Widening Corporate Spreads

Below shows the current spread between 10 yr B corporates and 10 yr Treasury note. Spread haven't been this wide since early 2009.

Widening spreads imply lower risk appetite (buyers less willing to pay up for lower grade corporate bonds relative to 'risk free' Tresuries).

no positions

Rallying to Resistance

Stocks have tacked on close to 5% off Friday's lows on the back of Fed chair Bernanke's Jackson Hole speech. We're now coming up on the SPX 1225 level that led the spill once breached nearly a month ago.

Will be interesting to see how things behave at these levels, as that 1225 now serves as resistance.

Personally, I've been fading (read: selling) this rally--unloading longs and adding to shorts. Have worked my net long stock exposure (longs minus shorts) down from about 22% to 13% of liquid assets.

Still sense that we have a date below w/ SPX 1025 in the not too distant future. As such, I want to use strength to reduce my net long position.

position in SPX

Nice General Market Valuation Piece

Fine weekly note by John Hussman. Particularly noteworthy was the 'Valuation Review' section. I continue to view John's work on general market valuation as among the best.

Note the graph that plots projected 10 year projected annual return of the SPX versus current SPX price level. Today's level of about 1200 projects to about 5 1/2% annualized.

To achieve projected returns corresponding to the oft cited 10% historical returns of stocks would require the SPX to be at about 800.

As Dr J observes, those rare secular buying opportunities (e.g., circa 1982), those that correspond to single digit P/Es and 6-8% dividend yields correspond to an SPX of 400.

John notes that while this may seem 'utterly ridiculous,' historical evidence suggests otherwise.

position in SPX

Stock Correlations

Have been running across claims that the correlation among stocks has been declining.

Data suggest otherwise...

position in SPX

QE3 Still a Possibility?

A year ago at Jackson Hole, Fed chair Bernanke signaled a major policy initiative aimed at stimulating the stock market, er, the economy, that became known as QE2. That policy lit a fire under the equity markets and they ripped higher--only to come tumbling down over the last month or so coincident with the end of QE2.

Markets were looking for some deja vu today as Bernanke took the podium this year's summer shrimpfest this morning. His speech did not detail a new stimulus program, although he did indicate that he has extended the length of the Sept FOMC meeting to two days so that the committee can amply discuss the various 'tools' at the Fed's disposal for stimulating growth.

That 'potential' for future Fed intervention was perhaps all markets needed today, as early market losses were quickly reversed as Bernanke spoke and the indexes sprinted higher for gains of 1% or so.

Hope springs eternal for the addict.

position in SPX

The Importance of Germany

The SPX has now retraced about 38% of its move from the March 2009 lows to the summer 2011 highs. If we don't hold here, a 50% retracement equates to, interestingly enough, about 1025. A 61% retracement works to 940ish.

The 'canary in the coalmine' DAX has already broken thru the 50% retracement barrier.

Why should the German market serve as the canary in the coalmine? Because Germany holds the keys to any resolution of the EU situation. Essentially, Germans must figure out whether they're willing to bail out the rest of Europe.

Given the recent century of Continental history, it appears that investors are increasingly having trouble seeing that happening.

position in SPX

Record Low Treasury Yields

Yesterday, 10 yr Treasury yields dipped below 2% for the first time. Investors want out of risk, and are currently seeking perceived safety of longer dated Treasuries (despite the recent US credit downgrade).

In a vaccum, this is deflationary action.

Technically, hard not to wonder whether we're putting in a double bottom here.

Seemingly, if we knife decisively below 2%, then it's a brave new world...

no positions

Downdraft Coming?

My sense is that the chances of a major wipeout our growing. Domestic markets today down 4% with some European markets (e.g., DAX down 6%).

Europe may be coming apart right here. The size of the debt problem is immense and it seems doubtful that Germany will shoulder the entire burden. Many euro banks down 10% today. US markets are a stone's throw from contagion.

Gold closed at another record high of $1827/oz. Investors are connecting the dots as the two options among sovereigns are boiling down to a) default, b) print money. The price of gold suggest folks doing the math are choosing b).

I've been rebuilding my short SPX position over the past few days and want to do more, but the volatility suggests prudence in spreading things out. Will likely use price to my advantage on rallies. The SPX seems to have room lower toward 1025ish.

Have once more started a GLD position although very hard to get large right here given the moonshot in price.

Frankly, silver looks more interesting to me right here compared to gold. Silver has not gone ballistic over the past two weeks like gold. Moreover, the charts suggest a bullish cup-and-handle pattern nearing completion.

A decisive move above 41 would be bullish.

positions in SPX, GLD, SLV 

Segmenting Financial Markets

Marketing managers learn early about the value of segmenting their markets. