The Inquisitive Mind

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.

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.

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 mark in early 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 may not free-fall 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.

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.

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, coupled 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 that 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 was because 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.

Equity markets spent the day consolidating the gains of the past two days. All major equity indices reached new highs above yesterday’s highs, but could not hold that level. Treasury bonds got a slight bid after yesterday’s decimation. The dollar continued its downward slide with oil ramping up in sympathy. Risk appetite continued to be high with the small cap Russell2000 putting up the best performance.

Pending Home Sales Surprise: How Many Will Close?

The market got a shot as the pending home sales released by NAR beat expectations.

According to the WSJ:

The National Association of Realtors said pending sales of existing homes in April rose 6.7% — the biggest monthly jump in eight years. The data built on a flurry of other recent reports suggesting that the housing market and the broader economy are stabilizing.

The good news about the economy keeps on rolling in providing fuel to the rally. However this particular headline might turn out to be the most misleading.

Two must-read articles discuss the consequences of higher mortgage rates and their impact on the retail mortgage market the day after. Over the past few weeks, mortgage rates have spiked up. Though many prospective buyers would have locked their rates, a lot of others may not have been able to.

The jump in mortgage refinance applications over the past two months has created a jam in the mortgage processing pipeline. As a result, many mortgage originators were unable to process the applications, especially refinance applications, in time for them to make the rate lock (which they do by hedging their interest rate risk). So if this spike in mortgage rates does not recede, at least some of the current contracts may not close, due to the lack of mortgage credit at the right rate.

Market Sentiment Driven by Fear: The Fear of Being Left Out

Right now the market sentiment is being driven by fear: the fear of being left out. This is a strange phenomenon, since typically the fear is of buying too high, only to see the market fall. This is one of the pitfalls of bear market rallies since even though portfolio managers are not convinced about the underlying fundamentals of the economy they are forced to participate since they are paid to be in the market.

The rally is being driven by optimism about future recovery and is fueled by excess liquidity which has been pumped into the system by central banks throughout the world. Though there is no doubt that things will get better, the market is perhaps over-estimating the extent of the recovery in the face of severe macro-economic challenges. However, bull markets have to climb a wall of worry, so unless proven wrong, the markets will continue to rally. However once it is proven wrong, the correction can be vicious.

The Anti-Dollar Trade

The anti-dollar trade continues to be strong with even the beleaguered Euro continuing to charge ahead taking out the 1.43 level today. Oil continued to trade strong with the July contract trading as above $69 before pulling back.

Though there is a lot of talk about inflation due to the Fed’s monetary policy, there has been very little attention paid to the dynamics of how the Fed’s current policy will lead to inflation. There is a large supply of spare factory capacity and unemployed Americans to keep prices on the input side low. Though short term interest rates may remain low, longer term interest rates are likely to continue to be creep higher over time, as the bond market adjusts to the huge overhead of new treasury supply. Higher interest rates will put a cap on economic growth which could have driven inflation.

The Fed’s printing press is pumping money into the economy but so far that money has not translated to higher velocity of money. Most of the excess liquidity has gone to strengthen the balance sheets of banks allowing them to off-load assets to the Fed, cut their leverage, and raise their capital ratios. The new money being printed by the Fed is essentially filing in the gap created by the loss of wealth due to fall in asset prices.

This can change soon if the economy shows signs of a stronger recovery leading to loser lending standards. However, as of now, small businesses continue to be short of credit, and with tougher lending criterion becoming the norm, a return to the go-go days of the past is improbable.

Fed’s Silence does not Imply No Plan

Though the Fed has not yet outlined how it will reduce the amount of dollars in circulation that does not mean it does not have a plan. Till this crisis unfolded no one thought that Bear Sterns will be bailed out using the Fed’s balance sheet, or the Treasury debt will be monetized using the Fed’s printing press.

The Fed is unable to outline its strategies at this point since those actions are likely going to drain liquidity from the market. From the economic sentiment point of view, any perception of tightening liquidity can become a big damper. They cannot afford to take that risk right now when the economic recovery is in a nascent state. However, once they see the economy finding a firm footing, and asset prices recovering, they will be more willing to lay out the plan.

