Significant Technical Damage Across Major Market Indices

This week’s brutal sell-off has resulted in large declines in many stocks. Looking at broad market statistics, the percentage of stocks which have fallen below key moving averages has exceeded previous corrections since the March 2009 lows. Here are some charts which show how broad the decline has been.

Percentage of Stocks above their 50 Day Moving Average

SPX Just 15% of stocks in the S&P500 are above their 50 Day Moving Average.

NDX The situation is even worse in the tech heavy Nasdaq 100 where just 12% of stocks are above the their 50 Day MA.

NYA The situation is better in the broader NYSE Composite. This index has many non-equity securities so the higher number is not a surprise.

Nasdaq The broader Nasdaq at 18% is slightly better than the Nasdaq100 but not by much.

OEX The S&P 100 is the worse of all, with just 10% of stocks above the 50 Day SMA.

The Ultra Large Caps did not offer any solace.

Percentage of Stocks above their 150 Day Moving Average

SPX The percentage of S&P 500 stocks above their 150 Day SMA fell below 60% for the first time since last April.

NDX 50% of all stocks in the Nasdaq100 are below their 150 Day SMA. This a level not seen since last March.

NYA The broader NYSE index has 52% of all securities trading above their 150 Day SMA.

Nasdaq The broader Nasdaq has less than 50% of all securities above their 150 Day SMA.

This number was even lower during the correction earlier this year.

OEX The S&P 100 has 54% of all securities trading above their 150 SMA.

Percentage of Stocks above their 200 Day Moving Average

SPX One third of all stocks in the S&P500 have broken through their 200 Day SMA.

NDX In the tech heavy Nasdaq 100 the number has fell by 26 to 64 this week.

NYA In the broader NYSE, 38% of listed securities have broken their 200 Day SMA

Nasdaq In the broader Nasdaq, barely 50% of all securities are above their 200 Day SMA

OEX The ultra large caps in the S&P 100 are doing the best with 65% of the stocks still above

their 200 Day SMA.

Failure to Hold 200 Day SMA
Though many stocks fall below their 50 Day SMA during corrections, it takes a significant change in sentiment for them to lose their 200 Day SMA.

Part of the damage is undoubtedly due to the big plunge on Thursday. It has shaken the confidence of market players and resulted in a reduction in risk exposure across the board.

Though the Main Stream Media have been hyping up the fat-finger hypothesis, that crash was primarily due to a withdrawal of bids as the selling intensified on Thursday.

A market which did not have too many shorts lacked the natural buyers to provide liquidity.

High Frequency players also withdrew from the market as it become clear that the market structure was breaking down.

Given the big run we have had since the March lows, the uncertainty in Europe and the potential for higher taxes going forward, the urge to take profits is likely to overwhelm the urge to speculate on further gains. The individual investors that were sitting on the fence, are unlikely to jump into the market after the 1000 point plunge, which has vindicated their fears about the market.

It is likely that all rallies will be seen as opportunity to lock in gains.

Apart from the market statistics I will also be tracking the flow of funds data over the next few weeks.

During the early part of this year, the inflow of funds to US Equity markets finally picked up. The troubles in Europe has also resulted

in reallocation of assets into US equities.

The Big Plunge is likely to alter this behavior as investor confidence in the moorings of the US equity markets has been significantly shaken.

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Russell 2000 Index Reaching Key Technical Levels

The small cap Russell 2000 (RUT) index is reaching some fairly significant technical milestones which might be indicating that a short to intermediate term top is perhaps near.

RUT finished Friday at a 52 week high of 66

6.02.

Measured Move Targets

This chart published by the Disqus user Joe8888 shows the measured move on the RUT quite well.

The first one is a measured move A=C pattern off the March Lows. The RUT hit a low on March 10 at 342.59. The early June peak was 535.86, which marked the start of the pull back to the July’s lows of 473.54. A measured wave C move from the July’s lows has a target of 666.81.

Another target is a measured move from the highs of Jan 2009 at 519, which marked the peak of the rally from the Dec 2008 lows of 371.30, a move of 147.70 points. The target for that move is 666.70.

In the shorter term, a measured move A=C pattern off the February lows (580.49) to the Feb high (633.55) measured from the end of February lows at 620.61, give a target of 673.67.

DeMark Indicators

The RUT has completed Bar 12 of the Daily TD Combo countdown using the strict rules; it has already completed bar 13 using the relaxed rules.

