows this, so the full court press was thrown at the markets after yesterday’s Treasury Auction disaster.

Yesterday Moody’s affirmed the US Credit Rating at AAA and this morning Standard & Poor’s did the same.

Do you think the Fed made some phone calls last night? Probably to Asia, that went something like this –

Fed – “Hello, Central Bank of China? Yes, this is Ben Bernanke and I just want to tell you that you had better start buying our bonds or we are going to tank the Dollar ASAP.”

Central Bank of China – “(grumble) we’ll buy some more of your worthless paper, but you have to hurry up and start the securitization machine again soon so we can sell you guys some more stuff you don’t need, on credit?”

When, not if Interest Rates break out, stocks are toast. Until that time comes, the Fed will keep printing money and risky assets will move as the button pushers rule.

Potential Breakouts
It seems that everybody is expecting a pullback. Isn’t that the ideal time to institute a short squeeze? The markets continue to test the lows of the recent trading range. Each day that passes, the markets work off their Short Term overbought condition and are another day closer to their next big move – up or down.

Here are the charts. I either own these or have stops in place to buy these.

QQQQ (NASDAQ 100 ETF) held the 200-day and is trying to break out of this 24-day consolidation.

IWV (S&P 500 Growth)
I have been telling you since things bottomed that Growth is outperforming Value. IVW is stuck at the 200-day, while IVE (S&P 500 Value) is well below the 200-day. You want to own strength, because Big Money is always selling weakness to buy strength - and in this market, that maxim is magnified with Leverage.

Energy (XLE) is leading, so I am interested if / when XLE breaks out above the 200-day and massive resistance at $52.5.

Shanda (SNDA) is a Chinese Internet company that broke out and rallied hard and then sat around for over a month. It has now broken out of that consolidation and is consolidating yet again. This chart is about as bullish as they come. My goal has been to be patient enough to let the leaders pause and give me a good risk / reward buy point.

All I can do is look for where the Big Boys are buying and go along for the ride, with Stops in place.

IBM is within $3 of where it was at the beginning of April. Let’s see if the Big Boys show up to drive it through resistance.

Amazon (AMZN) has been leading for some time. It has pulled back into the 50-day. The next big move wins.

The market doesn’t seem capable of moving higher or lower without Financials (KBE). KBE has been sitting around for 4 days. It should move quickly very soon. KBE was at $18.10 a few minutes before the close and then ramped to close at $18.30. It is currently at $18.48 in the aftermarket. My stop is to buy at $18.35. I will be really pissed if they gap it up at the open tomorrow and then sell it off hard, trapping the stop buys before taking it down. Such is the market I have to live with…

AEM and GGN are both Gold related and testing significant resistance. I’d really like to be in these if they break out.

Have Already Broken Out
STLD and MT are steel companies that have broken out of long bases. These will either end up looking like POT or MON. But again, I have to take shots when they are there and put stops in place to deal with the ones that fail.

AU is a gold stock that broke out today.

Agriculture (DBA) has been the leading area of commodities. I would love to see it pull back into the $27 range and give me a better entry point. But it may just run for the roses and force my hand.

Major Bottom?
UNG is the Natural Gas ETF. It has crashed since July 2008, and only ticked above the 50-day for a few days in early May. The pattern looks like a double bottom.

Look at the incredible volume today and the last few weeks. Grey bars are buying and Red bars are selling – the Grey bars appear to be winning.

Wednesday, May 27, 2009

Lots of Similar Patterns

Many sectors are stuck in narrow trading ranges. The next big move wins to break stocks out for another leg higher or down for a retest of the March lows. Only time will tell.

Commercial Real Estate (VNQ)
VNQ has been in a narrow trading range, tracking below the 200-day (Blue Line). A break above $32.50 is needed to get me interested or a breakdown that shakes out some current shareholders.

Transportation (IYT)
A break of $52.50 would be bad and indicate that a retest of the lows was under way. A break above $55 could carry IYT to retest the $62 high and the 200-day at $63.23.

Financials (KBE)
Financials are in a still pulling back from the May 5th highs and may work down to the old breakout at $15. A break above $18.50 would get me interested.

