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Are Stocks in the Last Stages of This Rally or Is This Just the Beginning?


Bonds and currencies are sending us clues.

As the media convulses over the idea of the Dow (INDEXDJX:.DJI) hitting new highs, it behooves us all to keep a clear head and to formulate our investment theses with intelligence and a wide lens.

Messages from stocks are one thing. Messages from stocks that mesh with positive messages from bonds and currencies are much better – for the risk bulls out there. Are we getting such confirmations from the bond and currency markets? Today's report will cover just that.

Before I jump into my fixed income and currency material today, I want to remind everyone what my current call on the market is (and has been). The chart below shows the S&P 500 (INDEXSP:.INX) on a monthly basis going back to the 1990s. My theory is that the S&P is in the final stages of wave "B" of the macro "ABC" correction to the downside. This macro correction follows what I feel may have been a wave V peak in 2007. The upside target for wave "c & B" is the 1,563.92 to 1,576.09 range on the S&P.

Click to enlarge

Why do I feel this may be the reality? There are a couple of reasons. First, when I count out the waves and sub-waves, it just seems to make more sense that this is the case. For the 2008 - 2009 sell-off to have been wave "C" of a large "ABC" or "zig-zag" correction to the downside – as many believe – the 1999 - 2002 decline should have been five waves and the 2003 - 2007 rise should have been three waves. I don't see that as being the case. Another school of thought out there is that the 1999 - 2009 period was one big 3-3-5 "flat" correction. That holds more water with me than the "zig-zag" theory – but I'm not yet convinced of that scenario being the reality.

The way I have the chart above labeled seems to me to have merit. I will change my tune, of course, if the 1,563.92 - 1,576.09 resistance range is taken out on the upside on a monthly closing basis. Anything shy of such a breakout occurring will keep me in my current (bearish) stance.

If the S&P can follow the Russell 2000 (INDEXRUSSELL:RUT) and Russell Mid-Cap Index (INDEXRUSSELL:RMCC) to new all-time highs and take out my resistance range, I will be on the 1999 - 2009 "flat" correction bandwagon and will set my upside target for this market at 1,775 (the 138.2% Fibonacci price extension line for this (current) third wave higher).

All of that being noted, why am I still a reluctant / skeptical market participant? It's not just the read of the stock charts. It's what I'm seeing in the other asset classes as well. Let's take a look at bonds.

Treasury yields are not ripping higher as they should be given the rally this week.

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The yield on the 10-year US Treasury Note (INDEXCBOE:TNX) did bounce off of the lows late on Tuesday, but they've only rallied to the 38.2% Fibonacci retracement (of the 2/25 - 2/26 down move) line. Meanwhile, the SPDR S&P (NYSEARCA:SPY) Depository Receipts have already nearly retraced all of that down move. The bond folks just aren't buying into this stock rally – or the Fed is just that involved in the bond market. In the latter case, I would be concerned as to why the Fed is still in there messing around. What do they know that we don't (regardless of what they say in front of Congress or on CNBC)?

Emerging market bonds still lagging.

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So are we seeing any more bullish signs in other parts of the bond universe? The iShares MSCI Emerging Markets Bond ETF (NYSEARCA:EMB) remains stuck below its 14-day moving average today. I personally believe EMB can make it up to the $120.75 level and still be in a bearish overall technical posture. The fact that it has not even rallied past the 14-day average is pretty telling of the weakness overseas.

High-yield bonds have rallied, but something ominous is developing on the chart.

Click to enlarge

The SPDR Barclays High Yield Bond ETF (NYSEARCA:JNK) has (unlike EMB) been rallying over the last several sessions – so that's good for the bulls. However, one look at the chart shows a potentially scary "head & shoulders" top formation developing. As a matter of fact, the JNK is right at the "right shoulder" resistance level as I type this article. If JNK fails to convincingly eclipse the $41.00 level, I will be operating under the assumption that the H&S formation is coming to fruition. In that case, my downside target (based on H&S measuring techniques) will be $39.66. That's not disasterous my any means, but it will be sending bearish directional messages to the rest of the risk assets.

So, the overall message from bond land right now (and yes, things can change quickly) is "risk off". Now, I want to check out the action in currencies to see if there are any bullish signals being sent from that arena.
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No positions in stocks mentioned.

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