Since the February lows, the RUT is on Bar 5 of the second set of TD Sequential Sell Setup, and bar 7 of the TD Sequential Countdown.

B arring

a sell-off which results in the RUT closing below the 654 level by Wednesday, the TD Sequential Sell Setup will reach the 8th bar on Wednesday.

A higher close on Monday will also fulfill the requirements of the TD Combo Sell count reaching 13.

The Pre-Lehman Weekly DeMark TDST Support level for the RUT was at 681.85.

Near Term Expectations

The RUT is nearing its 200 Week SMA which currently stands at 671.44. It has rallied more than 15% since its intra-day low of February 6.

It is now ripe for a pullback.

The bullish burst from last week will likely

result in some follow-through action which may take the RUT higher, especially if the S&P 500 ( SPX)

continues to make a move towards its January highs, early this week.

I expect a near term top to be hit by the middle of the week, where the RUT pull-backs a little and consolidates its gain. A 23% pullback of the move off

the February lows is very feasible and will likely put the RUT in the vicinity of its January highs.

A test of that level is likely.

Trading Opportunity

The obvious trade here is to put on bearish plays (outright puts, put spreads, outright index shorts) on the RUT via the futures (TF) or the ETF (IWM).

For those uncomfortable shorting a bullish tape, another trade to consider is to short the RUT against the SPX. The RUT has been outperforming the SPX since last December and the RUT:SPX closed at its highest weekly level since the start of the start of the great 2008 slide where large caps (led by financials started collapsing). If the market does consolidate near the Jan SPX highs, it is likely that the RUT will fall more.

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Natural Gas ETFs: Not a Good Investment

Over the past few months t here

has been a lot of investor interest in natural gas. The spot price of natural gas has collapsed to under $3 from a high of $14 last year. At the same time crude oil has rallied to a high of $74, from a low of $34. As a result the oil to natural gas ratio is greater than 22, at historic extremes.

Natural Gas ETFs: Trading as Closed End Funds

This extreme divergence in the oil to natural gas ratio has attracted a lot of investor interest in two exchange traded funds, UNG and GAZ (technically an ETN) which invest in near term natural gas futures. As a result of the huge amount of money pouring in, these funds have hit position size limits with the CFTC and have stopped issuing new shares.

As a result these funds now trade as closed end funds, with a healthy premium to their NAV. As of Monday’s close, UNG trades at a premium of $1.34, almost 12% above its NAV. GAZ trade at a premium of $1.19, about 8% above its NAV.

Natural Gas Forward Curve and ETFs

The natural gas futures market is pricing in a recovery in prices going forward. While the September ’09 contract is trading at $2.945 and the October contract is at $3.362, the December contract is at $5.155, more than $2.20 higher than the September contract. Going out to 2010, the October ’10 contract is at $6.018 and the December ’10 contract is at $6.8013. Notice how the forward curve is very steep in the near term and flattens out over the next few months.

However, investors buying these ETFs hoping to profit from a rise in the price of natural gas are in for a rude surprise.

These funds hold near dated futures. UNG buys the next month’s futures and rolls them over monthly.

GAZ buys futures two months out and rolls them over once every two months.

UNG currently owns October ’09 futures and will roll them onto November ’09 futures next month. The November futures are trading at $4.342, almost 23% higher than the October contract. If the roll were to occur today, the number of contracts which UNG will purchase will be 23% percent less than the contracts it sells.

Futures versus Physical Ownership

The example above illustrates how the NAV of UNG will not go up even though natural gas futures for November delivery are 23% higher than the October futures. This is an inherent feature, called negative roll yield, of any strategy which invests in futures to get an exposure to commodities. A primer for this effect can be found here. The NAV of UNG will not rise unless and until, the entire forward curve for natural gas rises AND the rise gets reflected in near term futures.

On the other hand an entity which physically holds natural gas, can buy the gas at the price of October futures, store it for a month, and earn almost 23% return on the investment.

Limited Storage Capacity: Big Risk of Spot Price Collapse

Since the ETFs use near term futures to get exposure to natural gas, they are highly susceptible to the volatility in the price of near term futures. Currently the spot market for natural gas is very depressed.

