Test

PIMCO Chimes in on Supposed Bond "Bubble"

This article provides a nice summary of reasons why Treasuries may not be a bubble in support of my prior post:

http://www.cnbc.com/id/38785166

I also thought this article provided a nice discussion of the stock market from a technical perspective in the context of the relationship of consumer staples vs. consumer discretionary stocks. What we see is that the "risk-off" trade has persisted even when the market appears to make short term moves upward:

http://www.investedcentral.com/public/chart_of_the_day.cfm

Analysis About Treasuries on CNBC Superficial as Usual

I have been listening to CNBC today and there have been numerous discussions about a US Treasury bubble. Most of the conversations focus on the low yield of bonds and how an investor can find more yield elsewhere (e.g. solid companies with good dividends). They also talk about valuations of stocks and bonds with bond values somehow being markedly overvalued (although I did hear one argument that the real = inflation adjusted return of the 10-year bond is reasonable and not overvalued). Wharton professor Jeremy Siegal even piped in as a bond bear just now. The rationale is that when there is inevitable inflation, the yields will go up fast, and the value of bonds/bond funds will crater, providing a nasty surprise to retail investors who have a tendency to pile into asset classes at absolutely the wrong time.

While it is important for those piling into bond funds to realize the potential downside risk (not a safe haven by any means), I think this is one of the worst discussions that I have ever heard because all these analysts are missing the point. The trend in Treasury prices is higher until the trend is broken. There was a clear change in the long bond chart price trend at the end of winter/early spring that I used as a signal to overweight bonds in my portfolio. In this sense it is no different than holding a fast moving stock. You don't necessarily sell it as long as the trend remains favorable. Those who followed this trend are up about 10% in just a few months, so the yield is completely irrelevant to the thesis upon which I overweighted bonds i.e. I sought opportunity for a capital gain by buying the long bond ETF (TLT) when I saw a break out in the chart.

So all the caveats apply here too--what goes up fast can go down faster in value. I would even add that bonds are due for a breather and a steep correction, so maybe it is not the right time to jump into this asset class. Several smart money investors that I do admire have clipped their longer dated treasury positions on strength this week. However, there is very little risk of inflation in the short term. The two key components of inflation are absent i.e. the money supply has been shrinking and monetary velocity is abysmal. These are the ingredients of short term deflation not inflation. The direction of the economy over the next 6 months should provide clues to whether we are in a Treasury bubble or whether we are just at the beginning of a new up leg in a 25 year bull market for this asset class. If the economy stalls further, you will not see inflation of any significance.

I will not profess to know whether we will have inflation or deflation in 5 years, but anyone who thinks Treasury yields can't go lower because they are already at historic lows seems to have missed the news in August that the yield on Japan's ten year bond is below 1%. Japan has structural deficits and debt much greater than in the U.S., and, yet, inflation has been nowhere to be seen for decades. Just keep that in mind the next time someone tells you there is a U.S. Treasury bubble....maybe, but maybe not...

The Market Will Interpret the Data Any Way It Wants

The market had a big gap up at the open today (8/2/10) as seen on the above chart and is near a test of the upper trend line that I had drawn a few days back. The market now faces a test not only of the top trend line but also a longer term resistance point dating a few weeks back to the mid-June high (highlighted by the horizontal line). The market is very immediate term overbought. Gaps are commonly retested, so expect the SPY fall back down into that gap between SPY 110 and 112. Below that there is also support at the lower trend line at about 109.70. The S&P 500 is above the 200 day moving average and market internals are markedly improved, so a pullback is likely a very good buying opportunity with placement of a close stop below the lower trend line. A cross above the June high would be bullish indeed and another point to wait for an entry into the market. Until that point, while the market technically looks poised to break out, we cannot confirm that the trading range between 1020 and 1130 or so on the S&P 500 is definitively broken.

The key piece of economic data driving the market at the open today was the China Manufacturers' Purchasing Index (PMI) which came in relatively low but better than some expected. This is the mentality of the market since last week = bad is good as long as it is not so bad. There is always a rationale behind such bullish reactions. The thought of analysts today who were bullish is that the government in China will now get their foot off the breaks and let their economy speed back up. Of note, our US ISM number was lower suggesting some weakness in manufacturing though far short of a recessionary number. Again, the interpretation of the bulls was that this number could have been worse. While it is beyond the scope of this blog to dig deeply into the numbers, my analysis suggests one could easily have looked at both the China and US numbers with as much concern as optimism. Economists that I respect such as David Rosenberg and John Hussman are still very cautious about the US economy and the risk of significant immediate headwinds related to housing inventories, mortgage interest rate resets, and consumer debt.

As many of my readers know, I remain long term bearish on the future of the economy and the US stock market. However, we have seen amazing periods of overvaluation and upward market moves over the past decade that lasted many years despite faulty fundamentals (e.g. internet stocks with no earnings models, an over leveraged private and public sector with an ensuing credit bubble and 4-year stock market rally). Stocks that are cheap can get cheaper. Stocks that are expensive can go higher and get more expensive for far longer than you think. The era of buy and hold is largely dead. I suspect that the current bull is one of many cyclical bull markets within a much larger secular bear market. Such secular bear markets have historically lasted 15-20 years where stocks provided zero returns despite major moves in both directions during those periods. Japan remains in one for over two decades. I strongly advise readers to consider using methods of tactical asset allocation such as those utiliized by Carl Swenlin of Decisionpoint.com and Mebane Faber at mebanefaber.com to allow for exposure to various asset classes while managing risk.

