Stocks & Treasuries Looking to Diverge

With indications of morning weakness, the Dow, S&P 500 and S&P 400 will be breaking down from their six-week digestion patterns. Amazingly, for the past six weeks these indices have basically traded from high to low inside the range they saw on September 9 & 12.

spy

This action does not change my thinking about a continuing pullback and not some large scale collapse. The first thing I want to see is whether this potential breakdown is held for more than a few days. Many times, indices break up or down from a widely followed range, only to see that reversed quickly and sharply in the days ahead which traps a large group of traders.

I also want to see how powerful today’s action is to the downside and if any sectors buck the trend. The defensive utilities, staples, REITs and telecom are the most likely candidates.

As I mentioned the other day, treasury bonds have been hit with the ugly stick and are trying to bounce back from the 200 day moving average which is just the average price of the last 200 days and a popular measure of the long-term trend. If the declines in treasuries is so strong, I would only expect a short-term bounce here as sentiment is now at a bearish extreme.

tlt

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Getting Anywhere?

Early Monday I wrote about the market setting up for a bounce. And that was certainly the case on Monday. Tuesday, however, was a different story as stocks gave back all of Monday’s gains and then some. Wednesday’s solid action, once again, puts the stock market on bounce alert.

I keep using the word “bounce” instead of rally because it looks like there needs to be some more work on the downside before the current pullback wraps up. With each successive red day, the markets seem to be rebuilding the wall of worry necessary to begin the next meaningful rally. The problem is that this does not happen overnight.

Stocks are “supposed” to make some upside headway right here and now. Treasury bonds are “supposed” to pullback right here and now. Gold is “supposed” to rally right here and now and the dollar is “supposed” to decline right here and now. That’s the short-term scenario, some of which I positioned clients for while some isn’t worth the risk.

I am still keenly watching which sectors lead the bounce and which cannot get off the carpet. Right now, very few look enticing for more than a quick trade.

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Monday is Bounce Day

After some normal volatility on Friday, the bulls held their own and are positioned to see some green as the trading week opens. There are two scenarios I am watching here.

The first is the lows hit on Friday. If the major indices close below those levels sooner than later, we should see some trap door, elevator shaft, immediate selling. That’s the more bearish path. Scenario number two has the market bouncing for a few days and then rolling over to revisit the lows from Friday where the bottom is quickly formed.

As I mentioned last week, the quality of the bounce is so important right now. Poor participation or sector leadership may well have more intermediate-term consequences, but if the bulls can make an internal stand, the stage can be set for Dow 17,500.

Just like with the stock market, treasuries are at an important juncture as well. They are positioned to see more upside, but that needs to be much sooner than later to stave off a multi-week pullback.

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2nd Fed Trend a Success… Pullback is Here

Yesterday, I wrote about the Fed statement day trends. History suggested, a pre announcement market of +-0.50% which was spot on with the day closing green; it closed neutral. Today, the post Fed model called for lower prices which is spot on as well. This is all in the context of the pullback I forecast two days ago.

Today’s action so far is nasty with my entire screen red except for the items that go up during a down market. Days like this bring the market closer to the eventual bottom, but it’s not there yet. Patience…

What is a little different right now is that very few sectors look appealing into the weakness, something that hasn’t been the case since 2011. Additionally, the treasury bond market, which I have been bullish on all year is flirting with the unchanged level when it should be sharply higher.

This will all sort out sooner than although I am very, very glad that we raised so much cash just a few days ago!

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Short-Term Pullback Continues

Stocks head in to the new week with the bears in control over the very short-term. That’s it. Not the intermediate-term and certainly not the long-term. The major indices peaked last Monday and look like they are digesting the recent gains in very orderly fashion. More all time highs should follow when this pullback concludes.

The next rally is the one I would pay particularly close attention to, especially in the small caps. The Russell 2000 is SUPPOSED to hit fresh highs. Should it fail when the others do, it would then open the possibility for more a more substantial decline, perhaps in the 5-9%. But that’s getting way ahead of ourselves.

For now, let’s see which sectors decline the most and entice buyers first. I also want to see how one of our biggest positions in long-term US treasuries performs. They are poised to see new highs for 2014 over the coming weeks as I have written about ad nauseum here. The trade from late 2013 is certainly long in the tooth by my standards and sentiment is beginning to bare that out.

Finally, it’s FOMC week and I will have more to say on that topic tomorrow and Wednesday.

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Bulls Hangin’ Tough

With the bearish seasonal headwinds this week, the bulls have done a nice job not giving up any ground so far. In fact, the bulls powered ahead on Tuesday and held firm on Wednesday. It certainly looks like the Dow and Nasdaq 100 want to join the S&P 500 at new highs this week. Although the S&P 400 and Russell 2000 have been laggards, they have certainly led the parade over the past week.

The real news so far this week has been in the bond and gold markets. As you know, I have been very positive on bonds since late last year, often calling myself “the only bond bull in America” or more recently, “no one”, as in “no one called this rally in bonds.”

Long dated treasuries continue to trade well and I expect some of the bears to throw in the towel now. And that’s why I am getting a little nervous being so bullish. It’s time to tighten up those stops and contemplate taking some chips off the table. With the Fed continuing the taper and the economy supposedly doing better, the bond market ain’t believin’. Something dark lies ahead.

Gold on the other hand is now falling sharply towards the sub $1200 target I have mentioned of late. Unless the shiny metal immediately reverses course, it’s going to be ugly until the metal hits bottom, probably next quarter.

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There is Always Something to Buy

Like a broken record, stock market sentiment remains at rally killing levels as it has for the past two months or so, but that certainly didn’t prevented us from taking full advantage of the Santa Claus rally. Now that the calendar turned and the most bullish period of the year has ended, the tailwind for stocks isn’t as strong. As the market has been for some time, it is stretched, very overbought and in need of good 5-10% pullback.

The very short-term can probably go either way with one more all-time high push this week or an immediate decline, but I do not believe a push higher will ignite another leg higher. Once last week’s low is closed beneath on a daily basis, the market should smack in the middle of the 5-10% pullback. Again, the bull market is not over and any weakness remains a buying opportunity until proven otherwise. Dow 17,000 or higher remains in sight.

The secular bull market in the dollar turns a very quiet 6 years old in March and we should see some real upside fireworks this year. I am most intrigued by the Treasury bond market here as sentiment continues to be awful and price is just starting to percolate. We have already seen very strong moves in the investment grade bond market which you can see using LQD and the much maligned muni bond market is showing some good signs this year. Use MUB as a proxy for that.

While I do not like commodities as a whole, copper has a short-term set up that has at least 2:1 risk reward to the long side. Corn looks really interesting here as sentiment has been at bear market killing levels and price is just beginning to turn around. Hmmmmm. That could be just a short-term play or end up being the trade of 2014.

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Bears Still Fleeing Bonds et al

It’s been a relentless assault on the bond market and other interest rate sensitive instruments of late. Treasury bonds, mortgage backed securities, high quality corporate bonds, junk bonds, utilities, REITs have seen intense selling pressure that has only paused for a day here and there since late April. Telecom, REITs and high yield bond mutual funds all hit our sell triggers last month and it certainly feels like consumer staples mutual funds and a few more bond ETFs aren’t too far behind.

I do NOT believe the bull market in stocks is over, but leadership has and is changing.

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Once Again, It’s About Europe

Socialist candidate Francois Hollande won the election in France, throwing the Eurozone into a tizzy as Germany no longer has a fiscally conservative partner in France.  This is going to get very interesting as we have Germany favoring austerity and a more hard line fiscal path, while France will look to curb the expense cuts, raise taxes and possibly increase spending. 

Markets cratered overnight, especially in Asia, but by the time the US opened, losses were more muted.  And by 4pm, all of the major indices were green except for the Dow.  Remember, it’s not so much what the news is as much as how the market reacts.  Frankly, I was a little surprised that our market took the news so well.  That could  be setting the US up for a bounce.  Closing below today’s low, 12,970 in the Dow, should set the wheels in motion for more selling with the major indices declining to new lows for the second quarter. 

Longer-term, this should be positive news for gold and US treasury bonds, but let’s let the market tell us over the coming weeks and months.  I still think gold sees a significant low this quarter that could launch a major rally.

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The Most Unloved Investment

Last Wednesday, I participated in an interesting discussion on CNBC’s Closing Bell regarding what I consider to be the most “unloved” investment.  Most continue to scratch their heads as to why they haven’t cratered with the trillions of the dollars our Fed has created over the past few years.  But there are bigger stories at play. 

For years, most have thought that inflation would really kick into high gear, but that certainly hasn’t happened.  You may have seen it at the pump or at the grocery store, but those are considered “transitional” and easily cured with higher prices.  Think about it.  The higher the price goes for a certain good, the more likely we are to cut back and/or find a substitute.  I am a big chicken eater,  but if the price of chicken doubled, tripled or quadrupled, guess what, I would find something else to eat like turkey.

That may be all well and good for chicken, but what about heating my house with oil?  Aren’t I stuck? After crude oil skyrocketed to $147 in 2008, alternatives really started to sprout up.  Americans dramatically cut back on miles driven and oil used at home.  They also started purchasing wood burning and pellet stoves, solar panels and geo-thermal systems.  In most cases, there are always ways!

Anyway, I digress.  Since 2007, I have believed that our biggest enemy would  be and is deflation, not inflation.  During the credit crisis, trillions and trillions were “vaporized”. Remember all those alphabet soup products that banks were inundated with?  CMOs, CLOs, CDOs, SIVs.  The ones that were AA and AAA but really were junk?  Think of all that money that went away!  Although the Fed has created trillions, it hasn’t come close to replacing the money that was lost. 

Wages are a component of inflation and wage growth has been essentially non existent.  And the elephant in the room, housing?  That’s the largest component of inflation and it would be very tough to argue that housing prices are and have been on the rise.  So in my opinion, we are in need of a little, controllable inflation. 

So I think I uncovered a good future topic.  Enjoy the video.

http://video.cnbc.com/gallery/?video=3000087612&play=1

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