Buzz on the Street: When Federal Reserve Doves Cry
A look back at the happenings on Wall Street this week, as seen by Minyanville's Buzz & Banter.
Here is a small sampling of this week's activity in the Buzz.
Monday, July 8, 2013
As you can see on the chart below, the monthly TDST Setup indicator has had a flawless record of marking tradable highs/lows for the PowerShares DB Agriculture Fund (NYSEARCA:DBA), and it should complete yet another TDST Buy Setup at the end of July. Incidentally, by the end of the month there's also the likelihood that DBA will complete a weekly TD Sequential Combo Buy 13, which remains outstanding from when the TDST Level Down was broken on a qualified basis. The coincidence of selling exhaustion indicators on multiple longer-term time frames, would provide a very low risk entry point. The one double-edge variable on the monthly chart is whether the Buy Setup will complete above or below the TDST Level Down at $23.79. If the former, all the ducks would then be lined up to get long; if the latter it may be a closer call.
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Breaking Bad or Breaking Out?
I am scanning through sectors to get some clues for the next direction. I see a lot of sectors breaking out over their respective downtrends today. Transports, retailers, and several others. Oh and by the way, have you looked at the banks lately? These are usually bullish continuation sectors when leading. Just sharing what I see.
As I run through these sectors, I am going back into portfolio mode and adding back select names as we have recaptured the 50 day moving average in the S&P 500 (INDEXSP:.INX). I too, am surprised by both the brevity and shallowness of the correction, but now is a great opportunity to buy high-quality stocks.
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NQ and ES Levels
NQ (Nasdaq 100 future) found support Friday at the July 3 naked VPOC of 2929 and is trying to work its way up to the June 19 naked VPOC at 2986.75. That same move for ES (S&P futures) would put upside risk now at 1643.50. Looking for confluences up there, we have the ES weekly R1 at 1642.25. Closing above those levels would pretty much be the end of the line for bears. But this is Monday, and the week before option expiration week with a lot of headlines to boot. In fact, such a big open before all the upcoming events is a bit suspicious, to say the least. Levels where bears regain strong control would be below ES 1620 and NQ 2946.75.
Tuesday, July 9, 2013
Gold (NYSEARCA:GLD) gapped down last Wednesday in an attempt to discredit the Gilligan buy signal it left on June 28.
However something funny appears to be happening on the way to the bear cave and another leg lower.
GLD is offsetting last Wednesday's gap and is verging on attacking last weeks high which will turn the Weekly Swing Chart up.
If the turn up plays out and GLD extends it is in a stronger position to attack its overhead 50 dma.
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10-Year Notes Surge Higher: Bull Trap?
Vadim Pokhlebkin - Elliott Wave International
This past Friday, yields on the 10-year US Treasury note saw their biggest jump since August 2011. But on Monday, the tens rose (and yields fell). Is it a bull trap, or is the reversal for real?
To help answer that, let's turn to Elliott wave patterns. The basics are simple: five waves in the direction of the main trend (an impulse), and three waves against it (a correction). Impulses are strong, fast, and with little internal overlap; 3rd waves are usually the strongest. Corrections, on the other hand, are hesitant, choppy moves.
With that in mind, please take a look at the chart of the 10-year U.S. Treasury notes, below.
As you can see, prices have moved swiftly lower in recent weeks, with little overlap. Yet the upward push from 124-115 has had the opposite look and feel. That's why the ongoing price spike most likely is part of the developing upward correction, an ABC.
The larger-degree wave 1 (circled) is now labeled complete at 124-115. The five-wave advance off the low is now the first leg of an ABC zigzag, the developing wave 2 (circled).
This wave count opens the door for additional strength within the 125-235/126-100 area. Pivotal, near-term support lies at 126-100.
(Adapted from Elliott Wave International's Interest Rates Specialty Service.)
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A Historic Mispricing
Two weeks ago, I pointed out how the 2y5y curve was steepening extremely sharply, which would typically mean that the Fed is set to turn into an easing cycle. They are doing the exact opposite, though by all money market standards, they remain very easy in the literal sense.
The reason that this curve is steepening is technical in nature because the forward path of the Fed Funds rate does not account for any rate hikes until mid-2015, which means the 2-year will reflect a zero rate for the life of the note. The 5-year is pricing in a normalized Fed Funds rate by the 5th year (when pricing the term premium or forward rate). This is where the Fed's policy of forward guidance is blowing up in its face, but on to more important things.
This has left, in my opinion, a historic mispricing in the market, as it prices in the fastest rate of tightening in history. Unfortunately, the average Joe cannot throw around a leveraged $100mm to play a 2s5s or 2s3s flattener (selling the 2yr, buying the 5yr) in the UST market, but you can in the Eurodollar futures market. Eurodollar futures are essentially a 3-month LIBOR future, meaning betting on an implied rate for 3-month LIBOR at a certain time in the future.
Historically, 3-month LIBOR has averaged 25bps more than the Fed Funds rate. The result of this spread remaining flatter in an "easy" market is due to the complacence of everyone thinking that the Fed will buy every bond in sight or never raise rates. The jury is still out on the extent of the latter, but the former is definitely excessive.
On last Friday, the June 2015 vs June 2016/2017/2018 spreads (or 2y vs 3, 4, or 5y) all hit historically steep levels and offers an insanely lucrative risk-reward. From these levels, the spread will flatten for a variety of different reasons which I will lay out below. Playing this kind of spread trade also offers very little directional risk like outright long Treasuries, but with the same mindset that the Treasury is mispricing the rate of tightening into the future.
The spread will tighten/flatten if:
-Economic data improves at a faster rate than Fed forecasts or market forecasts as the 2-year yield will rise at an increasingly faster rate than the longer duration (2y3y has best return in this instance).
-Economic data worsens or does not improve vs Fed forecasts or market forecasts, the longer duration yields have a long way to fall if this is the case (2y5y has best return in this instance).
-Financial stress short of a catastrophe, historically, will cause the shorter-duration LIBOR futures to rise at a faster rate than longer duration.
The spread will widen/steepen if:
-The financial system undergoes a catastrophic 2008 meltdown. In that instance, LIBOR futures will price in a higher rate of financial stress further and further out as banks hedge their balance sheets against higher funding rates. This is why a number of people, myself included, were freaked out over the past few weeks because of the rate at which these curves steepened, the only other time it has happened in that magnitude was during 2008/Lehman/Bear Stearns, not even that bad during LTCM's blowup.
-The Fed changes guidance or thresholds for its forward rate policy, causing longer rates to price in a higher Fed Funds rate later while the 2-year is unmoved.
The spread will do nothing if:
-Market and Fed forecasts are right on the money. If you hold this trade longer and roll it forward, there is an equal chance that it could flatten or steepen from here, though the odds of it steepening are slim given historical spreads that have little room to steepen further.
The spread is more exacerbated in Eurodollars. For example, the spread between the June 2015 and June 2016 is 106 points while the 2y3y curve is only 32bps, and so forth the further out you go.
Please keep in mind that ED futures have 2000:1 margin leverage, so it's not a risk-free game. The spread trade is designed to reduce that risk and avoid any outright directional risk.
Charts below included for visual color are the 2y5y curve, Fed Funds rate vs Jun 2015 - Jun 2016 and Jun 2018 spreads, and Jun 2015 - Jun 2016 historical spread.
Thank you to Vince Foster and Kevin Ferry for assistance in explaining Eurodollar futures mechanics
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Wednesday, July 10, 2013
Clear and Present Markets
1. Pay attention to news about the remilitarization of Japan. At a time when the US is under pressure to cut its largest budget line item, one way to do this without negatively impacting the profitability of these companies is to sell more technology to our allies, and Japan is a massive economy with little military power. This is a theme we have been watching all year, as a new Chinese Administration came to power and the dispute over the Senkaku/Daioyu Islands. As Japan builds out its military capabilities, it will be done as a "defense Force" emphasizing missile defense and emergency response over first strike capabilities. Raytheon (NYSE:RTN) should be a primary beneficiary of this strategy. I would be cautious though of Lockheed Martin (NYSE:LMT) though, as its F-35 Joint Strike Fighter appears to be a plane that does not suit the modern threat environment, and is facing order cancelations from allies.
2. Chinese trade data showed 3.1% decline in exports in June. This is part of the government's strategy to reorient the economy more toward more sustainable domestic consumption and away from exports. This entails consumer spending to increase from 34% of Chinese GDP, and move closer to the 70% of GDP seen in developed nations. It should also be noted that the new administration is cracking down on the illegal transfer of funds off-shore, which a report by Global Financial Integrity estimates was ~$3 trillion over the last decade. The report noted that 90% of this money was transferred through fraudulent invoices, which would have skewed historical trade data. No one believes the Chinese data anyway, but building credibility in the economic data will be important as the new administration attempts a difficult restructuring.
3. With Bank earnings coming this week, I think analysts may be overestimating the ability of the banks to take advantage of higher interest rates. The banks will have to write down the value of fixed income securities in the Available For Sale (AFS) category, which is probably a one quarter event in the short term, but most have not been writing a bunch of new loans at the higher rates (according to the Fed H.8 data). The categories that are growing are C&I and CRE, which have been highly competitive areas. I do expect improvement in credit performance, though which should result in solid operating performance in the Q. So, Net Interest Margin (NIM) pressures are easing, but I expect banks to realize this benefit on a lagged basis if at all.
4. The most important story of 2014 will be the implementation of ACA, which restructures 20% of the US economy. This is a massive undertaking and there will be problems with implementation, but the systems are to be rolled out by October, so expect more focus on this as we get closer. There are questions about whether it will get implemented, but I think it will. My early take on the path is that early adopters will be the sickest, and temporarily increase utilization rates and increase the cost profile, before they fall again in subsequent years. This sets up managed care to profit in the out years. Major pharma benefits in the short term, with generic and OTC drugs becoming more important as we shift more of the cost burden to the patients over time. Corporations should be the biggest beneficiaries of ACA implementation, as it reduces their costs. They will either dump workers on the exchanges and take the tax hit, or self-insure to get around the tax penalty. Self-insurance will drive the system toward more of a preventative model, than a fee-for-service model
Micron Offers Bulls an Entry Point
Those holding Micron Technology (NYSE:MU) shares in their portfolio are likely doing a double take as shares declined nearly 7% in trading yesterday afternoon, closing nearly 10% off of recent highs. News that Micron CFO Ronald C. Foster had locked in gains on the combined stock and option equivalent of nearly half a million shares since June 3 likely contributed to the weakness.
The 50 Day Moving Average currently sits around the $12 handle which is also where the stock broke out from a long basing pattern. Between $11 - $12, plenty of support resides that should hold if in fact MU is to trade higher again in short order. I'm comfortable entering long at $12 with a stop just below $11, and will likely dollar-cost-average down should I be given the opportunity to do so. From here, I'll look to hold shares long until next resistance is reached above the $17 handle, which is more than 40% higher from current levels. I'll look to remove my cost basis and roughly half of gains here, with a final target north of $21/share. As for time frame, year-end seems appropriate for both targets to be reached.
Good luck out there!
FOMC Minutes Swan Dive
Not much to offer here that hasn't already been said by officials, in Bernanke's press conference, or that we've covered here. A few brief comments:
-They seem more worried about volatility and whether or not institutions can adjust to rising interest rates (given what we know about their balance sheet composition). Additionally, members saw the extended period of low interest rates may encourage investors to take excessive credit or interest rate risk, but the recent rise in rates may have reduced that incentive.
-The cost/effect analysis of asset purchases by the FOMC's staff was seen to not have an adverse effect on financial market stability.
-Increased worries over the downside risks to inflation, which are viewed as transitory due to a one-time reduction in Medicare costs.
-Financial stability has increased over the inter-meeting period, but broad based financial stress averages remain below average.
The one scary thing is that they've now clearly spelled out that they don't know what to do in the most transparent fashion possible. The response to further volatility was to expand on the number of economic variables, the wrong thing to do; more transparency is the last thing we need. When I remarked this to Todd, he agreed that it would be very scary when the market woke up to the fact that the Fed doesn't know what to do anymore.
I did find it funny reading about the FOMC's judgment regarding which inflation measure to use going forward, whether or not they should focus on core prices, without food & energy, or so on. It reminded me of a Buzz I read of my Dad's from a long time ago, about whether or not the core prices or core prices plus food & energy costs (the headline CPI number) was the best measure of inflation. Hopefully it's worth a laugh:
"I don't know about you, but I ate breakfast before heading to the gas station this morning. Then I had some coffee and turned on my lights and computer systems. And I intend on driving home today, having lunch AND dinner before turning on my lights as it gets dark. Then I will likely turn on the TV and watch the NLCS. All before doing it again tomorrow."
Thursday, July 11, 2013
Bernanke's Mea Culpa
Stocks at the open have "surged" as Bernanke released more doves than Prince at a concert (as a Twitter follower of mine likes to say). Emerging markets (NYSEARCA:EEM) are ripping, bonds are recovering, and all is well because more stimulus will be in place. Intellectually, this is illogical. Bernanke effectively said that deflationary pressures remain high, which warrants more money printing. The stock market seems to like the fact that the Fed has admitted it has not done enough, or rather that it continues to fight an uphill battle towards reaching their inflation goals. So while stimulus may continue to be in place, optimism about the economy seems very much disconnected from the stock market's current levels, at least here in the US. Our ATAC models used for managing our mutual fund and separate accounts have not participated in the rip higher over the past two weeks in stocks which came seemingly out of nowhere, but a rotation by end of week is always possible. Emerging markets remains a key area to watch for a major mean reversion trade, which may be coming shortly.
Apple Acts Well Despite Negative News
Apple (NASDAQ:AAPL) has climbed to a new recovery high today, and is attempting to squeeze through a week-long resistance plateau at 424-425.
If successful, this should trigger upside continuation towards a test of the May-July resistance line, now at 443.
At this juncture, only a break below 420 will compromise the still-developing bullish pattern.
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The China Syndrome
We've heard a lot recently about China and how its slowing economy is going to pull the rest of the world back into a recession (see chart). I don't believe it! First, China's authorities are cracking down on illegal invoicing, which makes the trade figures look weaker than they actually are. Second, there are rumors swirling the PBOC is going to take some stimulative actions in an attempt to strengthen China's economy.
