Nikkei Cratering But...

Much has been said lately about a collapse in the Japanese economy based on their high levels of debt relative to GDP and their relatively stalled out revenues to service this debt. These thoughts tend to arrive each time the Nikkei 225 Index is having issues and the Yen is strong. The thought is simple: A falling stock market locally will hurt the banks that are holding equities in their portfolio and a rising Yen will kill of exports thus hurting the trade balance and the level of revenue to service the debt. Thus the result is another banking crisis and sovereign default - at least that is what is being speculated. With the fall last night of 3.5%, the talk about default is rising again, even in the quiet month of August, setting up what people believe will be a very tough September if this trend continues.

I argue though that the move in the Nikkei is still just a correction within a rising bull market. Why? Well the trend model is still bullish as shown on the chart. Also, the US markets are still in a bullish uptrend though with the selling over the last few weeks, that bull trend is now having trouble - it is still a bull though. If the bull market remains, then that would imply that that the gap between the Dow Industrials and the Nikkei should close, as it did during the breakout in 2003. This would mean that the Nikkei is undervalued relative to the US market. The catalyst for this would be a reversal in the Yen which is in breakout mode as shown on the chart. A move back below the projected 115 level would imply a false breakout and could very well shoot the Nikkei past the Dow in terms of outperformance - this all implies that the Nikkei has the potential to rally 30% going forward.

So going forward, I believe the US markets hold their bullish posture which means the Nikkei is undervalued relative to the Dow, using the Yen as a comparison. If the Yen reverses course, and breaks back below the projected 115 level, we will have a false breakout - these normally imply a move to the bottom of the range or roughly the par level in the spot market. At a minimum, it would imply a 8% correction lower on the chart (higher in the spot market) to the 13 month MA. A break of that level would confirm the reversal.

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Not a Good Close

I have always despised the trading in August because it was very erratic and scalping normally was the best strategy - since I am not good at scalping, thus August was normally a tough month for me. So when we dove yesterday into the close, I fully expected the market to bounce because reversing posture in the last few days of August, from long to short or vice versa, has never been profitable - till yesterday! The market dove into the close and the chart below shows why. A channel is shown on the char with the well defined peaks above and point below - the S&P moved right through the support and below the trendeline setting up what looks like a date with those two previous points of support. IN early trade this morning, the SPUs went below those supports and have since bounced above. We'll see what today brings.

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A Warning Sign

The Aussie Dollar/Swiss Franc cross rate is a very good indicator of problems to come (ie bear markets) or a turn towards higher risk taking (bull markets). In the boxes are the periods of time that I have noted as bull and bear market time frames. The cross rate tracks these periods of time very well though one could argue that given the problems in the Eurozone and the massive amount of money flowing into the swissie from Europeans, the ratio is losing its luster. However, it is a warning sign that perhaps more problems are on the horizon for the commodity currencies and the global bull market. The 87/90 area is key as the bull market from earlier this decade held that support while things in the equity markets really got bad in 2008 when the ratio walloped the support. At the moment, just a warning sign that it is below trend.

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For Nasdaq, Still a Breakout

With all the consternation lately about how the equity markets are in a bear market, this chart argues otherwise with a breakout from a pennant on the largely momentum based "renko char" - one of the key variables that I use for my trading.. This chart is not on an island either as the other four major indexes, as mentioned previously, are all maintaining uptrends.

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Dax Holding On

Contrary to the S&P 500 which is almost 15% from its previous highs, the German Dax Index is fighting to stay close to its previous highs. The German economy is growing at a much greater clip than the US and of late the Euro has has had a renewed weakness versus the good ole greenback - the weaker the Eruo, the cheaper their goods to export globally. so one could say that a stronger Euro could be a problem for the Germans. And this weak Euro seems to have kept the Dax Index from rolling over with the rest of the globe over the past year (South Korea and a few others held in as well).

So what happens if the Euro finds supports and begins to climb higher? The Euro bounced off support over the past week and back over the 1.27 level. Meanwhile the Dollar index has rolled back over the 83 level as we closed up shop today giving the euro some broadbased support. Given this headwind, if the Euro were to start accelerating again to the upside, the Dax find upside gains few and far between leading to a 10% brisk fall back to the 5300 level. The 6000 level as the chart shows has always been a tough one for the index to break through. A rising Euro will help in keeping the lid down on the gains. Of course, if the Euro loses the 1.25 level, as I noted earlier this week, the story changes and the rally accelerates to the upside. Needless to say, this is a key juncture for the Dax..

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One Last Thing...

