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?

LONG TERM DOW CHART

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.

SHORT SHORT SHORT SHORT

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.

THE TECHNICALS SAY

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.

When Will Fed Put on Brakes???

Stock markets soared today breaking though 1200 on S&P and 11,100 on the Dow. Interest rates (10-year) bumped up moderately but I believe this is going to be the key. Long term analysis of the 10-year trend indicates that this rate could rise to 4.5% but perhaps not until the end of 2011. Until the Federal Reserve finally admits that there is real strength in the market, stocks will continue to rise. Probably also until the end of 2011. With this in mind, and considering the Dow's current trend. Dow Industrial levels could break as high as 13,000.

As long as the Fed says they are on hold, you've got to go with this madness. But the results following this rally will be disasterous. When you feel wonderful about the market, it's probably time to sell. But this feeling is not likely to take hold for another year.

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Mother of ALL Head and Shoulders

Predicting that the market could fall to 7,000 a few years ago was not that much of a challenge. Anytime you get a well-formed shoulder, as happened from 1998 to 2003, and the market then takes out the high level for that period (12,000), one has got to start thinking of the head and shoulders formation. While it is often difficult to time the market top, one can remain confident in the notion that the market will eventually fall.

And fall it did. My biggest surprise was when prices continued to run through this neckline. Now, the runup we have witnessed seems incredible for many but if we view things in the context of the head and shoulders formation, it shouldn't have been improbable that the market could climb as high as 12,000. Even now, with the Dow average breaking below 10,000, if we view the trading action that occurred between 1999 and 2000, we can see that there was a relatively long-term trade range between the 10,000 level and above 11,000 almost touching 12,000.

Normally we see the right shoulder reflects the activity of the left shoulder. This means that this market formation is usually very symmetrical. Chances are we are going to see another market meltdown with the Dow average dropping down to 7,000 or lower. But an important thing to remember is that it could take three or four years for this to occur!. In the meantime, there will be great profit opportunities. But as markets again test high levels, you might want to establish short positions in equities, and perhaps selling long term puts or buying long term calls, at the bottoms. But only be selling puts against stocks that you are short.

Normally, we project the downside target of a head and shoulders formation by measuring the neckline to the peak of the head. Since this is a symmetrical formation, we can expect the price to fall by a similar amount. Notice though that the neckline to peak is 7,000 points (from 7,000 to 14,000). A 7,000 point retracement would bring the Dow to 0! Ouch. A look at a log chart though shows a price target down below the 4,000 level.

It's always good to have a long term philosophy in the overall market when positioning your trades. We will be looking or a bottom in this market move and provide some buying ideas both for individual stocks as well as for diversified portfolios. If you have a special interest in following our ideas, be sure to contact me at gary@assetdesigncenter.com to be sure that you receive all updates and ideas.

Dow Industrials Tests Important Level

The Dow Industrials continued to rally after a better-than-expected jobs report. No doubt, stocks look good and Size, the key indicator that I watch to judge momentum, continues to rise. The Dow is trying to push through an important weekly level today so it will be interesting to see how the day plays out. 9337 is the important barrier. Currently, the Dow is up 125 points pushing it to 9380. Continued strength should push the Dow upwards around the 10,500 level.

Consumer Confidence Improves

Consumer Confidence rose to 54.90 vs 40.8 in the previous month. Ten-year rates rose above 3.45% while the Dow Average is rising 100 points to 8380+. We are looking for a test of the 8575 level on the Dow this week.

In other news today, the SP Case Shiller Real Estate Index showed that house prices continue to fall. The 10 city index fell 18.6% year-over-year. Markets did not react to this news

Bull Run Falls Short

Bull Run Falls Short

End of Month Report - Part 1

Major Stock markets staged a remarkable comeback in March with the Dow Jones Industrial Average rising to 7,608, up 545 points or 7.7%. The S&P 500 rallied 8.5% to 797.87. While the gains were impressive, the S&P’s failure to close above 800 and the Dow’s inability to break above a major resistance level of 7,676 leaves doubt that the downtrend has come to an end.

I mentioned in previous writings this month that Volatility Levels are starting to drop. This is generally my first signal to anticipate a potential stock turnaround. The second step would be to look for a basing pattern in the charts.

With the Dow at least rallying this month, I will look for one of the following two scenarios to play out in April. Either the market will drift, potentially setting up for the three month test of the February lows, or the market will bounce down from the 4-month moving average and make new lows.

