I’m writing this on Wednesday afternoon (May 22), so for all I know we could wake up Thursday with the futures at new highs. However, it’s worth noting some of the technicals that today's sharp reversal has put in play.
The 30-year Treasury deserves the first look. As I have tweeted several times in the last few days, the long bond has been toying with very important levels for some time. Today almost all of the remaining bullish hopes were shredded. Namely:
Big “outside” day confirmed by the largest volume since the June contract has been trading;
Spike higher on Ben Bernanke’s speech was rejected right at the 144-day Exponential Moving Average (EMA);
21-day EMA crossed below the 55 EMA;
All three EMAs are now downward sloping;
Close below daily TDST Level Down at 142-31 while just on bar 4 of TDST Buy Setup; “a lower open and lower low” will qualify the break of the TDST Level Down support (for a short primer on DeMark indicators, see here);
On the weekly chart (using the continuous contract) there’s trendline support at 141-30, weekly TDST Level Down at 139-30, and TD Prop Exhaustion Down target at 138-13.
Some big picture thoughts on what the long bond action may mean:
The long bond has been weak for quite a while despite the Fed’s buying; bond offers into POMO bids have been pretty high of late;
The long bond dropped all day Tuesday even during the nasty equity reversal; no flight to safety there; sure smells like bond holders are putting their money on a Fed exit;
Speaking of exits, Bernanke expressly stated in his testimony that the “run-off” option may be the preferred approach for ending QE. Buy that narrative at your own risk: Having to “run off” the portfolio means the Fed knows it is trapped and cannot sell into a market that has no buyers – at least not for many percentage points higher in interest rates. And who will buy the Treasury future bond issuance? Can we ignore that the Fed has effectively been monetizing the entire federal government deficit?
The possibility of a “jump in interest rates” has been advertized wrongly for years, with yours truly at the head of the pack. That does not mean that it won’t happen, and not "eventually," but more like "soon";
After the initial scare, equities of banks, insurers, asset managers, and anything that can borrow short and lend long should be a nice to place invest;
REITs, utilities and MLPs, where unfortunately many money managers have hidden their conservative, “I want safe returns” clients, are at risk of being shredded, as risk-free rates become more competitive with other type of yields (and how much of those yields are the result of leverage anyway?).
On to the equity indices. Aside from the nasty-looking “outside reversal day,” which is already getting all sorts of attention, the S&P 500
(INDEXSP:.INX) escaped from closing below the daily TD Reference Close Down at 1648.10. That, combined with a lower open and lower low this morning, would have been a horrible setup for bulls. But no cigar for the bears, and a fair amount of more damage is needed before anyone can argue that the chart looks bearish.
The Nasdaq is cutting it closer. The Nasdaq-100 Index
(INDEXNASDAQ:NDX) closed $0.20 below TD Reference Close Down, but the PowerShares QQQ Trust ETF
(NASDAQ:QQQ) managed to close $0.02 above. Interpret it however you will, but see it. More importantly, even though it has not mattered for months, on Tuesday the QQQ completed a TD Combo Countdown Sell; the corresponding Risk Level is at $76.66.
Meanwhile the Russell 2000
(INDEXRUSSELL:RUT) “little guys” took it squarely on the chin. Both the Index (RUT) and the Russell 2000 ETF
(NYSEARCA:IWM) broke the daily TD Reference Close Down. Combined with the “price flip” printed today, if we meet the “lower open and lower low” conditions, the small caps look on their heels.
Don’t tell corporate credit and derivatives that their equity and Treasury brethren are misbehaving.
While the latter were getting manhandled, the corporate bond market and related derivatives continued the never ending party. After $11 billion of new issuance Tuesday it was $12.6 billion yesterday. Spreads were flat and credit derivatives continue their incredible shrinking show, with both Merrill
(NYSE: BAC) and JPMorgan
(NYSE:JPM) CDS tighter by 7%.
Bottom Line: Unless you believe in unicorns, you cannot possibly think that equities will never again correct for more than just a few hours. In fact, we know the mantra that the sharpest corrections take place during bull markets. The question is how deep a correction we will eventually have -- 3, 5, 10%, or the October 19, 1987 variety? The 1987 crash was certainly a crash, but in the scheme of the budding bull market, it was little more than a 4-day correction. The underpinning of this bull market (corporate credit) remains intact, but we are stupid overbought at these levels, so manage accordingly.
As for the long bond, the story may be different. There’s absolutely nothing structural to justify long term rates where they are. Unlike stocks, where companies (according to Bill Gross) are buying back $50 billion of their own shares every month, the long bond rate is being held down by the Fed “Mother of All Ponzi Schemes.” This scheme will end like all Ponzis end, with the last sucker holding the bag. Unfortunately, we are all suckers because what will be decimated is the Fed’s balance sheet (our balance sheet), and we will get hit again when our cost of money rises rapidly while the Fed’s assets sink just as fast.
I could have, and I have, argued multiple times that the bond gig looked like it was on its last leg, only to see it turn the other way. Maybe this time is déjà vu all over again, but it doesn’t mean that technically it doesn’t look as ugly as ever.
Positions in SPX, NDX, Long Bond, TWM
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