Weekly Overview for June 23th

Wednesday’s Fed’s Monetary Policy Statement and Press Conference by Chairman Ben Bernanke set off quite a shake down when all he did was basically say the same thing he has been saying for quite a while now and that was that he would begin to taper once he saw that the US economy was in firm footing. He did however talk as if the US economy was on its way to better days, although still admitting that the labor force had a ways to go. He left interest rates unchanged. Even though US stocks were taking back some of their prior losses, they fell off once Bernanke confirmed his somewhat hawkish stance. Markets all over world had already been heading south though some did take a bigger dive off the Fed’s news. The US index gained 2.3% for the week while the S&P, Dow and NASDAQ all lost 2.11%, 1.80%, and 1.94% respectively. The rest of the world fared worse. Canada, Mexico, Brazil and Chile all lost over 4%. Over in Europe, the Italian FTSE and the DAX were the biggest losers at -5.48% and -4.17%. The CAX40 lost 3.87%, the FTSE fell 3.05% and the Eurofirst index was cut down 3.68%. Over in Asia the Hangs Sang was down 3.37% while Shanghai lost 4.11%. The Nikkei was the only major index in the green posting a 4.28% rally taking some of its losses back from this month’s slide.

Bonds all over the world spiked on the news with the US ten year leading the way moving up a murderous 18%–opening on the low and closing the week on the high at 2.51. And Mr. Bernanke said he was not worried about interest rates at his press conference. And the media played it down as nothing to worry about for the US has been at higher levels and that the reason interest rates were rising was because it was a reflection of an improving US economy. But regardless of all 85 billion dollar a month liquidity in the markets, interest rates have been on a steady march up since the bottom at the all-time low of 1.39% hit on July 22nd of last year. And since the move up from the April 28th correction low of 1.61%, the index has been on a solid march up with only a two week breather when it consolidated just about sideways before making its 18% surge.

On the chart below study the correlation between the US Stock Index and the US 10 year Yield. Keep in mind that as bond prices fall interest rates go up and vice versa. Also note that investors usually go to bonds when they leave stocks and run back to stocks when they leave bonds depending on the risk on risk off environment. Hence, the usual positive correlation between the stock market and Yields. Notice the tight positive correlation in the yellow box. Now what should worry most is the disconnect in the final green box. What does this mean? People are leaving stocks, not just in the US, but all over the world and running not to the safety of bonds but to cash—hence the recent strength in the USD, EUR and GBP.

US 10 YEAR YIELD

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And to make matters worse, money has been running out of commodities, the commodity countries and emerging markets on the back of a contracting China.

Though worrying, the impression the media and most analysts are giving is that the good times are here and that the markets are over reacting. Even some of the more popular currency analysts sound desperate in their faith that the Fed set out a definite plan to ease back and finally exit QE when the Fed said no such thing. In a nut shell, they think since Ben said he would taper back when the market improved enough, they are assuming that QE would soon be over sometime next year. And as proof that better days are here is the improved and improving housing market. Most are ignoring rising interest rates and the few that do bring it up are put down by the argument that interest rates are rising because of the improving economy and that the US has had interest rates much higher and would be ok—all paying no heed to the debt levels throughout the private and public sectors.

In order for the market to be able to handle higher interest rates, debt levels have to be chopped down; and, the only way this can be done is if banks and governments default—something I don’t think the politicians will let happen. The Fed is stuck in QE to infinity then. As I have said, I believe the Fed is bluffing and now I am starting to believe the smart money does too. And as proof I turn back to the ten year chart and Elliott Wave.

The Yield in the ten year is carving out a path to the upside in classic Elliott Wave style. Minute blue circle wave one is made up of an almost text book leading diagonal. Wave one is longer than wave three which is in turn longer then wave 5. Also, wave two is longer than wave 4. And, I said almost text book because normally you want to see the slope of wave 1, 3 and 5 decline in turn. Here wave 5 slope is the steepest, however, it does over shoot slightly the upper 1/3 trend line in classic diagonal fashion before it dumps off for a steep wave 2 correction that completes just past the 61.8% fibo—a common retracement for a wave two retracement off of a leading diagonal.

US 10 YEAR YIELD

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And I don’t see how the move up for the third wave doesn’t worry the Ben or analyst. So far it looks like a classic wave three that has finished its wave one with a shallow wave two and an extending wave three already more than half way to the 161.8 extension of wave 1 at the 2.78% rate.

At this rate, the housing market is doomed. Home ownership is still at an all-time low. Most of the demand is coming from hedge funds and speculators that are in it for the rents. Right now, at these low rates, there is money to be made. This will soon change however. I wonder if the hedge funds have an exit strategy. Just what are they planning to do? Sell these rents to the public? Yes, they might be getting renters now, but just who is going to rent the houses that are only now coming off the back log of foreclosures? Remember that these people in these houses couldn’t pay their mortgages and have also been living in these houses for free during the foreclosure process. With rising interest rates, the rents have to go up too. Maybe their plan is to try to sell the houses back to the people that couldn’t afford them in the first place.

Or maybe they think the same people that are going to buy the Feds bonds when they try to unwind their balance sheet will buy the houses too.

Now what does this mean to us traders? Well so far we should pay no heed to the mass media and play it risk off until the charts tell us otherwise. I once read a book by a very popular currency analyst and she mentioned that the first thing she does in the morning is look at the headlines and news to see what has happened in the markets before she looked at her charts. So I did at first when I started trading but have since learned that it’s the opposite that is prudent. Now I turn on my charts and go through all my charts to see what price has done and is doing. Then, after I get a good feel I turn to the news for the sentiment of the day. And right now the Sentiment is a disavowed nervousness overly focused on whatever sign of life is out there while ignoring the elephants in the room.

Study the VIX below and notice how it has made closes averaging 20% above the red 10 period moving average. Fear is definitely in the markets. Also notice the Bollinger Band squeeze coming undone, a sign of possible heavy volatility to come. Also notice the long wicks on the candlesticks. Especially the last three weeks with the index closing in the middle ranges showing larger inter-week mood swings. And to confirm the nervousness the RSI is clearly now in overbought territory. As I have mentioned, the VIX is mostly used as a contrarian indicator. But as all indicators on charts, they must be seen in the perspective context of all the asset classes and media at large. If the media were like: “Look out below!”, I would start looking for buys. But that is not what I am getting from the media.

THE VIX

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I would also like to point out that on the weekly chart the US Index closed above the Wave. Notice also that the 144 black dotted line has crossed above the black solid 169 with the SMAs lined up in the buy formation.

THE US DOLLAR INDEX

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With this week’s huge sell off all over the world in stocks I am now favoring this expanding triangle wave IV at Super Cycle degree count in the DOW. The cycle black wave d can be counted three ways—two of which count complete with the most likely below. With what is happening over in Asia and Europe’s renewed Greece problems coming to light again, it could be another ugly week for equities.

THE DOW 30 WEEKLY

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THE DOW 30 DAILY

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Have a great week traders!

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