S&P 500 Pause or Failure at Resistance?

The 200 day moving average is often viewed as a key technical marker for a bull or bear market. However, it is clear that the price of an asset class simply closing for a day or two above or below this level does not signal an all clear signal. This chart shows the SPY daily price action (the ETF for the S&P 500). One can see that in mid-June we briefly broke above the 200 day moving average (blue line)for about 4 days only to break back down. This week we again have been trading above the 200 day moving average only to see a very bearish price reversal (price started up for the day then went down dramatically suggesting the bears had gained control) today as of early afternoon on some deflationary comments from a member of the Fed. I think it is too soon to conclude that we are now back in the trading range of S&P 1040-1120 of the past few months as many technicians felt we needed to consolidate a bit after a rapid run up last week. If we are to continue higher from here, I would look toward the white lower trend line that I have drawn as a possible level of support where we would have a new higher low to follow the higher high in price three days ago. Uptrends tend to be marked by oscillating prices between higher highs and higher lows. The pattern remains consistent with that possibility unless that trend line is violated.

I quote this portion of a recent post here--"A word of warning, however. I am not a believer in the predictive value of stock market moves to necessarily provide a 6-month guide into our economic future. After the bear market began in early 2008, the S&P 500 went back above the 200 day moving average twice in May 2008, before then descending on a long term downward path. Clearly, early May 2008 was a dangerous time to get back into the market without a risk management plan. Even for long term investors, I would tread similarly here back into the market with a defined risk (i.e. stop loss) such as the ones suggested above."

So here we are in the early spring/summer of 2010 with two failures to hold the 200 day moving average. Continue to use good risk management if you are going to expose yourself to market risk. I have found that lagging a move above a key resistance point or moving average cross by several days or 1-2% (waiting before buying to make sure the price holds above key technical levels) dramatically increases long term returns and reduces volatility in simulated trading models of the S&P 500 and other major markets.

Positive Momentum, A Positive Summation Index, and the Predicted Stress Test Result

It would be hard to fight all the good news and momentum of the past week. The oil leak in the Gulf was slowed. FINREG as a headline risk is now past. Earnings and revenues for the quarter completed have generally been better than expected. Further, as I predicted a few days back, the bank stress tests proclaimed that all was well in European banks. The fact that this seemed to act as a positive catalyst for global stock markets tells one something about the irrational behavior of market participants. While I will admit that I have not read in detail the criteria of the stress tests, I have heard repeated criticism from reliable sources that there was an assumption that there was no risk of sovereign debt defaults (or least an omission of consideration of such risk). Regulators made this assumption despite the fact that Euro banks hold risk of hundreds of billions of dollars in sovereign debt/derivatives related to that debt. As an investor, one should be wary of the conclusion that the ultimate capital shortfall in the European banking system is around $3B....With likely continued good news on the earnings front over the next several weeks, the only headline risks appear to be in employment and GDP reports. Unless, there is a negative surprise on those counts, headline support has helped the bulls regain control of the of the stock market. As John Hussman notes in his weekly report today, the gradually deteriorating fundamentals of the U.S. economy are not likely to get in the way of technical changes in the market short term as the former are not day to day news events.

I would caution that this market has had several apparent breakouts of the trading range and is very tricky. However, on a technical basis, the market is looking stronger. The upper trendline drawn on the S&P 500 ETF in several previous posts has been broken to the upside, as has the 50 day moving average. The next challenge for price is the 200 day moving average just above an S&P level of around 1110. In terms of position, I think the market moves of the next few days will provide an indication of short term further momentum with clear levels to be used as support and resistance. Personally, I would not be short unless we see the 50 day moving average and former trendline violated to the downside. One could take a long position right here with those as your stop points or wait for a hold in price above the 200 day moving average. Of note, I have repeatedly pointed to the NYSE Summation index (a measure of market internal strength by advance and declining issues) as a clue to when the correction might end. This indicator has stayed negative throughout the correction off the April highs. It is now above "0" supporting the breadth of the aggressive recent move upward. Thus price momentum and market internals are now supportive of an end to the correction.

I word of warning, however. I am not a believer in the predictive value of stock market moves to necessarily provide a 6-month guide into our economic future. After the bear market began in early 2008, the S&P 500 went back above the 200 day moving average twice in May 2008, before then descending on a long term downward path. Clearly, early May 2008 was a dangerous time to get back into the market without a risk management plan. Even for long term investors, I would tread similarly here back into the market with a defined risk (i.e. stop loss) such as the ones suggested above.

Downtrend Remains Intact

Initially, I had some concern that the bullish price action yesterday was evidence against my projection of a downward move below 1000 on the S&P 500 (or below 100 on the SPY ETF). However, one can see on the chart above that the 50 day moving average coincides with the upper trendline of the down going channel, and price action has failed to break this area of resistance repeatedly over the past week. Until those lines are held by upside price action, the downtrend remains intact. One potential cause for optimism is that we now see a divergence in the trendline of S&P 500 price movement and the MACD indicator (i.e. the trend in MACD is increasingly positive). Such divergences typically predict a reversal of the current price trend though it can take weeks to months for this to manifest. CLICK ON IMAGE TO ENLARGE CHART