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…

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.

http://zerohedge.blogspot.com/2009/05/deep-thoughts-from-bob-janjuah_26.html

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?!?!”

Heyidiot.com...

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.

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.

http://dealbook.blogs.nytimes.com/2009/05/08/egan-jones-takes-dim-view-of-morgan-stanleys-health/

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!

http://www.bloomberg.com/apps/news?pid=20601087&sid=aoz7URVpwVro&refer=home

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.

Nixon
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.

Watch the Dollar

Last week I speculated that Obama would have to go back and do a second “Stimulus”, because the economy is broken – too much capacity, both in facilities and employees. But I forgot how Team Obama deals with the creation of money – they don’t go to Congress and have it appropriated via a vote, they go to the NY Fed and have it printed by leveraging the TARP.

The rally yesterday was led by Financials, and now we know why. Today, the Fed released the revisions to the TALF program – the one that buys Toxic Waste off of the books of the Banks are ridiculously high prices and enriched Banks Shareholders (BAC, C, WFC et al) and Bondholders (think PIMCO) at the expense of the US Taxpayer (you, me, our kids, their kids…).

http://newyorkfed.org/markets/talf_cmbs_terms_050109.html

When originally constructed, TALF was supposed to only buy newly created Securitized Loan Portfolios (those created after 7/01/2008). This was designed to protect the Taxpayer from having to buy older portfolios of Toxic Waste (the 2003 – 2006 vintage mortgages where the homeowners are 30% to 50% under water and the mortgages are worthless). TALF has proven to be a complete failure, because nobody is borrowing and insolvent banks aren’t lending – they can’t.

Mortgage Pools purchased had to be Senior claims on 1st Mortgages that were being paid on time and were not Interest Only loans. I guess there went too many of these for sale…

TALF 2.0
The new TALF rules (effective 5/19/2009) make no mention of limiting purchases based on origination date and imply in roundabout language gymnastics that purchases will include Junior debt. I feel my wallet getting lighter and lighter…

http://newyorkfed.org/markets/talf_cmbs_terms.html

US Dollar
As the Stock and Commodity Markets ramped higher yesterday, the Dollar got smoked again, taking out more short-term support.

The Dollar ($USD) and the S&P 500 ($SPX) have been virtual mirror images of one another. The charts show times of greed (Dollar falling, SPX rising) and fear (Dollar rising, SPX falling).

SPX is now in the range of pretty significant resistance, and the Dollar is approaching some decent support, so maybe these trends will take a breather soon. We’ll see.

The Euro ($XEU)
The Euro is the anti-Dollar for Central Banks. If you need a reserve currency other than the Dollar, the Euro is your most likely choice – the Dollar falls, the Euro rises and vice versa. Therefore, the Euro can also be considered a risk trade.

On this chart, I want to show you how the Euro has been moving in lock step with Silver and Gold. They all bottomed in October / November 2008, then rallied, then sat around for about seven weeks and have been trying to work their way higher the last few weeks. The Euro, Silver and Gold are clearly places where money wants to hide as the Fed embarks upon their Quantitative Easing experiment. So your stocks are up, but your purchasing power is falling. As I have said from the beginning, there is no free lunch…

SPX Versus Gold
Gold appears to be in the process of breaking out of a 14-month base. Taking out $1,000 could be incredibly profitable for Gold and Gold Stocks. I bought the pullback in Gold and am looking to add to any breakout.

Unlike the stuff that has been rallying off of the lows, I like the fundamentals of Gold and have no problem holding onto it. The only potential issue for Gold is that the IMF is threatening to sell all of their Gold to finance their SDR “currency”. The IMF has a huge supply of Gold, but any break in price caused by IMF selling will be one of the best buys of your lifetime. Make no mistake that when the IMF sells its gold, it is no longer relevant – so they may be reluctant to sell it.

Look at how Gold topped as the SPX bottomed in March. I would not be surprised to see a pullback in SPX coincide with a rally in Gold, which tests the $1,000 range. That is not a prediction, I am just eyeballing the chart and giving you my opinion.

Gold
For those who think that if you miss THE LOW, you can’t make money, take a look at how Gold has had many rallies since it bottomed in 2001.

This is a classic Bull Market, where price rallies, gets stretched above key moving averages and then spends months sitting around or pulling back into these moving averages, before rallying again. Look at how many times the 12-month average was touched and held (Blue Arrows). It broke down in late 2008, but then rallied sharply to recapture the Blue Line. I bought Gold (via GLD) on the latest pullback. I want to add on a breakout above $1,000. A failure in price below $836 would concern me.

The Euro
Here is a long term chart of The Euro. Like Gold, The Euro had a great move off of the 2001 low – a low created when the Fed made money super cheap, smoking the Dollar and setting up the Housing Credit Bubble.

The Euro broke out in Mid 2007 and ran for another year or so. It then topped and retraced about half of the 2001 – 2008 rally. That is normal. Now the Euro is battling to recapture the 2007 breakout point at about 135. I get really bullish on the Euro above 136.29 (Blue Line) and 137.72 (Red Line).

The British Pound(ed)
On a side note, look at the British Pound. Yikes!
Britain rivals the US in its desire to fix things via the printing of money. Maybe now is the time to take a trip to England…

The bottom line is that Dollar strength may lead to or result from a weakened risk appetite. That would be bad in the short run for stocks, commodities and commodity-based economies and currencies.

Dollar support lies at 81.46, 81.40, 80.50, 80 and 78.34
Those will be the areas where I would look for a reversal. Price may overshoot for a few days and then recover quickly. We’ll see how it plays out.

Euro resistance lies at 137.72, 137.76, 138.38 and 142.50

There is a significant band of resistance on SPX from 902 – 954

A retracement of the March rally may shortly be in the cards.

What I am Looking For
I want to buy strong sectors breaking out of big bases on heavy volume, or I want to buy strength pulling back into moving averages.

Here is the diagram of the Bull Market / Bear Market cycle for a stock from Stan Weinstein. If you have not read his book, then it is a must for your summer reading list (http://www.amazon.com/Stan-Weinsteins-Secrets-Profiting-Markets/dp/1556236832)

From the diagram, you can see that stocks top, then trend down strongly (Bear Market), they then sit around for many months, before breaking out and trending strongly higher (Bull Market).

Do any of these remind you of Weinstein’s diagram?


These are all Commodities and Materials. They are most likely economic recovery plays, as well as real asset hiding places as the Fed prints money.

I had to wait to see where money would be focusing in this new Bull Market. I had the luxury to not have to chase, because I did not get creamed in 2008.

Now I will be looking to buy pullbacks into the 50-day (Black Line) and expect mistakes to get bailed out. The goal now is to own the leaders who are dragging the markets higher, and not the laggards that are getting pulled upward by an ascending market.