The following graph illustrates Scenario #1 …




SCENARIO 1: The three-month test of the low scenario might be the best possible outcome. Should the average remain stable, closing next month little changed, the price could rest right on the four month moving average. Then in May, we would be closely watching to see if the Dow could hold the February closing low of 7.062. Should we hold the 7,062 low, look for a long-term rally to begin.

Again, with the volatility indicator reversing, it’s very possible that price will drift sideways. While the above scenario could be the best scenario a variation of this is that the market will continue to drift sideways until it meets the ten month moving average (the red line). It could take another six months of sideways action to meet the 10-month moving average.








SCENARIO 2 is not as friendly and more probable considering the uncertainty that surrounds the banking system, auto industry and other sectors of the economy. As I have mentioned several times in the past month, markets almost always try to come back and test key areas of support and resistance. By not being able to maintain above the 7,600+ support level, chances are that the market will sell off in April, making new lows.


The battle for supremacy was fast and furious as expected. Like a battle between two prize fighters, the Bears were getting beat badly as the Bulls pushed the Dow towards 8,000 last week. The Bears though were not giving up and staged an attack starting on Friday, pushing the Dow down into the 7,400 area! The Bulls came back today, pushing the Dow up 200 points, above the support level.






In the end, the Bears again took charge, driving it index down below 7,600 at the market and end of the month close. Only last minute settlements brought the Dow above 7,600. There truly was a monumental battle here between the Bulls and the Bears. The Bulls could not hold their ground in the end. I'm sure that we will quickly learn whether the Bears will remain in control. As I write around 8:50 pm, already Dow Stock Index Futures are trading down to the 7,500 level.

GROWING CONCERNS

Believe me, I would love to be a fundamental analyst. But accounting data seems to be so manipulated, numbers massaged, footnotes everwhere. Who can tell what is going on? And if you wish to analyze various segments of most corporations, that data does not exist in public information. I fear that fundamental analysis will take another hit with the proposed Mark-to-Market (MTM) changes. What is MTM all about?

MTM is commonly used in the futures and other derivatives markets. At the end of each trading day, gains and losses are settled up. If you have a position that gained in the day, money from the loser would flow to your account. If you were the loser for the day, money would flow out of your account. If you don’t have the money, then you will get worried calls from your broker asking you to please, at your earliest convenience (by the end of the day) to add funds to your account or the position will be closed out.

The big reason that MTM is causing so much concern now is because many of the mortgage based instruments cannot be valued because the housing market is so volatile. If you can’t value the assets on your books then how can you determine what the bank is worth and how much cash they need to protect themselves and their depositors. What the banks are proposing is that changes be made in the accounting standards to allow them to value these “value-less” assets at face value instead of the current market value (which is very low). This would allow banks with very risky positions to look great on paper. Another blow to those who really want to understand the fundamentals. Without real transparency, is it worth it to buy bank stocks in the future?


THE US DOLLAR AND MTM

The government could be supporting the MTM accounting changes for other reasons as well. Recently, the Federal Reserve Bank announced that they would be aggressively buying long-term treasury notes and bonds in an effort to lower interest rates, helping to bring mortgage and other credit rates lower. The problem with this action is that the Fed is buying Treasury securities at very high prices and reporting them on their balance sheet to support the integrity of the US dollar. What would happen though if interest rates do advance sharply? Bond prices move inversely to interest rates so if rates advance, bond prices would fall. And the longer the maturies are, the more volatile the price movement would be.

It’s not inconceivable that bond prices could fall 25%! Imagine what impact that could have on the dollar from an integrity standpoint. If the assets backing the greenback decline in value (or become worthless as could be the case for some “toxic assets” they are holding), foreign investors could exit their positions in the dollar en masse! BUT WAIT! No no no! We don’t use the mark-to-market any longer. Our devalued investments can still be valued at face value since someday, we expect that they will reach maturity and we will get all of our money back. Will investors continue to be deceived? Or perhaps there is just no place else to go with money.

Dow Surges - BULL MARKET?

Dow Surges – New Bull Market?

The Dow Jones Industrial Average surged from a March 9 low of 6,440 to a high of 7,969 before falling back on Friday to close at 7,776, up nearly 500 points for the week and up nearly 1,100 points over the past three weeks! Virtually every sector of the market rose this past week with the exception of bonds and gold. Many commentators began stating that with the Dow’s upthrust of over 20%, “we are now in a BULL MARKET!”





In an effort to keep things in perspective, notice how the Dow average has rallied to the four-month moving average. A review of my universe of stocks reveals that many stocks are following this pattern. Will this be a level of resistance?