I want to note that KBE did break above $18.50 this morning and I did not buy it. I was concerned that it would not be able to carry much higher after the size of yesterday’s advance. I was right. I have seen too many failed breakouts recently and am a little leery.

Energy (XLE)
XLE has teste the 20-day (Green Line) on numerous occasions since the March lows (Green Arrows). A break above $50 is good and a break below $47.50 is bad.

Oil Service (OIH)
I had to double check to make sure that this wasn’t the chart of XLE…
Same story as XLE - the 200-day is a brick wall and until it is taken out, nothing happens. Unless something dramatic happens, this will be one of the first things that I own when I start buying.

Homebuilders (XHB)
A break above $12.75 is good and a break of $11.83 is bad. Notice how XHB has already retraced 38% of the March low to May high. That makes this a weak sector, along with Financials and Transports. I want to focus on leaders and not so much on laggards. I will need to watch these groups carefully. Your holdings are either pulling the market higher or hanging on for the ride up – you want the leaders in your portfolio!

Relative Strength in Commodities
I wanted to show you how the different types of Commodities are doing relative to one another. I show them from strongest to weakest.

Agricultural Commodities (DBA)
DBA has been the best performing commodities area. It has been able to break out of a base dating back to early October 2008. It has also cleared the 200-day (Blue Line). I will be looking to buy pullbacks into the Red Line (with a tight stop, of course).

Industrial Metals (DBB)
DBB crashed into the 200-day (Blue Line) and has been pulling back ever since. It now sits on the 50-day (Black Line). A break here could carry price down towards $13.

Crude Oil (USO) has been a substantial under-performer. It has barely broken above first resistance and is nowhere near its 200-day or the highs of December 2008.

I will focus on the leaders and not the laggards.

All Commodities (DBC)
The entire Commodities Complex can be owned in one ETF – DBC. You can see how DBC has lagged DBA because of its weighting in Energy.

DBC has now been basing (trading sideways) for 6 months, so a break above $23 and the 200-day will be very constructive.

NASDAQ 2002 and Today

A few weeks ago I mentioned that I thought the current rally would in some ways mirror the way the Market came off of its lows in 2002 – 2003. Specifically, I mentioned that it would be normal to see the markets oscillate violently about the 200-day moving average (Blue Line).

Here is the NASDAQ ($COMPQ) and how it bottomed in 2002 -2003. See how for three months price violently traded along the 200-day? The trading range was very Bullish and constructive, but also violent and unsettling if you owned stocks (I did back then and remember the time well).

$COMPQ ended up retracing 62% of the initial rally, before putting in a “double bottom” at about 1,263. It then broke out of the 3 month consolidation and sat around for a few weeks (black Circle) before launching for 4 years.

Will the markets play out exactly like 2002 – 2003? Not exactly, but the process may have some similarities. The initial pullback off of the 200-day has been far less violent than in 2002, so the depth of the selling in this consolidation may be less than in 2002 -2003. It just seems that the Big Boys are more willing to commit money more quickly than they did in 2002 -2003.

The other thing to note about the 2002 -2003 bottoming process is that each low slightly undercut the previous low. This served to scare some weak hands into selling. Do not be surprised to see this occur during the next few weeks. This is important, because the best entries into positions have been on violent pullbacks, so reversals will need to watch very closely.

Clearly Today’s US Treasury Auction was an Epic Failure

Bonds are Getting Smoked Today
Look at how hard they are getting hit today and how hard they have been hit the last few days!

20-year (TLT) -1.30% today, -7% in 4 days
7 to 10-year (IEF) -0.89%, -3.7% in 4 days

Grandma won’t be sleeping too well when she gets her May 2009 statement…

Keep things in perspective, this note from –

“Market participants report very heavy paying by convexity based accounts which is the reason for the very long caption for this post. In my years in the bond market the crazed convexity crowd was always the last in for the trade. When they appear the trade is nearly over and it is time to go in the other direction. By definition, they often sell the lowest prices and buy the highest.

So maybe, just maybe, we are nearing a bottom after a brutal move.”

