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US Stocks: Over-Leveraged Markets at Risk of Global Margin Call

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The shift to a bear market is just a matter of time. The Fed would have zero control over a global margin call, a real risk that would lead to markets divorcing from QE.

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Technicals:
Technicals represent the market forces that, over time, will no longer be under the FED's control. The transports have made parabolic moves on the weekly and daily charts. Bull markets don't start with old economy indexes such as the transports going parabolic to all time new highs. Instead, that's how they end.

The Nasdaq-100 tracking ETF (Powereshares QQQ (NASDAQ:QQQ)) has formed the start of major Head and Shoulders (H&S) pattern on a weekly chart (See Appendix). iShares iBoxx $ High Yid Corp Bond ETF (NYSEARCA:HYG), SPDR Barclays Capital High Yield Bond ETF (NYSEARCA:JNK), and iShares IBoxx $ Invest Grade Corp Bond Fund (NYSEARCA:LQD), all of which are ETFs that track junk debt and corporate debt, have also been forming H&S on daily charts (See Appendix). These patterns are extremely bearish. We do not view H&S patterns, if confirmed, to be associated with merely "corrections." We would view the selloff with the current incredibly low short interest environment to be much more severe.

(Also read 10 Finance Books All Investors Should Read)

A Matter of Time
History invariably repeats through each market cycle, even if expressed in different ways as society evolves. This bull market will end, like all bull markets eventually do. By looking at the cleanest and simplest of market measures, we've found vulnerabilities and a foreshadowing of a bear market. The dearth of short interest and extreme long leverage in both stocks and bonds is not only scary, but was exacerbated by the Fed's policies.

The notion that stocks must sell off because of any of the things we have mentioned from a macro perspective is a matter of time, not a matter of timing. Like all bull market endings, it's impossible to time on a macro level. This one is even harder to time due to the Fed's artificial manipulation. However, the technical signals now in the market, along with the small but obvious divergence of bond prices and bond issuance, works as a whole as a timing mechanism for US equities entering a bear market. History says watch your charts first; connect the future obvious macro catalyst second.

Appendix:
The Head and Shoulders pattern is one of the most reliable and powerful trend-reversal patterns in technical analysis. The drawn neckline of the pattern represents an important support level, and the H&S pattern is confirmed when the neckline is broken.

QQQ Weekly (Aug '07 – Present)


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HYG Daily (Apr '11 – Present)


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About the author:

Scott Martin founded Macro Trading Consultants (MTC), a macroeconomic and quantitative investment strategy & consulting firm, in 2008, and continues to serve as CEO and Chief Strategist. After graduating from the University at Albany SUNY in 2000, he went through the trading desk training program and was a junior trader at Goldman Sachs. Subsequent to leaving Goldman, Scott was head trader at various hedge funds and broker dealers including the Abernathy Group, Diamondback Capital, and Keel Capital, before establishing MTC.

Henry Wong, Director of Research & Development and Managing Editor at MTC, also contributed to this story. Wong is a Bayesian statistician and received his master's degree in Statistics from Harvard University after graduating from Tufts University with a triple major in Math, Quantitative Economics, and Psychology. Prior to joining MTC, Henry worked as a proprietary equities trader and China-focused quantitative analyst.

See also:

The Roller Coaster Continues: What to Watch for in Financial Markets

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Is Gold's Long-Term Story Still Intact?

Twitter: @Minyanville

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No positions in stocks mentioned.
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