As I was cleaning up the office before heading out to the island (that includes email), I came across a note from Citi's FX guys. In short, their measure of correlation between the S&P 500 and the returns of macro hedge funds is tremendously negative - in fact the most negative since late 2008/early 2009. So basically the big guys are either long the long bond futures or they are short stocks (which is essentially the same of late).

I argued with a friend earlier today that this market cannot get more bearish than it is and he responded by saying that people can get "more bearish." Perhaps but if there are no bulls and many bears, where are the marginal bears to short or sell some more stock? This report just reinforces that bearish sentiment is way over the top and this market is setup for the monster of all rallies - that is if these macro guys cover and buy! Just to see the bears perspective, there is a risk that a vacuum could ensue of the buyers remained sidelined...I am not thinking such happens but it is on the table for the bears - in other words, if they show up and buy, look out shorts.

Well, that is my last post for August. I am heading out for some R&R. Haven't checked the weather but hoping things are nice. Talk to you in September.

Random Finish

After listening to bubblevision this morning (that would be CNBC), I was left wondering how the pm's don't believe it is a bubble in bonds (but stocks should move higher); how the 4% mortgage rate is being discounted as useless; and why nobody is talking about stocks - that last point was somewhat amazing to me that there was little mention on what one is buying in equities! If you add in the fact that Bank Credit Analysts have taken a more balanced appraoch (taking risk off the table and allocating more to bonds) and the argument this morning that lending is not happening - the latest figures from the fed show a turn - one has to wonder how much more bearish this market can become! The simple fact that people are buying bonds with 10yr yields at 2.50% tells me all I need to know - there is panic in the streets and stocks are cheap.

Now I don't normally give valuation arguements for stocks. I used largely price and time based models for the given asset. But there is one measure I use that I find very useful and it is the PEG ratio. Assuming the market earns $92 on a forward basis which is roughly 20% higher that the current level of earnings in the market, you arrive at a trailing PEG of roughly .75 - essentially the market is trading cheap to growth because the market participants do not believe that number is attainable. Further, if you add in dividends per share, you come to a number that is trading at less that .60x growth - a major discount for stocks. Last point: 10s at 2.50% is about 36x earnings or 4x the current adjusted PE plus dividend figure. Bottomline - too much money has flowed into bonds making stocks extremely cheap!

So what resolves this? I think the stabilization of the Nikkei 225 over in Japan and the selloff of the Yen globally. These two variables right now, in going the other way, are putting severe pressure on the Japan economy even with super low rates across the spectrum. They are bordering on technical default as many banks (I believe) own equities and the rising yen has choked off exports driving down taxable revenue thus making it more difficult to service the enormous government debt load (200% of GDP). A default by Japan would cause a major run into treasuries initially - then I believe a move out of them as debt all over the globe has risk priced into it.

Will the default happen? Not sure. I need to do some more research on the topic which I will do when I start my two week vacation tomorrow. Thus there will be very few posts between now and the week before labor day as I venture off to the island for some R&R.

Yields Reversal?

I have been tweeting and writing constantly about the bubble in yields. I don't believe the economy is going into a dive but I am not blind to the fact that the markets are finding risk taking few and far between. However, there is a point where enough is enough and 3.70% for 30 years is foolish! Perhaps I eat my words on this but at the moment, the markets saw a reversal today with the long bond making a new low in yields while the S&P 500 did the same on the short term side of the ledger. As the 10 minute chart above shows, the markets followed these moves with a reversal higher. I would hazard to guess, barring a very weak GDP number on Friday that we have seen the lows for yields for several months if not years. And for those buying down here and getting into bond funds of all kinds, losses can occur while the stock market leaves you behind.

I do have one concern and it relates to the daily trade of the S&P. Essentially on the close today I had 3 different sell signals show up in my models and they were of the high probability kind. If we reverse from these levels above 1050, it could lead to a nasty selloff towards the 1000 level and below if it gets out of hand. I am not playing it this way and think the market can continue higher but the markets have been very unpredictable of late.

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Buyer Beware

I had a conversation with an portfolio manager months ago but the relative performance of the emerging markets to the S&P 500. My argument was simple: the emerging market trade was overdone and a correction relative to the S&P was probably going to play out based on a stronger dollar and some mean reversion in the relative performance of the two indexes - a game that the emerging markets have won handily over the past 10 years. Over the past month though the game seems to be getting a bit more interesting. As the chart shows, the emerging markets index by itself is in breakout mode - but relative to the S&P, it sits well below previous highs which in a way is considered a "negative divergence." There is no doubt that the global growth opportunities sit in the emerging markets at the moment and simultaneously, the US is finding PE compression the norm even in the face of strong corporate balance sheets.