You can read about Convexity here, but essentially what this means is that Convexity players are crying “Uncle” and are just now hedging Bond Portfolios against the negative impact rising Interest Rates have on Bond Prices –

Here is a comparison of the 20-year US Treasury ETF (TLT) and the 30-year US Treasury Yield ($TYX = 30-year yield x 10). As you can see, TLT is now in a zone of massive support. I will be looking to buy a bottoming pattern here, especially with the understanding that the Convexity crowd is now panicking.

Remember, US Treasuries are a safe-haven trade, as is the US Dollar. I just wrote about the likelihood of a trading low in the US Dollar. So maybe something bad is about to occur – I’m thinking North Korea…

SPX Failing from Below The Trendline?

I have no idea what the last hour has in store for us, but as of right now, this is what I see.

Here is the hourly chart on the S&P 500, since the March 2009 low.
The Blue Line has been trendline support for the majority of the rally. It has now been breeched. Normally what happens in a maturing trend is that one a trendline fails, price rallies up to touch it before rolling over – to “kiss it goodbye”.

This is a potentially very Bearish pattern on the Hourly Chart. Support could be tested at 828, 797 and 766. That would be the “retracement” I have been looking to use as my buy point. We’ll see how it plays out.

Anatomy of a Failed Breakout

The biggest risk during this rally has been posed by what are referred to as “failed breakouts” – where a security breaks above resistance, then fails to hold and falls back below the breakout point. What I have seen lately is that failed breakouts get crushed over a very short period of time.

Monsanto (MON) is a perfect example. Monsanto is in the strong Fertilizer group and it broke out of a trading range last week (above the Green Line). Within a day, it fell back below the breakout point and through the obvious Stop Loss point (Red Line), before imploding over the last few days.

This is a very difficult environment right now, so use Stop Losses on all trades if you commit capital…

Tuesday, May 26, 2009

FX and Interest Rate Risks

Tyler Durden at Zerohedge came across a new piece by Bob Janjuah, Chief Stategist of RBS. It reads like all the stuff I have been obsessed with.

Here are some excerpts -

“Investing in risk only on the basis of 'liquidity' led to the crash of 2001/2002/2003 (where we blew up corporate balance sheets with debt), as well as the current crash of 2007/2008/2009 (where we blew up consumer balance sheets with debt), to which the Pavlovian response has been to blow up government balance sheets with debt.”

“Investing just because retail are buying has never been a strategy I would want to follow. And as for trading, YET AGAIN I am hearing a lot of the 'I'm just playing momentum, and will be smart enough to get out in time ahead of the turn' trading strategy. Have the events of the last few years taught us NOTHING?!?!”

Like I have been saying, all the Government has done is move the responsibility for all the bad debt from the Banks to the Taxpayers. My biggest fear all along is that there is nobody large enough to bail out the Fed…

“we are either at or close to the limits of fiscal 'support' so it is uncertain how much more debt even the public sectors can credibly get away with. At the same time, it is clear that at the moment the only 'solution' policymakers in Anglo-Saxon can come up with is more of the same that got us into the debacle we are faced with, namely the reflationist policy of PRINT/BORROW/SPEND/BUY MORE RUBBISH WE DON'T NEED/PUSH THE PROBLEMS INTO 'TOMORROW' & PRAY IT GETS BETTER - its all about avoiding taking the adjustment/the hit.”

Avoid the pain at all costs. Why lay somebody off when you can print a few billion and keep him employed another year in an inefficient job that produces nothing of value?

Why go through the efforts of renegotiating Trade Agreements to bring real Middle Class Jobs back home, when you can print a pile of money and pretend that consumption fueled by lending is better than investment fueled by saving?

Why cut spending when you can issue 30-year Bonds that the kids will have to pay off some day?

“As such, all this really means to me is that if the WEAK H2 09 scenario does play out as we having been saying all year, then we should expect a quantum increase in the scale/levels of QE (Quantitative Easing) the FED and BoE (Bank of England) may be forced to undertake, as this will be the only way, absent a real and sustained pick up in the private sector (which we CAN'T see at all) to create nominal growth.”

Inflate away the Debt is the game plan. The best way to do this is to crash the Currency. Short of an actual economic recovery, the only way to get rid of the Real value of all of the Debt is to inflate it away.