The Fed has already stated that when it comes to hard to value assets, they plan to hold them to maturity, essentially taking out the liquidity as the loans are paid back, or taking losses if the default. Other assets with short to intermediate term maturities too can be dealt with in the same manner. This gradual removal of liquidity is unlikely to create a shock. The challenge of course will be securities with a longer term but those are not a dominant portion of their balance sheet.

The often cited comparisons with the Weimar Republic are very much out of context. The ability to measure economic activity has increased by orders of magnitude over the past century. Not only is the data more accurate, it is also available real-time, cutting the reaction time of the Fed. The Fed is acutely aware of the risks, and will be monitoring them aggressively; there is no reason to suspect that they are asleep at the wheel.

With savings rate creeping higher and asset prices down substantially, the talk of hyperinflation, in my opinion, is pre-mature. It is driven more by trading houses moving away from the equities into the rally in inflation sensitive instruments like commodities. This anti-dollar rally is not based on measured economic data.

From a trading perspective I do not see any point in fighting the group-think in the markets, except with quick counter-trend plays. However, I see a much higher risk in jumping in on the inflation band-wagon since it happens to be the flavor of the month. One look at oil prices last year should fix those thoughts.

Market Outlook

Today, the SPX tested the 948-949 multiple times but was repelled. Though some may consider this market action as bearish, the fact that this is happening after a strong push over the past two days, means that the bullish sentiment is still very strong.

Others are referring to the relative underperformance of the Banking index (KBE) over the past few days. I presume that the market is reacting rationally to the pending new equity issuance from banks. However, banks have been leading this rally, so I will not be surprised if the weakness in that sector results in the market pulling-back to test the 200Day SMA from the upside. We are also approaching the release of market-moving economic data next week, and traders are likely to book profits.

If the test is successful, which I expect it to be it will likely pull in a large amount of cash parked on the sideline. I plan to do some buying when the market retests the 200 day SMA. However, I will be hedging the positions with either puts or bearish ETFs till a clean break of the current level (the yearly high) occurs.

The financial markets built upon the macro themes of the past week, as better than expected economic news from China and the USA lifted the equity markets. The GM bankruptcy filing was completely ignored by the market. The reflation trade was back in full force, and Treasuries were sold hard, with yields getting close to the highs of last week. The Dollar also fell though it finished off its lows. The SPX smashed through its 200 Day SMA and closed at the high for the year, along with the Nasdaq.

Technical Buy Signals: Possible Explanation for Futures Spike?
The strong monthly close on Friday, coupled with the open above the 200 Day Moving Average (on the S&P) triggered a lot of technical buying in the market. Fund managers who were waiting for equities to reach the 200Day SMA jumped in with their cash. A lot of bears, who were shorting the market near the 200 Day SMA, had to cover.

The buying pressure was also aided by calls by several Market Guru’s including Michael Belkin indicating that we are now in a global bull market for equities. The Coppock Guide, one of the oldest Market Timing signal also issued a buy. This flury of technical buy signals might be the reason for the spike in future purchases at market close on Friday.

Economic Data Impresses the Market
The overnight session started off on a very positive note with both the Chinese PMI surveys coming above some cautious estimate.There were expectations that the PMI would show a renewal of contraction in China, leaving a lot of disappointed bears. In the US personal income and spending data, the ISM Manufacturing survey, and Construction spending all came above expectations.

Equities were led by energy and materials names which were aided by the weak dollar. Treasury bonds were sold hard as fear of inflation is finding a receptive audience; though oil finsihed up gold finished lower. Most major equity indices closed at the high of the year.

Banks Raise New Capital
During the past month or two, a capital raise by banks has been a remarkably accurate buy signal for the general market. Today JPMorgan and AmericanExpress announced that they will sell equity to repay TARP. Our trading experience would be much more profitable if the banks would pre-announce, their capital raising announcement.

