Fed Day Today

It’s Fed Day today and many key markets face critical decisions. The hope being built into the markets is that the Fed will announce that they will start buying at least $250 billion in bonds and will ultimately purchase another $1 trillion to up to $5 trillion of new bonds over the next few years.

I want to start with the Euro (chart below), because so much of the leverage that is driving risky assets up and down is a result of currency Carry Trades. The uptrend in the Euro is now at day 44. Vertical moves like this tend to reverse (or at least pause) in the 45 – 49 day range. I have included resistance levels used by technical traders (and no doubt computer models). The inverse of The Euro is the US Dollar.



Here is the chart of the S&P 500. Key resistance is at 1,140. The setup is there for a reversal and the most bearish scenario would be a break above 1,140 that quickly fails and takes out the 20-day averages at 1,115 and 1,096. If that happens, I will update the chart with support levels.

If key resistance is broken, then the downtrend reverses and technicians start to look at 1,276 and 1,349. We should have a pretty good idea of whether or not 1,140 will hold over the next few days.



US Treasuries have been rallying since the first batch of Quantitative Easing (money printing) ended at the end of March. The 30-year Treasury now faces another set of potential resistance.



Gold has managed to hold support at $1,150 and has now reversed its downtrend from June. Key resistance is the $1,220 – 1,228 range. I will fine tune my support levels later this week.



Conclusion is that the decision of the Fed will impact Stocks, Bonds, Currencies and Commodities. That is the world in which we now live, because there is too much production capacity and vacant real estate, so the only money keeping the economy from contracting is money printed by the government – look at how bad the economic numbers have been since March ended (and Quantitative Easing ended).

Last week, Greenspan said that a rising stock market would do more to improve the economy than any additional stimulus or bond purchases by the Fed. Rising asset prices is a policy tool so expect them to keep spending money they don’t have until the Bond Market revolts and forces them to stop.

S(tuff) Off The Bottom

The general rule is that when the laggards stop falling, the markets can bounce. Laggards have been Retail, Housing, Energy, Financials, Materials and Biotech to name a few. The junk has bounced and now we are entering another one of those times for a potential reversal of trend.

A move above 1,130 by SPX sets up another one of those triangle patterns that have worked so well in Energy in June and SPX in July. SPX is now about 2% below that 1,130 -1,140 zone. The key over the next few days is a pop into the 1,130 – 1,140 range for SPX.

If the SPX consolidates in this 1094 – 1115 zone for the next 5-8 days and works off any Short Term -Overbought condition, then it is possible that the SPX could trade higher into the Sept period before a significant reversal, but that is the least likely scenario.

The potential reversal pattern is setting up for the S&P 500, Dow Jones Industrial Average, S&P Mid Cap 400, Russell 2000 Small Cap indexes. It has already set up for Transports (IYT), Materials (IYM), REITs (IYR) and Consumer Staples.

GE, JPMorgan and Wells Fargo also have the setup forming.

I am not telling you that the market has topped. I am not telling you to go sell or short a bunch of anything. I am simply showing you what I see and what I look for.





Here is resistance and support, with key dates on the S&P 500 Futures. Resistance clusters in the 1,122 – 1,134 range.



I mentioned a few weeks ago that it looked like Gold was topping. Gold, Gold Stocks and Silver have all had a rough few days, but Gold is now into support ranging from 1,156 – 1,133. Maybe we are setting up for a Long Gold/ Short Stocks trade. We’ll see how things turn out.

European "Stress Test", Basel III and Euribor

We all know by now that the European “Stress Test” was a scam of the highest order. This is obvious because a few days after the release of the “results”, the Basel III Accord was rewritten to lower the capital requirements for banks.

No Sovereign Debt Default Calculations
First, the entire reason for fear in the European Banks was exposure by the banks to the debts of countries who may default. So the stress test did not take into consideration the possibility that a country could default. Sovereign Debt was not even used in the calculations of the Stress Test. Amazing…

Clearly if the Stress Test affirmed the fact that a Euro Country could default, then the Euro is by definition defunct. So we all pretend that they are infinitely solvent… until the next crisis arises.

Hold to Maturity at Par
Have you ever wondered why banks are so reluctant to foreclose on properties? It is because the rules were rewritten last year so that a bank would not have to realize a loss on a Mortgage Bond until there was a material event like a foreclosure that forced them to do so.

The rules made it so that the banks can price nonperforming loans at 100% of their maturity value as long as they can expect these Mortgages to one day get repaid. This was the whole “Marked to Market” pricing discussion of last year. The banks use these mispriced Mortgage Bonds in their calculations for how much “Capital” they have and for how much they can pay out in bonuses. The higher the values, the higher the bonuses and the less Capital the banks need to go raise through stock and bond offerings.

