Monday, October 4, 2010

The Writing Is on the Wall

Interest rates continue to stay low and are threatening to break through and go much lower. There probably won't be any worry on the street until the rates test the 2.0% level on the 10-year rate. Below that, many believe that we are in a deflationary state. In MY younger days, 3% to 4% was the NOMINAL rate with inflation tacked on. Times have changed.

I have shown in previous blogs throughout the years that interest rates and the stock market always come to meet each other. When we see the bonds rallying and the stocks rallying, you know, there is something wrong. This undermines the whole theory of diversification. When business is good, the stock market goes up along with the demand for money. Thus interest rates rise and bonds fall. When the economy is weak, the stocks fall as do interest rates as the demand for money is weak. We see INFLATION in general, with all asset classes rising as now, when the government pumps money into the economy.

Oh, they say that they aren't doing it. The banks aren't lending. The money is sitting idle. But one need only look at practically every asset class out there to see that all boats are rising as excessive dollars are looking for a home.

THE INTEREST RATE CHART ABOVE reflects our times. Not to mention that rates have been falling for years and years, look how dramatically rates fell when failing to get through the 4.0% level! I certainly don't believe that we are having the major test of the low. IT COULD BE but with the Fed ever present in the Treasury market, vowing to keep interest rates down, any upward move in rates is sure to be short-lived. What happens though if rates do break down again?


Well friends, anyone who has passed Technical Analysis 101 knows the OBVIOUS HEAD AND SHOULDERS formation. I think that one of the keys to success in trading as a technician is being aware of the possible formations that are brewing. As a formation such as this generally is symmetrical, we can expect that the right shoulder, currently building, can continue topping out for another year, maybe more. This has been presenting incredible trading opportunities resulting in many 10-15% moves already this year. It's still possible to be making tons of money now without sacrificing a bias to the downside.


What's wrong with this logic??? If you can be long stocks AND long bonds in a diversified portfolio, why would it be bad to be short stocks and short bonds in a portfolio? With both stocks and bonds rallying, it seems like suicide to continue holding the typical modern portfolio. Wouldn't you think???

While I like to trade for profit, on peaks and valleys, I add on positions to a core BEAR portfolio. I hold positions in DXD and SDS for a potential down move in the stock market and TBT for a move down in bonds.


When we analyze the Head and Shoulders formation, the rule of thumb is that you draw a line connecting the neckline. I like to maintain the neckline at just shy of the 8,000 level and not a declining neckline as others might draw. But then you take the distance from the neckline to the peak of the move - 8,000 to 14,000 - 6,000. the market should fall by the same distance below the neckline as it rose above the neckline. OUCHHHH!!!!

I massage the data and look at the chart on a log chart but still. 5,000? 4,000? The risk is there.

Of course, if the market makes new all time highs, then this scenario is off. But let's look at the potential scenario politically. The Republicans make gains in the Congress in the next election. Gridlock continues for two years. A displeasing 2012 election, a bankrupt country, Tea Party grows and the fever is reminiscent of mid-1700s France! A DOW 4,000? I CAN SEE IT!

Can you? What are YOU doing to protect yourself? AND REMEMBER, the FLASH CRASH CAN HAPPEN AGAIN. No Stop loss order can protect you in a collapsing market. Ask any future trader who has experienced day after day of limit up or down moves. It really can get ugly out there. This is not a do-it-your selfer market.

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