Market Outlook
The equity indices finished strong, and it is likely that the momentum will spill-over to Tuesday. However rising treasury yields has led many to doubt the whether the economic recovery underpinning the equity markets rally will ever materialize. For today at least the markets ignored the yields and went-up across the board. The path of least resistance is up and there is no point fighting it. I plan to close out my short term bearish put positions on any sign of weakness.

A significant challenge in predicting the outcome of the current economic crisis is that it is global, with multiple stake-holders each with their own interests, but with a lot of inter-dependence. The intertwined nature of the global economy means that no single player can deviate from the norm, without paying a significant price itself.

This interdependence has a significant impact on asset ownership strategies. In this article I will discuss how foreign, especially Chinese, ownership of US based assets will be affected.

The US as the Driver of Global Growth

They used to say that if the US sneezes, Europe catches a cold. Western Europe is playing its part well with the Cold; but they have also been joined by Eastern Europe which has caught a severe flu. Asian economies show symptoms of allergies, though it likely to be seasonal.

The drop in US economic activity is giving the Western European economies a hard time; they also have their own sub-prime mess with the loans made in Eastern Europe to finance economic expansion. Eastern Europe will not recover till consumption in Western Europe recovers, which in turn will not recover till the exports to the US recover. Japan is in a similar boat with exports tumbling.

The emerging Asians economies have been affected but still continue to grow as internal demand continues to be strong in India and China.

China Stimulates; Recklessly Perhaps?

From the US perspective the biggest wild-card is China. The Chinese central planners have relied on the US consumer to help lift the Chinese people out of poverty. They are now trying to encourage domestic consumption with massive stimulus; however consumer behavior does not change overnight. The Chinese are culturally tuned to saving, and to expect them to become profligate spenders at a time when millions are being laid off from empty factors is over-reaching.

Another factor to keep in mind is that the pace at which the stimulus money has been spent in China has raised questions about the nature of due-diligence done in making those loans. Until now the Chinese were growing at a break-neck speed and any overinvestment was quickly absorbed by rising demand. However, the same reckless style may not work out this time, since demand growth is bound to slow down, given the global economic conditions.

China and USD Based Assets

There has been a lot of speculation about the Chinese controlling the US bond markets, the Chinese dumping US Treasures etc. in the financial media. Given the size of the China’s USD denominated holdings, it is natural for the Chinese to be worried about the financial turmoil in the US. With the current uncertainty in the global financial system, it is also prudent for them diversify their holdings away from paper assets into hard assets, like commodities and gold.

Economic Destinies Joined at the Hip

However, until their local economic consumption reaches a level that can challenge the US consumers, China will continue to need a healthy US. The Chinese have been dependent on the US consumer appetite, and their entire capitalist model is based on export-driven growth. Their economy and fiscal policies cannot make a sudden U-Turn from that model, especially since any significant disruption could result in civil unrest. The fear of civil unrest is strong within the CCP since the absence of vents to express dissent leads to an accumulation of pent-up frustration; which can blow up at the most untimely moment.

The Hesitant Financier

Given the dependence of their economy on the US consumer, the Chinese cannot afford to take any action which will significantly destabilize the US markets or hinders US recovery. This means the talk of the Chinese dumping US based assets or stopping the purchase of US Treasuries is perhaps overdone.

The Chinese may not like what is happening in the US, but they do not have any other viable alternative market as of today. They cannot afford to pull the plug on the US since the repercussions on their own economic and political system will be severe. Plus as a significant owner of USD denominated assets, it is against their interest to trigger a collapse in US based assets.

How Long Will this Affair Last?

This situation of the hesitant financier is unlikely to continue for too long. Within a decade, the size of the economies outside the US will reach a point where the dependence on the US consumer as the driver of growth will severely diminish. Further export oriented economies like China will redirect efforts to spur domestic consumption and bring their economies back into balance with global norms.

However, it is premature to call an end to central role of the US in the global economy. The flight to the dollar and US treasuries in Q4 2008 is ample evidence that regardless of what the pundits may say, when fear was in the air, everyone rushed to the perceived security of Uncle Sam.

After more than half a century of global leadership, the US’ central role will not change overnight. But the US can also not afford to be complacent. In the next few years, there will be alternatives available which will be big enough to offer the US serious competition. We have perhaps a decade to fix our house, before we lose the safety net provided by the bigger the safer economic group-think.