“Since early 2007 the Credit market has been the driver/lead indicator for markets. As the policy response has been to load up all the risks & debt onto public sector, going forward THE LEAD DRIVERS WILL BE FX (Foreign Exchange Rates) & RATES (Interest Rate) MARKETS, in terms of levels, direction and volatility, and NOT the Credit or indeed Equity markets. IN OTHER WORDS, just focusing on what S&P and/or the Crossover index is doing is NOT going to be enough.”

What this means in English is that the risks going forward will be how your assets’ Real Prices hold up versus a falling Dollar and rising Interest Rates. You will need to be aware of how a falling Dollar and rising Interest Rates impact your holdings – hint both will be bad, especially to Bonds.

“all I can see ahead are higher VOLS (volatility) in both markets and the real economies of the world, a higher risk free rate, higher hurdle rates to investment, and more selectivity around capital allocation and investment.....this means Risk
Premia MUST be higher....

Higher risk premia means LOWER PEs.....combined with profit outlook which is basically flat on 08 for 09 and 2010 at least, this means STOCKS ARE TOO HIGH.”

Historically, when you have been in periods of rising Inflation and Rising Interest Rates, investors become risk averse – therefore, stock valuations fall. This is also a result of the fact that as Bond Yield increase, they become more attractive to own than Stocks, so their Prices fall relative to the Earnings they generate.
The bottom line of this piece is to warn investors that the real risks going forward are a falling Dollar, rising Interest Rate, falling Bond Prices and cheaper Stocks relative to current valuations.

Trading Range Travel Day

SPX pulled back to support at 876 and held for a third time (Red Line). It also held the 20-day (Green Line). This was a natural place for the futures buttons to be hit and the move accelerated from the start of trading.
Today was nothing more than a violent move across a 5% trading range.

The NASDAQ 100 pulled back into the 200 day and held (Blue Line). The buttons were pushed from the open today and the market launched.

Here is the 5-minute chart of the NASDAQ 100 over the last two days of trading. You can see that it gapped down hard today and then ramped for 40 points (about 3%) in the first hour of trading. That is not mom and pop, that is Goldman and Morgan Stanley pushing the buttons.

I want to see breakouts. I am looking in Oil Service and Financials to see if they can breakout again for another leg higher.

Monday, May 25, 2009

Morgan Stanley, TARP and C-Level Bonuses

This stuff is starting to get to me.

On May 8th, the ratings agency Egan-Jones issued a note to clients that Morgan Stanley needs another $40 billion in capital to function.

A few days later, Morgan Stanley and the Fed told us that Morgan Stanley fine and can repay the TARP.

Somebody is full of it and think I know who it is…

Now, to add insult to injury, Morgan Stanley is giving raises to its top brass. These clowns should be in jail!

Sunday, May 24, 2009

The US Dollar, Inflation and Bonds

Yesterday, I paid $2.70 for a gallon of gas.

The economy is in the tank, three friends told me they got laid off this week and I paid $2.70 for a gallon of gas. Why?
Did you notice the US Dollar this week? It is down -4.1% in 6 days. It is down -8.1% since April 21st.

Crater the Currency
In 1980, Paul Volcker said the following (I know I have written this a dozen times, but it is playing out before our eyes and is central to investing over the next few years) –

“At some point you need to make a choice between cratering the economy and cratering the currency.”

In 1980, Inflation was rampant and the only way to kill it was to increase Interest rates to shockingly high levels. Money Market yields spiked to 22%. The 30-year US Treasury spiked near 15%. This killed economic activity and the economy “cratered” (recession).

In 2008, we were (are) faced with Deflation. Deflation has the opposite “cure” of Inflation – you need to make everybody believe that the government will “recklessly” print money. This expectation of massive future Inflation becomes the “cure” for deflation (see Bernanke’s speech in 2005).

But what are the consequences of massive inflation?
The real cause of rampant Inflation is that foreigners no longer trust the currency and sell it. This causes the currency to lose purchasing power, making it harder to compete in the international marketplace for goods and services – making stuff more expensive to you and me.