So what to make of this chart? Bullish or bearish? Well, lets add one more variable; inflows into emerging market ETFs. According to a recent report, emerging market ETFs are taking in so much more assets than comparable ETFs (and large cap domestic is showing huge outflows...). So everyone is running away from the US and investing overseas in what is termed the likes of the BRIC. The problem with the current move is that it is not grounded in the index itself but the weakness of the S&P and the fact that the dollar has come off and not turned to the upside in any sustainable way (one month does not make at trend). This essentially means that variables outside of the emerging markets are pushing them upward which is not sustainable. Sure the dollar could go into a multimonth or year downtrend again or the S&P 500 could suffer another flash crash (which I think is not in the cards) while the emerging markets index does nothing.

In other words, I think based on the fast money moving into these markets, the recent dollar behaviour to the upside and the renewed uptrend in the S&P, the emerging markets might be in for a world of hurt if these flows reverse.

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But I would buy India

Yesterday I noted that I would not be a buyer of China based on various indicators. However, in looking at its neighbor to the south, I would be a buyer of India at this juncture. The technical backdrop is solid as the index has seen steady gains (yet not parabolic) while the economy is expected to show better growth prospects going forward. While it would be naive for me to believe India is immune to the US problems, it appears the connection has waned a bit over the years arguing that if India can growth around 8-9%, then the downside is around 6% in my opinion on a US recession which argues for support. Further, with more global influence comes more opportunities and if the Indian economy grows, this should increase the the Rupiah globally - stronger currency combined with high rates leads to inflows of investment.


In terms of the chart, the upside looks to be about 20k at this point as shown. The index is not overbought and the trend measure I use to look at acceleration/deceleration is breaking out to the upside after consolidating. Such normally leads to impulsive moves to the upside - in other words, we could see the index move to the top of the range in short order and then consolidate again. A breakout to the upside would change the steady rise dynamic and lead to a rise in volatility. I am unsure if local authorities will be receptive to such given their history.


So overall, I am bullish on India via the solid economic position and the solid chart.

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Tale of Two Currencies

Over the past month, the Euro has been facing a world of pain to the downside, having rejected the 1.33 level like it was a brick wall. At the time of the top, I did not see the trendline drawn on the chart - it just happens to be right at 1.33. Sometimes the most obvious thing is in hindsight. More obvious was the fact that the 13 month moving average happened to be sitting at 1.33 and it hit that level on the dot. Thus two major reasons to sell. On the other side of the ledger, the British Pound, the same currency I was hammering away at in my note on the Chinese market, looks like it is in breakout mode with a move over the 13 month MA. This argues a few things. First, the EuroGBP will be trading in favor of the pound based on this movement and b) that the USD might be catching a legit bid at the moment.

So what does all of this mean? Well last time the Euro collapsed to lower levels, stock markets moved higher and the dollar traded strong. We saw rates back up as well with 10s moving towards 4% and the bond near 5%. With my bullish fundamental model for the dollar actually trending higher, a break of the Euro from the 1.25 level sets up the currency to trade back to the previous lows but I also perhaps down towards the 1.10 level. Before the market took this as a negative but given the economic data that poured out of the Eurozone before on the weak Euro, the market might take this as a bullish event.

Also in the past, a falling Euro/GBP cross rate has correlated well with a rising dollar index; this would have implications for the screaming yen. A change even slightly in the trend could be helped along by the BOJ, which is clearly not happy about the rising Yen. An improving pound also could help the UK move out of its morass and lead to better currency inflows - while hurting manufacturing somewhat.

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Gold = Golden?

At the end of July, I noted that gold has broke through good support around the 1170 area and was destined to trade to the bottom of the range near 1070. What happened through the end of the month though nullified the trade and set up a reversal from those lows heading into August, as the chart shows. Now it appears gold is targeting the 1250 level next and a break past the previous highs probably sets up 1350s or so. The dollar has been strong of late which has me wondering if there is a currency issue developing again and people are buying gold versus Euros.

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Uh Oh, breakdown?

Double dip talk picked up on two factors earlier this year; first on the flash crash which changed an optimistic outlook on the economy into a gloomy one; and the housing/employment mix. I have argued that the flash crash was just a very quick correction - one that would have taken place over several months similar to 2004 versus several minutes in early May. The latter factor I was taking a wait and see approach because I believed that the flash crash would effect the economy to some extent like the crash in the fall of 2008 stalled out global business but I was unsure how much it would effect it. Further, I was taking the optimistic view because I believed everyone was (and is) quite bearish on the economy and a "double dip" was forthcoming. Since the crash, we have seen employment figures miss on the headline (though improve on the hours and earnings side) and housing stats basically decline. Further industrial and small business metrics have been mediocre as well. Thus the fundamentals are not exactly improving - at the same time they are not diving like they were in 2008. In short, this "flash crash" has effected the economy but it appears people in the business community were ready for it.