These accounting rule changes have allowed banks to lower the reserves they have to keep for nonperforming loans. The decrease in these reserves are added directly to the Net Income the banks show at the end of each Quarter and have been used to pad their Earnings numbers.

It Gets Better
The series of Basel Accords were put in place to standardize the rules and laws of international banking, focusing a significant amount of time on accounting practices and Capital Requirements. The Basel III Accord was set to increase Capital requirements by the end of 2012 and the banks were terrified that it would force them to raise more Capital and lower their Profits, by lowering their leverage – with the definition of leverage being how many times you can relend the same Dollar over and over and over again.

The European Stress Test was run with the assumption that the net Capital Banks needed to hold would have to be 6% of the value of their good assets (Level I). Under this test, 7 banks failed. However, under the new Basel III rules, the minimum requirement for banks would have been 8% and under that standard, 39 European Banks would have failed the “Stress Test”.

If the rules had gone unchanged, then the estimate from Credit Suisse is that European Banks would have to raise another $1.3 trillion in new Capital. That money simply does not exist. So the rules were rewritten and released yesterday to great Bullish fanfare on the stock exchanges.

Capital Ratio Requirements were lowered, some down to 3%. More assets are now going to be allowed to move “Off Balance Sheet” (think Enron) to Level II and Level III. And the newly watered down, but stricter Net Capital Requirements will not go into effect until at least 2018.
Remember how Lehman actually failed?
One day, one of the banks Lehman was borrowing money from came back to Lehman and told them that the Collateral Lehman gave them was not worth enough to back the loan. Lehman came back to the bank and told them that they had no more Collateral of any value. The bank pulled the loan, word got out that Lehman had no more Collateral of value and 4 days later, Lehman was out of business.

The same thing is going on again. Banks are reluctant to lend to one another because they know that the bank that is borrowing from them is lying about the value of their collateral they would use to back the loan. So very little lending is getting done.

You can see this via the Euribor Rate (the Interest Rate at which European Banks lend to one another). The 3-month Euribor has continued to climb, even after the stress test results were released. My fear is that banks know the guys on the other side of the loan are insolvent and that they will one day not be able to repay their loans with mispriced Collateral.

The same thing is happening here. New home starts are at their lowest level since 1963 (when the data started). There are over 18 million vacant homes in the USA (versus 111 million households). 51 million of those homes currently have mortgages on them. How many of those mortgages are underwater and how many are delinquent?

What happens if there is another leg down in Real Estate prices? Asset prices have fallen substantially and the economy seemed to grind to a halt once the Fed’s Quantitative Easing program ended in March. The prospect of another leg down in housing prices (and Commercial Real Estate for that matter) has Bernanke talking about another round of Quantitative Easing. I think it is a given that it will occur and that the markets are currently vacillating between the fear that it won’t (Europe says they won’t do it) and the hope that they will (Bernanke’s testimony last week).

Financials and Retail

Financials
GE is the mother of all lenders, so let’s start here. GE had a low-volume rally (a wedge) into old support (now resistance) at $15 and imploded on Friday on heavy volume (Red Arrow). Bank of America (BAC) rallied into its 50-day on weak volume at got creamed for -9.2% on Friday – also on massive volume. That is not the action of a Bull Market…



Credit Cards
You have to wonder how much of the selloff in Financials on Friday was the result of the new Financial Reform Bill. MasterCard (MA) and Visa (V) have both found significant support right below their current prices on 3 previous occasions and those levels had better hold here.

The potentially bullish side is that the 50% retracements of the recent Bull Market sit just below the breakdown points, so a shakeout on a price break and then a rapid rally back up above support would not surprise me. The same thing happened recently on Semiconductors (SMH). Just more computerized fleecing of the average investor by the con artist on Wall Street.



Retail
Retail is an absolute train wreck. Take a look at the charts of Wal-Mart (WMT), Macy’s (M), Sears Holdings (SHLD), Best Buy( BBY), Nordstrom (JWN), Bed Bath & Beyond (BBBY), Costco (COST), Tiffany (TIF), JC Penny (JCP), Target (TGT), Saks (SKS), Overstock (OSTK)…

There are a lot of horrible looking charts in Retail. That can’t same much good about the Consumer.

Education – The “Wedge” Pattern

People ask me what do I mean by a “wedge” and why they should even bother looking at a chart.

Markets move in trends. During these trends, price moves too far and becomes extended. Extended would be defined as stretched away from key moving averages (the 50-day and the 200-day). Pullbacks are needed to regress price back towards these key moving averages. These pullbacks take the form of a “wedge” – a narrow spike counter to the prevailing trend.