New production brought online to harness shale-gas is flooding the market, while demand for natural gas is depressed due to the economic slowdown. As a result the amount of natural gas in storage is much higher than previous years. Due to s

torage capacity constraints, natural gas producers are being forced to dump the gas in the spot market at highly depressed levels.

As a result the spot price of natural gas is under significant risk of collapsing.

Some industry analysts say that natural gas spot price could fall below $2 or even $1 in the next two months, till demand kicks in, production slows down or spare storage capacity comes on line.

Any collapse of the spot price of natural gas will be reflected in near term futures contracts and adversely affect the NAV of UNG and GAZ. Further due to negative roll yield, the NAV will not bounce back even if the price a few months out does not collapse.

Difference between Oil and Natural Gas

The markets for natural gas and crude oil have dramatically different price dynamics. The price of Crude Oil is currently controlled by investor sentiment; it is seen as a hedge against the weak dollar. The infrastructure to store oil is a lot more extensive and global in nature, allowing speculators to ride out any short term supply gluts.

On the other h and, natural gas is primarily a market driven by supply

and demand dynamics. When compared to crude oil, international trade and the supporting storage and transportation infrastructure is miniscule.

End customer usage patterns will adjust to massive imbalance in prices of natural gas and crude oil, but this may not get reflected in the spot prices till the supply overhang of natural gas diminishes.

How to Invest in Natural Gas?

Natural gas ETFs not only have a big premium to NAV, they also carry the risk of price collapse of the spot natural gas market.

Further they are unlikely to benefit from the rise in the price of natural gas as predicted by the forward curve because of negative roll yield issue.

They clearly are to be avoided.

Equity of companies in the natural gas space might be a better investment. The holdings of the First Trust ISE-Revere Natural Gas ETF, (FCG), are a good place to start looking for companies in this area.

Due to the collapse of the price of natural gas, many companies in this space have balance sheet issues. So any investment should be preceded by some due-diligence on the fundamentals of the companies.

Many natural gas producers also hedged their production when prices were high and their share prices may already be reflecting that. But any rise in natural gas prices is likely bring in speculative traders back into the natural gas space and should provide a short term spark in equity prices across the board.

For those interested in arbitrage plays, the premium to NAV is less in GAZ compared to UNG. So a long GAZ, short UNG position is worth considering. Do note that GAZ currently holds November’09 contracts while UNG holds October’09 contracts. Due to the volatility of gas prices, the NAVs of GAZ and UNG will not move in lock-step. Further, since GAZ is much smaller than UNG in size, it might be able to issue new shares sooner than UNG which will shrink the NAV premium faster than UNG.

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SPX 1000, Nasdaq 2000! What Next?

The first trading day of August saw two equity indices reach major milestones, a very rare occurrence. The S&P 500 index closed above the 1000 mark for the first time since last November, while the Nasdaq composite closed above 2000 for the first time since last October.

The S&P 500 has rallied almost 50% from the lows reached just five months ago. Under normal circumstances, such a move would be a sign of a raging bull market.

However in spite of the historic rally,

a lot of pundits still question whether this is a bear market rally or a true bull

market.

Where is the Volume

?

One major reason for their skepticism is the lack of market volume. Typically during bull markets, the volume of shares traded increases as the market moves higher. However in this rally of the March lows, the volume has been decreasing as the price moved higher. Proprietary indicators developed by Lowry’s Research show a lack of what they call buying pressure; the market moved is based primarily on lower selling pressure since the March lows.

However, at the end of the day, the only metric of real-world significance is the price-action. And the price-action has been very strong.

Technical Theories: Buy Signals Everywhere

Equity indices have been on a tear since the swing low reached in July, moving up double digit percentages in two weeks. During this period a lot of technical signals which indicate a bull market have turned green. The 200 day simple moving average (DSMA), an indicator of the long term trend, started sloping up in late July. The 50 DSMA, is also sloping up and is well above the 200 DSMA.
July was also an outside reversal month.

Equity indices undercut the lows of June, but then reversed to close at a new high. During the recent bullish run, the number of stocks making new short-term highs has increased to new highs, signifying a broad-based rally. According to Dr.

Brett Steenbarger, today 1829 stocks make a 65 day (13 week or 3 month) high, while just 105 stocks made a 65 day low.

This is a new record for this bull market.

After the failure of the Head and Shoulder topping pattern in early July, the S&P 500 has broken the neckline of an inverse heads and shoulder pattern, which has been forming on a much larger time-scale. This article written by a trader I respect a lot, discusses different aspects of this pattern. Her target for the completion of this pattern is 1229, a good 23% above the current price.