While some sectors were ready for the flash crash, some sectors have not bounced back and threaten another leg down. As the chart shows for the Dow Jones Homebuilders and the Philly Housing Index, their underperformance versus the S&P is about to break lower and make new lows. If you remember, in 2006, as the chart shows, both of these indexes rolled over a whole year earlier than the bull market. Part of the massive bearishness we are seeing in the market at the moment perhaps revolves around this movement as we all saw housing having issues but nothing unraveled to months and years after the peak in 2006. On the chart there is a clear range drawn from the lows in 2007 through last Friday. Both remain below the 13 month moving average which is bearish and now they are threatening to take out those lows of the past 3 years - four bounces more specifically. If this one fails, then it appears the economy will be at severe risk and another leg down in housing will be forthcoming.

The most troubling thing about this factor is simple: if these housing indexes begin their break to new lows, chances are pricing and demand figures will follow. For the economy to improve, people have to be able to sell their home to move to productive areas that meet their skill sets. AT the moment, our economy is suffering from structural unemployment - skill sets in the wrong regions. If people can be mobile, they can take their skill sets to another part of the economy and gain employment. If they cannot sell, then the are discouraged workers and less productive leading to higher unemployment and pressure on wages where there are large supplies of workers for few jobs. Thus in my opinion, housing needs to be loose to allow for this structural unemployment to unwind some. Till then, no matter what the Fed does with policy, the unemployment issue will probably remain a problem.

With unemployment an issue, the economy will continue to flounder and this will put a serious dent in my bullish thesis if a major break in these housing indexes follows.

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Tale of Two Markets

Much has been said on this site about the bond bubble so I will spare you any restatement of the same old tiresome statements I have been making. However, take a viewing of these two charts. First one is of the long bond yield and how it is right at resistance as we head into a new trading week. A break over this level argues for a move higher towards the 3.70% level and then 3.88% which was a major level on the way down. This by itself is not that big of a deal. however, if you look at the second chart, that of the S&P 500 on the same 30 minute scale, it is right at resistance as well - that argues that both markets are interlinked at the moment contrary to what was being bantered about on bloomberg and CNBC on Friday by these yahoo bulls in the bond market (and growling bears in the stock market).

If the S&P climbs from here, the bond is going to make it ways towards that first resistance line. If the S&P continues on its move and gets over the 1080, the bond is going to spike higher - ie the bond market rally might be over or at least a correction will be taking shape. Like any euphoric bull market, the bond bulls will not go down easily and thus we'll probably see 3.88% serve as solid support for their case and a move back down towards the 3.70% level will probably follow. Stocks meanwhile are going through the August doldrums so whatever dance the bond was to do, the stock market will have to follow its lead and be a viable dance partner.

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Tweets Rundown for the week ending Aug 20th.