Asset prices went up across all asset classes on Friday, as stocks, bonds and commodities rallied with the US Dollar Index closing at the lowest level of the year. The equity markets had a spectacular finish after chopping in a tight range till the last half an hour. The energy sector outperformed most of the day with crude oil closing above the $66 level. The closing rally also lifted the materials, industrials, transportation and the banking index, while the Nasdaq closed at a new high for the year.

Yields fall as Bond Buyers Remerge
After the massive sell-off in long dated treasury bonds earlier this week, bond yields have pulled back substantially. It seems bond buyers were waiting for this round of treasury auction to be done before they stepped back. Since yesterday’s highs, the yield on the 10 year bond have fallen from 3.758% to 3.465%, while they fell from 4.628% to 4.338%. The drop in yields provided a much needed relief to the equity markets which were a bit disappointed by the less than expected rise in the first quarter GDP estimates.

Dollar Sells Off
The US Dollar continued the sell-off with the DX closing at its lowest level of the year. The Euro-USD futures (6E) too closed at the highest level of the year at 1.4164, which happens to be close to the 50% retracement (1.4156) of the Euro’s fall from last April’s high (1.5985) to November’s lows (1.2326). Some market commentators are calling for the Euro to continue to rise against the dollar till the 61.8% retracement at 1.4587.

I feel that central bankers outside the US are likely to make noises to stop the rise of the USD. Most of the developed economies are dependent on the US as their primary export market and continuing fall of the dollar will hinder their exports. As a result we are likely to see efforts at competitive devaluation by other nations to stall the fall of the dollar. Some of their actions may be pure jaw-boning to stop speculative traders; others may take specific market measures to help their cause.

The Spectacular Close: Futures Spike 2% in a Few Seconds
What a lot of traders are talking about is the spike in the equity markets at the close. The SPX was trading in the opening range (903-912) for most of the day before it broke through the upper resistance about 15 minutes before close. This seems to have triggered a large number of buy stop orders as the SPX surged into the close.

The move was violent and the SPX futures market, the most liquid market in the world, too got overwhelmed. Though the closing print on the SPX (cash) was 919.14, the ES futures traded all the way up to 927.75 at 4:00PM. The chatter is that there was an order to purchase 2500 contracts of the SPX futures at close entered by a single dealer (JP Morgan according to some). This corresponds to a notional value of $575 Million dollars. This resulted in all the offers to sell between 914 and 927 to be hit. This also triggered a lot of stop orders to buy, adding to the stampede.

Unnatural Market Action: Window Dressing or Something More?
It is common for stocks, especially those which have performed well in the prior month to trade up on the last trading day of the month. This is because of what is called window dressing where fund managers want to own stocks which have performed well to look good to their customers. However the spike at the end was not window-dressing.

There is some speculation that there was an effort to prop up the market into the close to ensure a finish close to the high levels of the month. It is very odd for a major dealer to wait till the close to enter such a large order especially on a Friday which happened to be the last trading day of the month. Liquidity tends to be less near the close on Friday as many traders and desk square out their positions before the weekend.

We are living in an era of significant government intervention in the financial markets. What some call market intervention for the greater good, others call market manipulation. It is not clear what happened today, but it was certainly not normal.

My Portfolio: Trading
I booked some profits on the TLT I has purchased earlier this week when it reached my 3% profit target. I continue to hold the bearish TBT Put spread. My USO put spread is not doing too well as crude oil continues to rise thanks to a falling dollar. Though USO is now at the upper end of the channel it is trading in, I will have to re-evaluate this position soon.

Altered Trading Mindset: Contra-Trend versus Trend Following
As readers may have observed, over the past few months my style of trading has become contra-trend. This is primarily a result of the market behavior over the past year where no trend sustains itself long enough to allow position trading. With sector rotations occurring every day, very few equity sectors are able to sustain their gains.