As I mentioned in my last post, it appeared that volatility levels were finally reversing indicating that the market could be starting to moderate. Be careful however not to get sucked into the euphoria that dramatic market moves instill. Be patient and wait for solid chart foundations to appear before making a move. Also consider that the 7,600 level on the Dow had previously been a strong support area. Before any sustained move can develop, the Dow will probably have to come back and successfully test this level.



TECH STOCKS ROCK

While many stocks and market averages appear to have risen only to a falling trendline, many TECH STOCKS are showing different patterns.





PowerShares QQQ Trust (QQQQ – 30.82). Notice how the QQQQ, an exchange traded fund that represents the top NASDAQ stocks, has tested its previous price lows and is now rallying. Notice also that it has risen well above it’s four month moving average, indicating strength. A review of technology stocks shows that quite a few have not only tested lows and established a base, but are at or above RISING four month moving averages.



Qualcom (QCOM – 38.94) is a prime example of a stock that made a three month test of the lows. The stock price has surged 16.5% so far this month. Strong base, rising trendline, I would expect this stock to continue rising.




Research in Motion (RIMM – 45.01) has jumped 12.7% this month after successfully testing the December lows. Even a move back to its recent high of 60 would generate a 33% return.


RETAIL STRONG

In our March 1 posting, we said that there were opportunities in Retail as well as Technology and recommended Kohls Department Store. As the chart shows, we were right on with our pick. Kohls (KSS – 43.14) has surged 22.8% this month. Other retail stocks have also done well: Gap (GPS – 13.05, +21%) and Best Buy (BBY – 38.04, +32%) were also on our client pick list.





WHAT’S TO COME?

Next week offers more excitement as President Barack Obama is expected to release details of a new $22 billion bailout package for General Motors and Chrysler. How the market will react to this and other news is anyone’s guess at this point. With the Dow just 100 points or so above the important 7,600 support level, my guess is that the Bears aren’t done yet and will try to drive prices back down.

With the end of the month falling on Tuesday, look for my end of the month blog that will include not only the US stock market, but also the Mexican market and the Mexican Peso.

Investment Picture May Improve

The Showdown!!

Stock market averages staged impressive rallies so far this week and with just one week left to go before the month ends, expect that the market action will be fast and furious. The bulls and bears will be battling it out over the market's current level - Bulls trying to take it higher and Bears trying to take it lower. As I had mentioned before, it's normal for a market to come back and test the former support level (red line). What had previously been strong support can now be expected to be strong resistance.



There are some signs (in this moment) that the market may be beginning to stabilize. First of all, the Volatility indicator that I have discussed in previous blogs appears to finally be reversing. This shows me that the downside momentum is finally slowing for the first time in seven months. Usually, when this happens, price will either go sideways until it meets a trendline or rapidly move to the opposite extreme which currently is at Dow 12,700!



INTEREST RATES PROVIDE A CLUE


Another thing to consider is that in normal times, stocks and interest rates tend to move in the same direction.

As I have been pointing out (as early as 2005 http://marketreality.blogspot.com/) normally interest rates and stock market movements are highly correlated. This allows us to be diversified among asset classes and help us receive moderate returns year after year. Starting in 2004 however, interest rates and the stock market prices began diverging. This resulted in both stocks and bonds rallying sharply. (Remember, bond price rise when interest rates decline.) The chart above shows the divergence with stock prices rising and interest rates falling. Finally, the stocks dropped and came right to the level of the 10 year interest rate! It's possible that once again, markets will start acting somewhat predictably with stock prices and interest rates again being correlated. With the massive amount of government intervention in the markets though, who can say what might happen.


BUT, if stocks and bond rates begin to act as they should, moving in correlation, then there could be good news for stocks and here is why. In December, we saw interest rates plummet as the Federal Reserve threatened to manipulate the bond market to meet its objectives. The 10 Year Rate fell to below 2.25%. But we can see that even as the Fed outright stated that they would buy $300 BILLION of long term treasuries, rates did not yet fall below December's lows! If you have been reading some of my other posts, you might recognize one of my most favorite patterns, the Three Month Test of the Low.

If this pattern holds, then we can expect rates (at least in the 7-10 year sector) to rally. Stocks should follow suit.

Rising rates would not be good news to US Treasury Secretary Geithner nor Federal Reserve Chairman Bernanke as their goal now is to bring long term interest rates to as low a level as possible. And while the government may be bigger than many billionaire investors who prefer to stand back and let the government do their thing, the government IS NOT BIGGER than the global market for US Treasuries.