1. Change of heart. Covering the whole short position. Will look at it again on Sunday night. Have a good weekend everyone. $USU Friday, August 20, 2010 2:58:19 PM 
2. Covering half my bond shorts on this dive lower. Will probably go home flat and reload next week. $USU Friday, August 20, 2010 2:56:00 PM
3. Adding to the bond short but tightening the stop. If we lose 1060 in the ESUs I will probably close and look for a new entrance. $USU Friday, August 20, 2010 12:04:16 PM 
4. I covered my very small profit in 10s. Holding the bond position. Thinking I might be on the wrong side. $USU $TYU Friday, August 20, 2010 10:16:36 AM 
5. Bond short tripped. Now position a bit more than modest. I posted on the blog my position on bonds. Now backing it up. $USU Friday, August 20, 2010 8:52:31 AM 
6. Looking to short bonds on a stop below. Action quite volatile in the early going so far. $USU. Friday, August 20, 2010 8:22:19 AM
7. Added to my TYUs short this morning. Holding a tight stop though. Market is not giving up as the buyers scour the dips. $TYU Friday, August 20, 2010 8:20:40 AM
8. I wonder if the robots attempt to wipe out the market overnight...does that mean I should be short? Looking both ways tomorrow. $SPX Thursday, August 19, 2010 4:33:13 PM 
9. B'berg folks just said that the movement in the bond mkt is justified based on the claims data. I have started a small shorts in 10s. $TYU Thursday, August 19, 2010 3:55:48 PM
10. Covering my VIX futs now. Right at resistance on the 30 minute. S&P is oversold. Might reload. $VIX $SPX Thursday, August 19, 2010 11:50:10 AM
11. Greatest selling momentum I have seen since early July. Will it repeat the buying momentum spikes yesterday and reverse? $SPX Thursday, August 19, 2010 11:20:25 AM
12. Looks like we have chosen the bottom of the range going forward. I have expanded my hedges a bit though a bounce would not surprise. $SPX Thursday, August 19, 2010 10:01:40 AM
13. Once again, bounced off the bottom of the range. 1084/1100 seems to be the game (as I noted this morning at my blog. Neutral at moment. Thursday, August 19, 2010 9:07:13 AM
14. Is it me or is everyone buying the TBT, shorting USTs or shorting the TLT now? $TNX Wednesday, August 18, 2010 3:19:11 PM
15. With that said, I am taking the 4 points and saying thank you. Back to neutral in the SPUs. $SPX Wednesday, August 18, 2010 3:15:57 PM
16. 2 days in a row where my buying power indicator was off the charts in the 1090s and so far mkt has turned away both times. $SPX Wednesday, August 18, 2010 3:14:55 PM 
17. Impressive move by crude into the pit close. As if the API report and other fundamentals do not exist. Good resistance at 76. $CLV Wednesday, August 18, 2010 2:28:02 PM
18. Upside stops cleaned out around 1098? I took a small short for a trade. Stop over 1100. $SPU Wednesday, August 18, 2010 2:10:05 PM 
19. Vol not treating me well today. Holding the trade but a bit surprised by the move. I have put out stops just in case. $VIX 2:24 PM Aug 18th 
20. Looks like someone is goosing the SPs again. Just a bit later than yesterday. $SPX 12:06 PM Aug 18th 
21. CL report better than API. Demand up but supply rising. Basically inline overall though gas missed a tad. Not supportive. $WTIC 11:51 AM Aug 18th 
22. CL seems to be pricing in a weak DOE report this AM. This sets things up for a reversal if the report does not follow thru on API's. $WTIC 11:26 AM Aug 18th 
23. Adding aggressively to my VIX position this morning. Thinking correction in stocks to continue and vol to rise a bit. $VIX 10:46 AM Aug 18th 
24. Interesting reversal in 10s from sub 2.6 to above it. One day does not make a trend but a cont'd equity rally might help rates higher. $TNX 10:22 PM Aug 17th 
25. I started a position in the VIX near the close. Looking for this correction to continue though lows are probably still in. $SPX 10:20 PM Aug 17th 
26. Going through the overnight data on ES - someone just pushed 1000s of mini's thru in the normal quiet hrs of morning. Missed this! $SPX 10:19 PM Aug 17th 
27. Weak API numbers. Not good for crude. Big jump in gasoline rel to expectations. Distilates up as well. Could pressure CLV tomorrow. $WTIC 5:39 PM Aug 17th 
28. Correction is still in play but I am flat as a pancake tonight waiting for the next sign. Follow thru needed for the bulls tomorrow. $SPX 5:15 PM Aug 17th 
29. Stopped out on the breakout. Resistance right at 1094 area. $SPX 12:45 PM Aug 17th 
30. Bulls determined to take this market higher today. Looks like I am on the wrong side of this market at the moment. $SPX 11:47 AM Aug 17th 
31. Buyers are holding the SPUs up well here around 1084. Wonder how many stops are underneath? I have tightened my upside stop. $SPX 11:22 AM Aug 17th 
32. Impressive jump in IP but the tumble in the CEO Index still a headwind. Need biz to come back quickly. Keep the bull alive. 11:17 AM Aug 17th 
33. Back on the short side of the trade now. Market holding in. Thinking we have one down day before friday. $SPX 10:44 AM Aug 17th 
34. I am positioned for an afternoon dive. Not sure yet but have the stops in place. Action is just horrid. Yet again, it is August. $SPX 3:16 PM Aug 16th via web
35. Key point for the S&P 500. Momentum signal to buy. Needs to follow through over 1080 in SPUs to confirm. $SPX 12:44 PM Aug 16th via web
36. Guy on CNBC just said that housing is a great investment...this is the lingo we heard all the way up to the bubble...not good for my outlook 12:41 PM Aug 16th 
37. Not a good open at all. No bounce whatsoever and everyone so very much bearish. 10:30 AM Aug 16th

Blame it on the Claims

Buzz lightyear of the Toy Story movies is known for his popular saying - "to infinity and beyond!" Following the very weak Philly Fed this morning, the bond lept 1.5 points in a heartbeat (or less than an heartbeat it seems) smashing traders over the head with a bullhorn and going "beyond" most traders tolerance levels. I had a friend say to me that he would be looking for the first sell off to get out of his positions because he has been "wrong." But in all seriousness, have you seen many bulls arguing that the bond trade would be the trade of 2010...to the downside in yields? Further, as I tweeted yesterday, it seemed like everyone was shorting the bond - and today, they all got run over!

