Rates Rise as Fed Meets

Ten year note rates surged to close above the 3% level yesterday spurred on by improving consumer confidence and housing data. Rates may continue to rise following today's report on 1st quarter Gross Domestic Product (GDP). Analysts predict that the economy might have shrunk 4.7% last quarter. An improvement over the previous quarter's -6% decline.

Markets have been reacting positively to recent economic data releases even though the numbers are still very negative. For example, yesterday's Case-Shiller report on real estate prices showed a year over year drop of 18.6% based on February figures. Business news analysts claimed that investors were encouraged that the rate of decline may be slowing. January's figure showed a 19% year over year decline based on a ten-city index.

The government's debt auctions continue to go well. Despite the massive amounts of debt the US is incurring, Treasury Bill, Note and Bond auctions continue to be over-subscribed. The dollar has remained strong in world currency markets.

With all of the cross currents in the news, trying to make decisions on future rate moves based on fundamentals proves to be difficult. On one hand, the economy still appears to be very weak. The potential damage that the Mexican flu can cause to the world economy weighs in favor of lower rates. However, the ever increasing US government debt levels should add to higher rates.

Technical analysis however indicates that pressures are building to push rates higher. Rates have been continually falling for years though. The recent monthly test of the lows may prove to indicate that this exceptionally long termed move may have finally come to an end.

Don't ever lose sight of the market truism, "Markets can remain irrational much longer than investors can remain solvent."

Ten Year Notes Set to Rise This Week

Ten year treasury yields rallied sharply last week despite less than favorable economic news. Unemployment numbers continue to rise and other data points continue to be negative. But despite poor economics, both the stock market and interest rates rose.

As mentioned last week, we were short both calls and puts on the futures. The rise in rates caused the future to drop sharply, making our May 126 strike calls virtually worthless. The positions were closed out winning nice profits.



The chart above shows the weekly interest ten year rate while the chart below shows the June ten year note futures contract. In examining the charts, notice how we may be setting up for a decline in rates and a rally in the futures. You can see that in the rate chart, the moving average is still declining pretty quickly. While rates advanced above the trend line, I would say that it's still too soon to play rates to go up. But the picture may change next week.

Looking at the futures chart, you can see the three-period pattern developing here. I would expect note prices to rally and try to take out the highs of three weeks ago. And, perhaps the rally will break through the double top and accelerate to still higher highs.

With this in mind, I purchased May 125 calls near the close of the day on Friday. I am also short puts so the position is very bullish. Should we fail to take out the previous highs or if we don't close above the closing price three weeks ago, I'll probably be reversing my position, expecting a big drop in notes.

On the positive side, as I mentioned in earlier blogs, it seems that interest rates and the stock market are starting to be correlated. If this correlation should hold true, expect the stock market to fall some this week. But this might be the last chance we have to get on a move that could take the market substantially higher.

Interest Rates Set For Upmove

INTEREST RATES SET FOR UPMOVE

Monthly Report - Part 2

Long-term interest rates fell in March but as the chart of the 10-year interest rate index (TNX) illustrates, the rate found support at the 4-month moving average and appears to have successfully completed a three-month-test of the lows. With this in mind, we need to be looking for an entry position to be short treasury bonds and notes. For those with a heavy bond allocation in their investment portfolios, be sure to have your adviser monitor this and shift out of long term bonds to a shorter maturity or cash.

On a shorter-term outlook, the 10-year rates appear to be continuing to head lower so you may wish to hold off before making a decision. I will watch it closely so you can monitor the blog to see when I take action. As the weekly note rate chart below shows, the rate has been hitting overhead resistance and appears to be headed lower.




Lower rates seem to be the normal thought now as employment numbers continue to worsen and the potential bankruptcy of General Motors and Chrysler weigh heavy on the market. First quarter earnings will be coming out as well. While few have high expectations for improved earnings, reports coming in at worse-than-expected levels could send shivers through the Treasury markets, especially considering the rosy reports banks were giving recently, telling the public that January and February were profitable months. The final wildcard is the Fed. What kind of impact will their purchases add on rates?

The weekly chart illustrates the persistant downtrend on rates with significant resistance coming in at the 2.83% and 2.91% levels making it hard to reconcile the monthly chart showing the potential for a directional change in rates. But it could happen. In general, the treasury market is spooked by the heavy supply of bonds, notes and bills that are continually coming into the market to support the trillions of dollars in spending that President Obama is proposing. When this thought prevails, rates rise. Another factor that cannot be ignored is the G20 meeting that is about to get underway in Europe. News about the dollar could have an impact on rates.


VOLATILITY LEVELS LOW





The volatility level for the 10-year note continues to drift lower and lower and is currently well below the average. For bond and note option premium sellers, this low level of volatility needs to be taken into consideration before selling short. Not only does low volatility translate to low option premiums, there is also the risk that a volatility spike could turn your far out-of-the-money options into in-the-money positions.

I will be watching for a bottom in the rates. At that time, you could consider a number of instruments to take advantage. For stock portfolios, consider the Short and Ultra Short Bond ProShares. These instruments will rise in price as interest rates rise. For well-capitalized players, consider entering into a short 30-year bond or 10-year note futures position to maximize your profit potential. For those who wish to make some money with less risk, consider selling out of the money bond and note call options.

Be sure to work with a futures investment professional to advise you on such strategies. Futures trading is very risky but when done right, can give you great profits in any kind of market.

OUR MARCH OPTIONS RESULTS

Despite the low level of volatility during March and the sharp move in price caused by the Fed’s announcement to buy long-dated treasuries, our futures options trading positions returned $915 per $10,000 investment net of transaction costs. I enter April short options with a bias to the upside for bonds. I will be watching for a reversal soon and expect bonds to fall by the end of the month.

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.