Moreover, as I stated on TV this week, I don't believe most of the economic numbers coming out of China. Indeed, "I have seen the truth and I don't believe it!" To be specific, China's survey procedures do not keep up with the surging services sector and the household survey doesn't capture the upper-scale household figures. Further, according to the astute GaveKal organization, "Aggregate consumption statistics are inconsistent with the retail sales figures and company reports." So NO, I don't think we are into "The China Syndrome."
As I concluded in yesterday's Morning Tack, "Of course today, it's all about the release of last month's FOMC minutes, where pundits will parse the Fed's every word in a monthly ritual that is becoming absurd." And yesterday, it was indeed all about the FOMC minutes as the stock market stumbled into the mid-afternoon FOMC release, and then attempted to stage a rally. The rally was based on the fact that nothing new, or interesting, was in the June 18-19 FOMC meeting minutes.
As our economist writes, "Fed officials are divided on the need to taper the pace of asset purchases. The majority does not seem intent on reducing the pace right away, and some want to see greater improvement in jobs and in the economic growth outlook."
However, I have learned over the years that the first "move" by the stock market following any Fed release tends to be a false move, and that was the case yesterday, as the S&P 500's (SPX/1652.62) rally attempt failed. The result left the SPX hugging the "flat line" into the close. As stated, Wednesday/Thursday of this week do not have much of a positive energy reading, but Friday does. To be sure, Wednesday's rally attempt struggled below the June 18 reaction high (~1654, as forecast) with modest selling occurring. To wit, Downside Volume was only 55% of total NYSE Up/Down Volume. This morning, however, it looks like Friday has arrived early with the pre-opening SPX futures up some 15 points on the Fed's "cooled" taper-talk, Japan's comments about the economy finally improving, no Greek tragedy anytime soon, etc. Accordingly, I'm still looking for a "blue heat" upside double-top blow off next week.
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Friday, July 12, 2013
Putting the Heavy Equity Inflows Into Perspective
You know, it's funny, on Wednesday, I said to "Zeke" (friend/mentor/PM) -- "Even though volume's relatively light on this move, today has a the feel of some NEW money being put to work... I'm seeing some ETF monetizations, namely in the Russell 2000 (NYSEARCA:IWM), which typically can mean parking inflows." Well last night, as Mischler's Rob Livio sent around, Lipper dropped a "hot lava" bomb (which by now many of you have seen):
US stock funds gain approx $11.8B inflows in week ended Wed; largest gain since January.
Let's put this into perspective. We know that in late June, there was $70b + outflows from FI, $14+ b alone at PIMCO. We know that by all accounts, despite bull/bear sentiment indicators, the average American and Global Institution has been relatively underinvested in US equities.
1. Remember the Gallup poll in May, which asked Americans the following question: "Do you, personally, or jointly with a spouse, have any money invested in the stock market right now – either and individual stock, a stock mutual fund, or in a self-directed 401(k) or IRA?" The results showed 52% responded yes, 47% responded no, and 1% had no opinion. To put that result into context, it's the lowest reading since the poll was first conducted in September 1998. Moreover, at the last market peak, in 2007, 65% of respondents answered yes to having stock exposure
2. Mischler's "Smartest Man in Global Capital Markets" has told us that Global banks have taken equity exposure this year, from all-time historic lows near 40%, to currently 50+%, on the way to historic norms of 60+%.
So, everyone has been talking of the great myth of the "great rotation" from stocks to bonds, like one would talk about Charlie Brown's "Great Pumpkin." I'm not a rocket scientist, but, it seems to me that the retail investor, to this point, had not been pushing the "top."
Lastly, I would add, Dow Theorists like Acampora will now be looking for the Dow Transports (INDEXDJX:DJT) to confirm the new closing high (3rd this year) on the Dow Industrial Average (INDEXDJX:.DJI) . The previous high close in the TRAN was 6549 on 5/17. The Secular Bull fans could soon again be dancing in the streets.
Rolling the Dice With Boeing
Boeing (NYSE:BA) is getting wrecked on news of a fire on a 787 Dreamliner (which has some history of technical problems with batteries) at Heathrow Airport.
Details are hard to come by. Nevertheless, I just threw caution to the wind and picked up some $106 calls expiring today for a nickel a piece. In the event this fire was not caused by a problem with the batteries, the stock should snap back hard.
There's 100% downside risk on this trade, and this may be a real long shot considering the time frame (less than 3.5 hours), but the risk-reward is insane in the event the fire was not caused by a fault with the plane.
So maybe there's only a 1/10 chance this trade pays off, but the payoff could be upwards of 25/1 if we get news that the fire was not caused by the plane itself.
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