In my opinion this rally in the US treasury market is simple. The momentum was already up in price for the UST complex and the Fed came in a few weeks ago, argued that the economy was soft and they would be putting the interest and maturities from their balance sheet to work - in the long end of the UST market! This pushed the trend even further and essentially putting another Pimco into the bond market (how about those 5000k contracts at a time, eh?). Every hedgie on the planet who plays momentum jumped on the trade and away we go! As the day wound down and I prepared to short the 10yr note futures, with a modest stop I might add, some guy on bloomberg says that the rally in bonds makes sense when you consider the claims data. Huh? Adding further gasoline to the fire was Tony Crezenzi, who I have a ton of respect for, saying that at 2% growth, rates are not unreasonable or something like that. I made the move and shorted 10s - modest position again.

Perhaps this was not a wise move but let's consider the facts again. Corporate earnings are not falling off a cliff and a fair value at the moment for the market higher than current values. At the moment, the 10yr is 400% overvalued relative to my earnings measure which is basically a 60 year record! If you take into account corporate earnings, sprinkle in some now rising agriculture prices and already high crude and the softs, you have asset inflation that is just dying to pass through to final goods. Those goods in demand....forgetaboutit! Already moving up. Inflation is in those goods demanded and in my opinion, that is all that matters.

So the facts argue that the treasury market is severely overvalued and displaying tremendous momentum to the upside in price. Further the hounds are out buying corporates at 1% for three years (IBM) and muni's like they are going out of fashion. Meanwhile, JNJ's dividend yield is higher than some levels of its debt. Folks. This is a bubble on so many levels. Perhaps retail does not realize one can lose money when rates back up?

With that all said, one has to obey Mr Market and be careful. The S&P 500 traded very expensive to its fair value from mid 1999 onward and the nazz went screaming higher before getting killed a year later. Thus I will be patient but to me this trade will materialize sooner than later and for all of you bond bulls out there, momentum is a 2 way street.

Games of 3

Every once in a while, I notice a few things in the market that make me go "uummm." For example, the other day on the rally out of the 1070s for the S&P 500, we saw a big drop in cash money flow around 1084 but a surge in the index futures that kept the market from falling - and instead goosed it pass resistance at 1090 and up towards the 1100 level. The "surge" in the futures pits was a bunch of dealers buying and this pushed the locals to raise prices - never mind that the broad market was actually going the other way! This type of activity occurs all the time but it is never so blatant...but alas, it is August - a period where the rookies are running the desk and the pros are on vacation.

Another interesting development is the pivot of 1090 in the SPUs. Over the last 2 days, in looking at the 5 minute chart, it has served as a point to place one's stops - that is right above 1090 to buy and right below 1090 to sell. The dive late yesterday was quick and efficient once 1090 was taken out. Earlier we had a dive and a rally. And before that a rally followed by that aforementioned dive. This morning we had a slight change in the behavior. Some cowboy(s) decided to run this higher on the close of Japan at 2am (don't ask me why I was up). The market climbed through 1090 but was met with sellers at 1092 and proceeded to break thru 1090 and dive to 1086. Around 6am the 'boys were back making another run higher to 1092 yet again.

The last thing that makes me go hmm, revolves around buying power. Yesterday and the day before the market zoomed to the highs on heavy volume only to be met with broadening top formations - distribution if you will. Each time my momentum indicator was registering a 140 which is absurdly high on the daily chart but symbolic of strong pushes with a 30 minute perspective. Generally with the former, you get a top and a market correction; with the latter we get a high momentum burst to the upside. What we got was the daily character influencing the 30 minute trade which while a rare occurrence, it is not something that can't happen as a result. But when it does, it has a message: August of 2010 will be a tough one for the bulls. There is just not enough firepower to the upside and no shortage of sellers.

So let's bring these thoughts together. Institutional buying around 1085; 1090 seems to be the revolving door for the trade; and 1100 seems to be the point where the short term guys buy but the point where the institutions are selling. Thus one very tight trading range. My guess is that the move for the fall will be determined largely from what happens in this area - a break above and the bull resumes or a fall below and the sellers pile on. Till then, game on!