Over the past month, the macro themed trades like commodities and currencies are finally showing a sustainable trend. However, I have missed out on these trends because I could not reset my trading thought-process to follow the trend. This afraid to hold fear seems to be common theme across many traders. This perhaps is the biggest indicator that though the equity markets have risen in value, the bullishness which should accompany it is missing.

Market Outlook: 200 Day SMA Beckons but Short Interest Missing
The SPX is creeping ever closer to its 200 Day SMA which now stands at 928.60, about 1% away from the close today. This average is coming down about 2 points every day, and it is very likely that we will touch the average next week, especially after the bullish close this Friday.

Many market participants are expecting a big round of short covering once the SPX reaches this level and fresh money pours into the market to chase the rally. One caveat though is the large drop in short interest in the market. According to Bespoke Investment Group, the short interest on S&P 500 stocks is at the lowest level since February 2007, with the average stock having 7% of its float short.The largest decline in short interest was in the Real Estate Group.

The past few months have decimated the bears, who seem to have thrown in the towel. Though this can be bullish in the short term, it also means that any correction may be more severe since there are not that many shorts who will buy to cover during a decline. One can argue that there are so much money on the sidelines belonging to the people who missed the rally that they lack of short interest will not matter.

In any case, we are living in very interesting times with the financial make-up of the world changing dramatically. For an investor it poses significant challenges. At these times, I like to remember that cash too is a position.

The financial markets had a relatively sedate day with the action in the bond markets driving equities. The 7yr Treasury auction was met with reasonable demand which had a calming effect on the bond market which finally got a bid. This helped the equity markets finish positive for the day. The energy sector out performed today with a greater than expected draw-down in oil inventories sparking another rally in oil and oil related equities.

Treasury Market Recovers

The treasury markets were volatile today, selling off before the auction and then recovering after the auction to finish strong. One metric I follow at the long end is the difference between the 30yr and the 10yr yields. This spread narrowed today, closing below its 50 Day SMA for the first time since early January. I presume the 4.5%+ yield on the 30yr bond is attracting buying interest, now that the technical factors associated with the spike in yields have abated.

Often the most complex market behavior has very simple explanations. The recovery in Treasuries after the bond auction, could simply be attributed to the fact that the Treasury is done selling for this month; and the next auction is going to be in the second week of June, almost a life-time in the current markets. With the overhang of new supply not present, bonds were bid today.

Economic News: Continues to Point to Improvement

The equity markets have some good economic news to cheer. There are clear signs now that the economy is gradually bottoming out. The new Jobless Claim number came better than expected, while continuing claims continue to go higher. The Jobless Claim number seems to have topped out in the mid-600K and seems to be declining gradually. This job-loss number is a co-incident indicator; it hits its top when the economy hits bottom.

On the other hand the news from the housing market continues to be dismal, with almost 12% of all home mortgages delinquent. Durable Goods orders came in higher than expected in April but were revised downwards for March.

The GDP number tomorrow is going to be important in setting a tone for the market. There are some expectations that last quarter numbers may be revised up.

My Portfolio

I continued to day-trade today, using the action in the bond market to guide my equity futures trades. The TLT acted as a leading indicator for the price-action in equities for most of the day. I added to my TLT position in the pre-auction sell-off. The treasuries are getting a bid and I expect a 3% return over the next few days.

I was a bit pre-mature in establishing my bearish put spread on the USO; it has rallied about 2% from my entry point. However, I am not particularly concerned since this is a spread which expires July. It is quite reasonable to expect a pull-back to the $60 level in the front month crude contract over the next two months. There is a huge overhang of excess supply parked in tankers anchored off-shore which the market is ignoring. Like last summer, the price of oil is being driven up by the falling dollar trade, where investors seek haven in commodities. However, the economic environment we are in is dramatically different from last year, and I believe that the speculative excess in the oil markets is not sustainable.

Market Outlook: 200 Day SMA Looms

The S&P500 is now within 24 points of its 200 Day SMA. I expect the market to test that level soon. After a rally of such a magnitude, it would be highly unlikely for the market to come so close to the 200Day SMA but not touch it. Perhaps a bullish GDP report tomorrow will provide the ammunition for the market to make that charge