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.

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.

Energy
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 Acrossthecurve.com –

http://acrossthecurve.com/?p=5730

“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 –

http://en.wikipedia.org/wiki/Bond_convexity

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…

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.