Overvalued...enough Said

As the buying continues into the US Treasury market, I figured some perspective was in order today. If one believes like myself that the economy is not going into the tank but rather will muddle along, then this move in the 2 year is simply bubblicious....everyone I know is buying bonds at the moment and I am unsure what the flip side of this story will look like. As the chart shows, three instances over the past 15 years have occurred where the 2 year has outperformed or underperformed the banking Index (BKX). Each time the banks held in and the 2 year note had to play catchup to move back towards the mean or the banking index in this case. Thus from this chart, the 2 year is almost 100bps overvalued. A spiking 2 year probably won't be good for anyone buying here.

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How about that!

This past weekend, my long time trader friend, Ed, came to town to visit with the family and his hold friends - he lived in the northeast before moving out to Chicago to trade at the Chicago Mercantile Exchange. He was a trader in the pit at the 'merc and when i visited him years ago, the mini S&Ps were just in their infancy and the big contact of the S&P was the guide to the equity markets. Since then this thing called globex was created and grown and online trading took off - thus now he is out of the pit and trading mini S&P's for a living. So when we sit down and talk markets, two views clash - the one that has the trader perspective of the pit and emotions versus the analytical one of myself who has been behind a desk his whole like and uses spreadsheets and software programs to gain an insight into the marketplace. The most talked about topic is that of the economy and this once again comes down to what you see in reality versus what you see on the computer screen.

Ed's belief is that the economy is weak and getting weaker. He thinks the S&P, while cheap on a historical basis, can easily get cheaper because we are in an environment that features massive PE compression of multiples and low correlation. In short, valuation does not matter at the moment because of the continued risk in the economy and possible inflation spike that is probably coming thanks to the Fed's super easy policy. He thinks that Wheat is just the beginning on the spike side as the movement in corn and beans will be coming sooner than later to the upside joining already high crude prices and super high gold prices. While gold would be a logical buy, he thinks that the gold story might be limited to a trading range because inflation is priced into it at the moment. Lastly, he is of the belief that any incumbent this fall will lose in their reelection bid - not just democrats.

So how did I respond? Lets look at these piece by piece.

Valuation does Not Matter

My response was that I do believe valuation matters - at least on the Macro level. My valuation bands formula which essentially measures three types of markets (panic, normal, euphoric) basically bounced off the bottom of the normal valuation band which argues that the market should now bounce to the top of this valuation band. At the moment, the S&P 500 is hanging out around 9.4x forward earnings plus cash and the top of the range is 11x. While I agree PE deflation is occurring at the moment, while the economy maintains a sort of weak growth but no dive and unemployment does not get meaningfully worse, then I think we maintain this range. Thus I think on balance the S&P should make its way towards 1150 at some point this year. A break of the 9x range and then I need to change my story.

Inflation an Issue

I am divided on this issue. Within my Trimmed Mean and CPI models, I see inflation compression pushing towards deflation. Within the market I see the exact opposite. Does this mean the statistics are lying or that profit margins are being hurt? So far with all the layoffs in the corporate world combined with a cut back in salaries, the answer to this question is unclear. However, given my belief that the Fed is way too easy with current policy via the rate side of the equation, I think an inflation spike, at least within the asset markets, is now on the table. The CRB has woken up of late and crude has basically held in for the past 6 months. Now with the agriculture sector all waking up, food prices are about to see a sizable move higher since these are goods in demand - people have to eat!

Gold range bound

I share the opinion of my friend Ed in that gold is probably range bound. I am impressed again with the move though that took gold down through major support around 1180 and then back above it (and to the current 1220s levels). A break past the 1250 level would change the battleground in my opinion; in short, inflation within the asset markets would be confirmed with gold breaking out. Failure to do so and I would imagine the contact moves back down to the bottom of the range and then all the gold bugs rethink their premise...again!

Incumbents out!

Unique thought but I have to agree with it. Public sentiment versus Washington at the moment is just rancid. Good luck if you are running!

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Omens

Over the weekend, every "johnny come lately" technical analyst cited the infamous Hidenburg Omen. In fact, one person tweeted that it was one of the most searched topics on google this past weekend as everyone has to find out where the markets were going next, based on this indicator. As I tweeted over the weekend though, I don't belive in the indicator as the Nasdaq has been so weak - essentially their new highs to new lows has been decidedly negative for a while now so the difference is the rate senstive names on the NYSE are distorting the data and creating the "Hidenburg Omen" situation. So in an effort to review the history of the Hidenburg Omen, I went to my trust stockcharts.com site nad looked at the chart. In short, this omen is not a good thing to see in that they warn of problems impending - at the same time, a collapse in stocks has not followed immediately which is what the Johnny come lately's are looking for.