You can see that during the Bull Phase last year, when prices became overbought, they were capped by a line (Upper Green Line) that paralleled the 200-day (Lower Green Line). Several sharp pullbacks can be seen taking price back down into the rising 50-day and the 200-day averages. The sharp pullbacks are the “wedges” and are defined by the Blue Lines.

The opposite is true during the recent Bear Phase, where price extends significantly below the 50-day and then sharply regresses back into the 50-day and the 200-day. The trend is defined by the parallel Black Lines. Wedges are rallies into a now declining 50-day average.

See how the last moves on the S&P 500 have been selloffs that extend below the 50-day and then sharp rallies (wedges) that take price back up into the 50-day? That is the definition of a Bearish Phase. It should be of great concern that seven days of gains were wiped out in just a few hours of trading on Friday.



See the pattern of a downtrend, with sharp counter-rallies into the trendline? The pattern is apparent for Homebuilders (XHB), Retail (XRT) and Energy (XLE).





Financials (XLF) and Materials (IYM) have bearish wedges, but they are in a trading range, with support (Red Line) holding so far for each Sector.



Remember, Financials and Retail topped in early 2007, so they will need to be watched closely as a leading indicator for a potential market top. A market rally that does not include Financials and Retail would be very ominous. I am going to do some detailed charts of the Financial and Retail sectors later this evening.

Has Gold Topped For Now?

Gold was been wedging up towards $1,250 over the past few years. It overshot the top of the uptrend in June, and that is often what happens at a top and a reversal of trend. Gold got sold off to close out June and has now tested and failed to break back above the 50-day (Black Line). It now sits on the support line (Blue Line) of the entire multi-year rally. With all the commercials on the radio about buying Gold, you have to wonder if there is any money available to drive prices higher right now.



It is not just the metal Gold, it is also the Gold Mining companies (GDX) that are testing their multi-year uptrend. GDX failed to break above obvious resistance (Red Line) and have now not only failed on a rally into the 50-day, but has also failed to hold support from the February 2010 lows (Green Line). The uptrend from 2008 looks very suspect at this moment.



The same goes for Silver. It failed to break out last month and has now failed at the 50-day (Black Arrow). Support is obvious.



All of this is important for Precious Metals, because in Bear Markets price rallies into declining 50-day averages and then collapses. It is also important, because big money had a chance to break prices out to new highs and they failed to do so. It still could happen, but as of right now, there is not enough new money or conviction to move prices higher.

Nice Bounce, But Where Is The Volume?

Last Tuesday I sent an email out with the following -

“(F)rom a technical perspective the highest probability is a reversal in the next couple of days.”

“Will this simply be an oversold relief bounce or something more? …Will the bounce be strong, or merely a weak bounce into moving averages that can be shorted?”

Volume on the rally has been terrible and now the Market Averages are at key resistance. That is the trait of a Bear Market. The S&P 500 ($SPX) has made a vertical move into resistance on declining volume (Red Line). The same goes for the NASDAQ ($COMPQ).



Here are some important sectors. Consumer Discretionary (XLY) and Financials (XLF) have both bounced for the fourth time in recent months. Each of these bounces has been on declining volume into resistance. Maybe this time is different…

Retail (XRT) and Home Builders (XHB) have both had weak bounces on imploding volume and look like they are just consolidating before another leg lower in a sustained downtrend. Trends are trends until they break, and they usually go a lot farther than you think they can go.





These are important sectors. They tend to top out early and serve as an early warning sign for economic weakness and Bear Markets. They peaked in 2006 and 2007 and led the whole way down last time.

Here are some key stocks. These stocks are a huge percentage weighting of the Market Indexes and very important to the economy. All Microsoft (MSFT) has done is get stretched too far below its 50-day average (Black Line and Arrow) and bounce – again, on weak volume. That is the definition of a Bear Market! The same goes for Walmart (WMT).

General Electric (GE) held $15 for nine months and then broke below it in June. It bounced on very light volume and could only get above $15 by gapping above it at the open today – probably to try and trigger a short squeeze. But a failure here would be really, really, really bearish.

Chevron (CVX) has also simply bounced into resistance on horrible volume.





Volume is critical, because it tells you what the big boys are doing with their money. Weak volume means that they aren’t buying and that they are more likely simply moving prices higher, so they can unload more shares. That is the definition of distribution.

Before you get into Bear Markets, the big boys sell for months. They sell just enough to not break prices down completely. Prices sit in narrow ranges, until one day they break and then a flood of selling starts. Prices regress back to moving averages and then another leg of selling starts.

That is what has me so concerned about what is going on with the S&P 500. Nine months of a trading range that sees rallies into the 50-day on weak volume and then support gets broken, followed by a rally on weak volume.

This is yet another make or break point for the markets. A pullback that tests 1,010 and holds gets me excited again. A pullback that breaks 1,010 and next support is 950. Pretty sobering stuff.