The Slow Turtle trading system compares the 22 week moving average with the 55 week to capture long term trend changes. It generates a buy signal when the faster average crosses up over the slower average and a sell signal when the reverse happens. Nasdaq100 is making that cross this week, while the SPX is fast approaching that level.

Richard Russell’s Interpretation

This article discusses Richard Russell’s interpretation of the Dow Theory and the buy signal it generated. Quoting Mr. Russell’s letter, it states:

“… My interpretation? We are now in a cyclical bull market as opposed to a secular or primary bull market. In effect, we’re in an extended bear market rally. The true bear market bottom lies somewhere ahead.
“There is no way of knowing how high this bear market rally might carry. The question – is it worth playing this cyclical bull market? My answer is yes, but play it very conservatively and carefully.”

The last sentence captures the essence of investing in this market.

The Chinese Experiment: Reengineering Chinese Consumer Preferences

The rally has been driven by expectation of continued growth in emerging economies (primarily China) as a result of the massive government stimulus injected into those economies.

It is based on the expectation that growth in the emerging markets will help cushion the effect of the credit-led slowdown in the developed economies. The roaring bull market in commodities and technology stocks is an indication of this bias.

The Chinese economy is joined at the hip to

the Western consumer. The Chinese Communist Party is trying to separate the two using its fiscal policy as the scalpel. The CCP hopes that the massive stimulus spending on infrastructure will compensate for the loss of export jobs and incentives to encourage consumer spending will grow domestic consumption.

There are strong indications that many loans have been granted without due diligence about the viability of the investments. There are murmurs that at least 15% of the loan amount has been siphoned into Chinese equity markets which are up almost 85% this year. Whether CCP’s growth at all cost style of managing the economy will work is yet to be seen. Risking whatever is left of your nest egg on the potential success of CCP’s experiment of reengineering consumer spending attitudes is a dangerous game, which has to be played carefully.

Navigating the Markets

In my July 14 article after Intel’s earnings, I had expected another leg up in the equity markets with an initial target of 1000 on the SPX which has now been met.

The now failed Heads and Shoulders pattern had trapped a lot of trading account short.

This resulted in a massive-short covering rally with hardly any pullbacks, with the Nasdaq100 (QQQQ) closing up for 13 days in a row.

Once the stock indices made highs for the year, they have attracted more sideline money as the rally builds on itself converting more skeptics into believers. Though the initial burst was led by technology stocks, the rally has broadened with low P/ E value stocks also participating.

The SPX is approaching a key Fibonacci Retracement and the highs of November 2009 around the 1007 level. It is likely that the market will face some resistance here, and pullback. The pullback may go back to the 950-960 level which forms the neckline support of the inverse head and shoulders pattern.

In April, I had written an article describing how more money will come into the market as it crosses key technical levels. Assuming the 950-960 level of support holds, I expect another bullish run, which is likely to suck in a lot of sideline money. The ensuing rally is likely to be strong and perhaps on better than average volume.

However, I see this as a melt-up kind of rally where mutual fund money chases equities not because of some newly discovered confidence in the underpinnings of the economy, but because of the fear of underperforming the broad market.

Jeremy Grantham of GMO, who had correctly predicted a liquidity driven stock market rally this summer, feels that equity markets are at or near fair value and are starting to overshoot. In his quarterly letter (registration required) he is advising clients to go underweight in their equity portfolios if and when SPX is between 1050 and 1100.

Sentiment is Key

Given the shaky underpinnings of this rally, I strongly believe that investors should focus on the market sentiment more than anything else. When the market ignores bad news, but rallies on good news, it is relatively safe to be invested long.

During the July rally, the market shook of below expectation results (or forecasts) from major bell-weather stocks like Microsoft and Amazon. A downward revision in the first quarter GDP number or the continued high level of first-time jobless claims did not slow it down. The dollar continues to be sold, and risk appetite seems to be rising.

However, the wall of worry put up by the underlying economic figures looms high and sentiment can turn on a dime.

While the rally is likely to continue, investors should follow their trading plan consistently and set hard stop levels, to limit capital-erosion. The market has also rallied almost 50% from its lows, and averaging down carries a lot more risk than it did a few months ago.