The policy is to kill the Dollar and make everything cost so much that you and I have to take more risks with our money to maintain our standard of living. Nothing in any of these policies has anything to do with fixing the economy or building a middle class. It has everything to do with inflating asset prices and inflating away the real value of all of the debt we have as a country.

I have been a raving lunatic about how adverse the consequences would be from the horrible policy decisions of the US Government. I have been very afraid of the problems caused by Quantitative Easing and massive “Stimulus” designed to do nothing more than keep people working at inefficient jobs (think Government jobs) and prop up asset prices by making money artificially cheap (sound familiar Mr. Greenspan?).

US Dollar vs Crude Oil
Here are the charts of West Texas Crude ($WTIC) and The US Dollar ($USD). Since Obama told us all to buy stocks in early March, USD and WTIC have been mirror images of each other. Very simply put, people have been fleeing the Dollar and buying Real Assets to protect their purchasing power as the US, the UK and the IMF have created over $1.5 trillion of new paper money.

Now you know why I was (am) afraid. Inflation is the net result of all of this money printing. Inflation will be created by imploding real value of the US Dollar.

In the early 1970’s Richard Nixon had the brilliant idea to try and force the economy to maintain a 3.5% Unemployment Rate. He tried this by increasing the money supply by 10% in a very short period. The result was Inflation. He took us off of the Gold Standard and cranked up the printing press (The Money Supply has been increased by 110% over the last year).

Price Controls
Because Oil and Agricultural Commodities (Food) are priced in Dollars, the price of Gas and Food went up – to unacceptably high levels. The pain of such high prices during a period of economic weakness led to the brilliant idea of controlling the prices and wages. This led to shortages and long lines for gas. We just increased the Money Supply at 11 times the rate of Nixon – how scr**ed are we?

The US Dollar is now at the “Line of Death” at 80. A break from here is devastating. A near term bounce and short squeeze should be anticipated.

If (when) the Dollar breaks long term support, we will see the price of stuff go parabolic. As an investor, you will need to own a lot of Real Assets. Not Real Estate, because it is valued in US Dollars and will see its purchasing power devastated by the falling Dollar, but Raw Materials. Raw Materials can be very efficiently owned through ETFs that trade anywhere from 3 million to 30 million shares a day.

Bond Prices
I have had a lot of inquiries lately from people looking to get higher yield from longer maturity bonds. For several years I have been warning of the impending Inflation Wave and the surge in Interest Rates which will inevitably accompany it.

Real Bond Prices
Here is a chart of the performance of the 30-Year US Treasury Bond adjusted for Inflation. Taking the annual return of the Bond and subtracting the Annual Inflation Rate, you get the after-inflation Rate of Return – the “Real” rate of return. In times of inflation, the “Real” return on Bonds can be very negative!
This chart makes it fairly clear that Bonds have incredibly long periods of sustained real gains and real losses. From 1940 – 1981, you lost more than half of the Real Value of your bond portfolio. Holy cow. Remember, this chart takes into consideration the fact that the annual interest payments on the bond are being reinvested.

In 1982, Interest Rates peaked and have been falling ever since. These falling rates have led to a quintupling in the Real Value of these Bonds.

I obviously like charts, and I am telling you that crashes tend to occur after a 500% to 600% run in an asset class. This chart of US Treasuries looks like Real Estate in 2006, Emerging Markets in 2006, The NASDAQ in 2000. US Treasuries are Grandma Money and Grandma is gonna get killed in these things…

So Where Can You Hide?
Here is a chart comparing the return of the 3-Month Us Treasury Bill (3-Month) versus the Consumer Price Index (CPI). As you can see, the compounded return of the 3-month Treasury kept up with inflation through the bulk of the inflation wave through the 1970’s. Short Term is where you want to focus your money.

You want to do this, because the Short Term holdings will see their Interest Rates reset much more quickly as inflation increases. Here is the chart of the 3-month US Treasury yield (IRX) versus the CPI (Inflation). IRX does a very good job of capturing most of the increases in CPI for investors.

Inflation started to uptick in 1967 and was finally “cured” in 1982. Here is how the 3-Month and the 30-Year Treasuries performed –

I will continue to focus on protecting principal from the ravages of inflation versus trying to get a higher short term yield from longer maturity bonds.