In reviewing the last few years of omens that showed up via my trust stockcharts.com model, they tend to argue that problems could be arising (they show up early) and tend to confirm the movements by the rate structure of the market taht the economy is weakening. In 2007, there were a bunch of these omens according to my chart and the reason was simple; people were buying rate senstive issues on the NYSE and as rates fell, the stock markets fell - as the 10 year versus S&P shows on the chart. From what I can see, this omen does not lead to collapses in stock prices though from one of my other friends, she said that it has not showed up as much as I am showing and it is more powerful than I am letting on. Till I see that data, I will stick with this model and argue that while the "omen" is not a good thing, I do not believe it is as powerful as people would like. Further, one of these omen's showed up near the market highs in August of 2007 when liquidity was a problem in the marketplace and the markets proceeded to rally to new highs in November. So I remain skeptical of this indictor.

Another indicator that is bothering me a tad is my on balance volume model which is starting to roll a bit. This argues that the downside volume is starting to pick up the pace versus the upside volume over the past quarter. If this continues the indicator will roll over and perhpas get confirmed by the rest of my market model. While it is bothering me, I remain long term bullish at the moment.

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Cisco'd

Wow, reading through the various reports on Cisco this morning, I have never seen so many rats run away from the recommendations. One analyst called the report a disaster and another said the party is over. This all following a report where they beat by a penny and beat on what I thought was the revenue guidance (but missed on the whisper which has capsized the stock). Market sentiment is just so poor at the moment that the action in CSCO (dn 8%) is not a surprise. Following the conference call where Cisco's Chambers used the word uncertain to color the future, the SPUs slammed lower dn 10 quick one's to the 1075 level, after closing 3 pts below fair value to start with. In summary, market sentiment stinks!

However, when sentiment is so poor, values begin to materialize which is why I added to CSCO this morning. I also bought a few other names that were being drilled only because they were tech. The movement in the SPUs since yesterdays morning open at 1100 has been about steep dives and slow rises. Of late, the latter has won the battles which has led to strong closes in the contract. Since I believe this is an overreaction combined with my bias within the trade now swinging to the long side, I think that this overreaction by the bears to CSCOs numbers will lead to them covering en masse. 1090 is the level I am watching though 1100 is more important.

One more thing before closing - yesterday, my bearish cabal (those of my fellow traders who were bearish) were adamant that the October collapse was now setting up. Since I don't believe we follow such a path, I debated them on it. Not one said we would have a rally into year end so I was on my back foot in every conversation or IM.

Bottomline is simple: everyone is way to bearish for this move down to materialize. Froth on some level is needed regardless of what the machines do. Thus, I am looking long.

Yen Breakout

I have been very skeptical of the Yen's recent strenght on the back of very poor domestic fundementals as well as my belief that it was not yen strenght but rather dollar weakness which in the end, as we have seen with the Euro's mvoe higher, such a state does not lead to long lasting selloffs. In any event, a Yen breakout looks like it could lead to some selling and a sldown in hte trend of the S&P 500. also the Nikkei will not respond well either. BOJ authorities last night mentioned that the mvoe in teh Yen was unwarrented adn hinted that intervention was coming. Yet again, intervention never works so why even mention? Because if the Yen were to put in a reversal at this point, the momentum is not nearly strong enough to withstand intervention. My feeling is that there are many traders with one foot out the door on this one. They just need a catalyst.

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Overnight Dive

Interesting overnight session thus far. Traders saying that conditions are thin which could explain the dive downward below the support around 1121 and the 65 period level at 1120. The low of the trade happens to be the bottom of this trading range around 1114. A break through should lead to a test of the 1106 area and then things get serious for the uptrend - reason being is simple; seasonally this is supposed to be the strong week and if the markets actually finishes lower, that would argue for overall market weakness. With the break overnight I am now short so we'll see how this plays out.

As for the other major news event of the day, ie the Fed, just a quick word. Money supply figures have been slowing on the growth side and outright negative on the loan and revolving credit side so the Fed's move to reinvest dividend and maturities basically keeps the money supply constant - accelerations of money supply are an increase in easy conditions...a decrease in money supply is a tightening of conditions...and doing nothing and keeping things steady is a neutral stance. So while the Fed claims things are weakening, they are in fact neutral while things are weakening. I don't see a double dip as a viable threat but the economic indicators are clearly slowing.

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