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Equity Markets: Start of a New Leg Up?

Over the last month the equity markets have drifted downwards after the SPX failed to move beyond the 950 level after multiple attempts.

Dur ing

this period the 200 Day Moving Average has provided the market with a well defined level to trade off, with equities bouncing off this level multiple times.

The 870 level on the SPX also held firm with sharp rebounds during intra-day probes of this level. The market is waiting for the earnings season, and if early signs are any indicator, corporate America seems set to please the Bulls.

Meredith Whitney moves the Market
Over the past year and a half, former Oppenheimer & Co analyst Meredith Whitney has been moving the market down with her bearish calls on the financial sector. However, this Monday, she came out with a bullish call on Goldman Sachs and a not so bearish view on the rest of the banking sector. This triggered a strong rally in the banking sector, which was aided by Goldman’s blowout results on Tuesday morning. General wisdom suggests that the overall market cannot move up without the financials leading the way, and the healthy action in financial stock is music to the Bulls.

Intel Blows through Estimates

After the close of the market Intel announced its earnings which beat Wall Street estimates by a mile. To add fuel to the fire, their outlook for the next quarter was significantly better than the average street estimate. The markets have responded very favorably to these moves, with the Nasdaq100 futures (NQ) up more than 1.6% after hours.
Intel is attributing the strong performance to renewed growth in emerging markets, especially China. Since Intel’s chips power almost all computers sold today, Intel’s rosy forecast is seen as a sign of improving health for the entire semiconductor and technology sector.

Did Wall Street Underestimate China

?

Recovery in China is a key component of Intel’s forecast. The Chinese government’s stimulus

package has been focused on turbo-charging internal demand via very loose purse-strings. The total amount of lending in the first four months of 2009 has exceeded the total amount lent in 2008. Incentives to purchase new automobiles have led to a 35% surge in sales, to an annualized rate which may beat the US new auto sales figures. It seems that Intel is now seeing the impact of the massive spending binge and factoring that into its forecast.

Intel’s result and forecast suggest a mismatch between Intel’s expectations and current Wall Street expectations of the impact

of Chinese stimulus. It is not obvious whether this mismatch stretches to other segments of the market. However, Intel’s forecast is likely to result in a thorough review of Wall Street’s existing view of the impact of Chinese stimulus. I definitely expect upward revisions of earnings estimates for other players in the technology sector; with some spillover to industrials and materials.

Liquidity driven Rally to Continue

Intel’s results and the market reaction to it suggest that pronouncement of Jeremy Grantham of a massive rally are likely to come true. Grantham believes that the massive coordinated stimulus injected into

the financial system will create a liquidity driven rally. There is already some speculation that a significant amount of the Chinese stimulus has found its way into financial markets and is the driving force behind the meteoric recovery of equity prices in China. The bullish spring run in crude oil too is being attributed to excess liquidity finding a home in commodities.

But will it last

?
Assuming the market rallies, the big question will be whether those levels can

be sustained. Unless economic fundamentals catch up with the equity markets that is unlikely to happen.

I believe that government action can delay or soften the pain, but

cannot eliminate the effects of structural changes occurring in the global economy.


The US consumer will be weighed down by high unemployment, a lack of available credit and high taxes. China will have to engineer a massive shift towards domestic consumption from its export led growth model. The problem there is that the Chinese are habitual savers, and are unlikely to go into a spending binge when the collapse in exports is resulting in millions of lost jobs.

I agree with Mr.

Grantham’s thesis that the global stimuli will do more to spruce up equity markets, with a little lasting impact on the underlying economic fundamentals.

Investment Plan

The SPX corrected almost 10% from its early June highs and held the key 875 level on a closing basis. Though many market technicians are pointing to a well formed Head and Shoulder pattern which suggests a downward move towards the low 800s,

the earnings surprises are likely to weaken the bearish bias.

Assuming that other technology heavy weights come out with strong earnings, I expect the tech sector to lead a rally in equities, which will test the recent highs. A clean break above the recent highs would put 1000, a key psychological level in play.

However, any bullish bias has to be tempered with the knowledge that the underlying economic situation remains precarious. This rally is going to be driven by high expectations which may or may not materialize. The key as always, but more so now, will be to observe the animal spirits: how equities react to news both good and bad. In a bullish tape, all news is bought; in a bearish tape, even good news is sold.

As long as fundamentals remain questionable, sentiment will perhaps be the best guide in navigating the markets.

Disclosure: Vikram actively trades the US financilal markets and holds long and short positions in many instruments and securities mentioned in this article.

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Relocated

Over the past few weeks we relocated from New York to sunny California, and I took a break

from the markets.

Will be back in action soon.

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Monday Roundup: Choppy Consolidation in Equity Markets

The financial markets continued to trade in a choppy manner today.

As I had anticipated, the price action on Friday, with the SPX opening at a new high but closing below prior highs (Trader Vic’s 2B pattern), resulted in more selling today. Equity markets gapped down open and were under negative pressure most of the day. However, the volume in the sell-off was low and the markets did not lose any key technical levels. Later in the day, the markets had a wild swing up with SPX erasing all its losses and going positive before selling off into the close.

After the zig-zag action, the equities finished closed to unchanged but with a negative bias.

Reassessing Risk

The market is still digesting the implication of Friday’s jobs report. In spite of comments by the government that the recession is far from over, the market is pricing in a greater possibility of an end to the monetary easing policy of the Fed. The yield curve continues to flatten with many traders taking off the curve-steepening trade which has worked very well.

The rise in short term rates is forcing a re-evaluation of many assumption underlying the current equity rally, which is primarily a result of excess liquidity in the system (cash on the sidelines, with low borrowing costs).

In my view this flattening is a pure technical reaction as traders exit the curve steepening trades (long short term, short long term treasuries), and does not reflect any sustainable shift in expectations.

Regardless of how the non-farm payroll numbers are spun, the economy is still far away from a strong recovery, and higher long term yields are going to put an even greater pressure in keeping growth down.

As anticipated, the dollar continued to strengthen.

However after reaching an early morning peak, it weakened through the day, with the Euro finishing almost 1c higher from its lows against the dollar.

Oil is showing remarkable resilience in spite of the strong dollar. Oil was supported by a bullish call by Morgan Stanley, following on the bullish statements by Goldman Sachs last week. Both GS and MS are major participants in the physical delivery oil market, and such calls which help sustain the speculative bias, are helping to strengthen their bottom-lines.

Market Outlook: Choppy Action Will Likely Continue

Late day spikes where the broad market rips up 1-2% in a matter of minutes are becoming very common.

Many of these spikes are triggered by short-covering when the market gets over some key technical levels. This shows that though the bearish sentiment has not gone, it lacks conviction.

The bears rush to cover at the slightest hint of a rally.

Some bears will take heart from the fact that the market sold off into the close after the spike. Though the inability of the market to hold higher price levels is not strongly bullish, what is the key here is the ability

of the market to hold key support levels on the downside. In spite of the sell-off today at the open (and the close), the trend continues to remain bullish.

The market did not violate any key technical levels and the sell-off was at a low volume.

I expect the market to continue to display the sideways choppy action as the gains of last week are consolidated and some participants reduce their risk exposure. We are likely to see more intra-day swings, and a retest of the 200 Day Moving average.

However, unless the key technical levels of 903 and 880 on the SPX are violated, the trend remains up.

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Weekly Roundup: A Wild Finish to an Up Week

The financial markets had a roller coaster ride today after the surprisingly lower loss in payrolls reported by the non-farm payrolls report. Equity futures shot up almost 1.5%, well above their 2009 highs, while treasuries were sold hard.

After an initial sell-off, possibly related to automatic trading linked to equity futures, the dollar rallied with the Dollar Index Futures (DX) finishing 1.68% higher above the key psychological 80 level.

The rise in dollar was a result of perceived strength of the US economy.

However as soon as the dollar started rising, equities started to sell-off.

The selling took the ES (S&P Futures) from a high of 957.50 down to a low of 933.25. After some more ups and downs, the equity markets finished almost flat with a slight negative bias. Unlike last week there were no fireworks into the close, with the market staying in a narrow range in the final hour, a rare occurrence. Interest rates moved up across the curve, with the biggest changes in the shorter duration (1 to 2 years) leading to a less steep yield curve from the historic highs reached earlier this week.

Commodities performed reasonably well given the backdrop of the rising dollar today. Traders are now pricing in inflation and economic growth and not just a weak dollar in their analysis. Oil hit the $70 m ark in e

arly trading before pulling back to close with a slight loss.

A Closer Look at Economic Data

The surprise drop in the number of jobs lost, had a few dark clouds hovering over it. The hours worked dropped to a level which would have corresponded to another 350K jobs lost. The unemployment rate (U3) rose to a record high of 9.4% as more workers, especially recent graduates from schools and colleges joined the workforce. A measure of true employment which accounts for all under-employed workers, U6, reached a high of 16.4%; this rate was at 9.4%, a year ago.

The retail sales data earlier this week was weak as expected. What also surprised on the negative side was the much sharper than expected drop in Consumer Credit of 15.7B compared to the consensus of -7B.

Corporate Earnings and the Bottoming Economy

There is no doubt that the free-fall in economic activity has been controlled and the economy

has likely reached the bottom or close to a bottom. However, what the new normal will be like is not clear.

In spite of hectic activity in the distressed homes market, organic sales of non-distressed properties are very week. The rise in long term interest rates is likely to hinder this market even further. Home prices m ay not free-f

all too much further, but the activity in the non-distressed sector is likely to remain depressed for a significant time to come.

Home sales trigger a lot of consumer spending and that component of consumer spending is going to be missing from the economy, apart from depressed construction activity.

Consumer spending will continue to remain constrained due to higher unemployment, lower credit availability and a greater propensity to save.

This is likely to limit the upside to the profitability of companies which are dependent on US consumers. Though earnings estimates are likely to go up as analyst’ optimism catches up with green-shoots, the ability of companies to continue growing their earnings is going to be limited for quite some time to come.

Lack of Conviction Shows up in a Trigger Happy Market

The price action today showed how the equity markets lack conviction. The shock of the headline number of the NFP report sent the futures soaring, only for them to come down to earth as the rest of the report was digested. Such choppy volatile action is an indication of an uncertain market where participants lack conviction.

However, demand for equities will continue to be high purely from technical reasons.

There are a lot of fund managers who are underinvested in equities and with the end of the quarter approaching in a few weeks, not many can afford to remain in cash as equity indices continue to outperform cash.

It is very likely that the market may continue to go higher but there risk of a major disappointment will grow as time passes, and the green shoots do not grow into strong trees.

Art Cashin, the director of floor operations for UBS and a CNBC commentator said that another 1000 up move in the Dow will send him to the bomb-shelters.

Market Outlook

I expect the dollar to strengthen further next week as the anti-dollar trade unwinds. Unless the correlation between the dollar and equity prices reduces, equities are likely to be under pressure.

On a technical basis, the SPX’ price action today corresponded to Trader Vic’s 2B Rule, which would also suggest that a pullback is likely.

How long the pullback will last before the bulls rush is a different question all together.

Treasuries are likely to be under pressure as more supply comes to the market and the perception of an improving economy increases risk appetite.

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Thursday Roundup: Goldman Drives Equities Higher

The equity markets continued where they left off yesterday and closed higher across the board, with the Russell2000 and the Nasdaq making new 2009 highs.

The markets were led by two calls related to Goldman: the first an

upgrade of the financial sector including Goldman, and the second, Goldman’s new target for crude oil for 2009 ($85) and 2010 ($95). Goldman also predicted a sub-500K loss in non-farm payroll numbers due tomorrow. Consequently the equity markets were led up by the energy, the financial sectors and large cap technology stocks.

Treasuries, Mortgages and the Dollar Sell-Off
The currency markets had a particularly volatile day today.

The Euro sold off after the ECB kept its rates and quantitative easing policy unchanged. The British Pound was hit by a false rumor that Prime Minister Brown had resigned.

The dollar also strengthened after retailers reported large drop in sales. The Jobs Report came as expected, but in a bullish tape was interpreted quite positively, leading to a subsequent sell-off in the dollar.

The currency markets have ignored the failure of the bond auction in Latvia, and the re-emergence of risks associated with the non-Euro European economies on the European financial system.

Apart from equities, the story of

the day was

the sell-off in long dated treasuries and mortgages.

Any chance of a pull-back in mortgage rates decreasing and will continue to have a negative effect on housing.

The spread between 2yr and 10yr treasuries reached a new record today of 278.66bp, the steepest the yield curve has been for a long time.

Financial Markets and Economic Recovery
The financial markets are now pricing in either a very weak dollar or a very strong recovery. However the foundation neeeded to drive the economic recovery is being shred into pieces.

Energy prices are rising aggressively, based primarily on speculation of a supply-demand mismatch in the future. A weak dollar is aiding this run. This is eerily similar to last year’s run in oil prices, when a weak dollar, lead to oil spiking to $145, even though there was no sign of any real physical shortage of oil.

Big banks have accumulated a lot of oil and are now driving the prices up with their reports.

JPMorgan has hired a brand new super-tanker to store heating oil off the coast of Malta, the company’s first such booking in five years. As gas prices start approaching $3/gallon, they are again likely to pinch the consumer.

Long term interest rates are also likely to have a detrimental effect on mortgages and corporate spending.

But the equity markets are ignoring all those signals. The market wants to go higher since there are a lot of underinvested managers. It is going up on hope that an economic recovery will materialize to justify the prices. It is ignoring the risks to economic recovery by collateral damage caused by the current market structure.

Market Outlook
The market continues to be in a very strong bullish trend. With Rusell2000 and the Nasdaq making new highs, it is very likely that the S&P500 will also make a new yearly high tomorrow.

The SPX may have been waiting for the Non-Farm Payroll numbers to get out of the way before it charges ahead. Unless there a major negative surprise, I do not expect the bullish bias to change.

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Wednesday Roundup: Markets Get a Reality Check

The equity markets finally reacted to the broader economic picture after the large gains of the past few days.

The ADP employment report which included a steep correction to April’s number, coup led with weaker ISM index of non-manufacturing activity

led to a large gap down open in equity markets. News of disagreement about the policies of the ECB in tackling the financial crisis strengthened the dollar.

A larger than expected build-up of oil inventories added to the sell-off in crude oil. To top it all off, Fed Chairman Ben Bernanke warned about the risk posed by rising deficits, affirming that any talk of inflation is rather premature.

This also led to a sell-off in Gold and a bid in treasury bonds.

Inflation and the Anti-Dollar Play
In yesterday’s review I had written that the anti-dollar trade was going beyond what the macro-fundamentals suggest.

The problems plaguing the financial system stretch to most of the developed world, and the effect of Fed’s monetary policies are being exaggerated.

The Euro specifically is the default beneficiary of the anti-dollar trade, even though the schisms created by multiple political stake-holders tugging the ECB are hindering appropriate policy response. The trade reversed today, with the Euro taking a significant tumble along with oil. Though this is certainly not the end of the bullish run, it does highlight how chasing a crowded trade can hurt investors.

Bullish Sentiment Intact: 200 Day SMA Holds
In yesterday’s roundup, I had expected the SPX to test its 200 Day SMA from the upside, and

it did so today.

The bulls will take heart th at buyers emerged when the SPX approached the 200 Day SMA

at 923, and equities finished strong, wiping out a significant portion of the intra-day losses at the close.

It is fairly common for instruments to straddle the 200 Day SMA for many days, as the market tries to resolve its future direction.

This average is sloping downwards and the average will continue to decline for some time to come. As a result the market can continue to remain about the technical level, even when it moves sideways or downwards.

Ever since the market closed above the 875 level on May 1, it has not fallen below it.

As long as that level holds the bullish sentiment will remain intact.

My Portfolio: No New Positions

Though I had planned to open new long positions when the market tested the 200 Day SMA, I did not do so. This w as bec

ause the strongest sectors so far, energy and materials showed a strong pull-back today. The anti-dollar trade is likely to be unwound further, and these sectors will continue to remain under pressure. As I had written yesterday, the chart of oil last year should be a reminder to anyone who wants to chase commodities, when the global macro picture is clouded.

Refiners Sell Off

Unfortunately, my long call position on the refiner TSO, took a big beating today as the entire sector was sold off due to concerns about capital needs and earnings. VLO has suffered from refinery shut-downs leading to a loss, which they pre-announced today, prior to a secondary equity offering to meet some urgent capital requirements. Refiners continue to trade at attractive valuations to their book value. However their earnings continue to remain volatile.

They are great take out candidates for larger integrated oil companies but until that becomes a reality their share price will continue to be volatile. TSO closed below its 50 Day SMA today (15.78) and is likely to test its 200 Day SMA currently just above $14. That may provide a good longer term entry point for long positions.

Tomorrow’s Outlook
I expect cautious range bound trading tomorrow in front of the non-farm payroll report due on Friday. The market will likely consolidate it gains around the 200 Day SMA, perhaps retesting it.

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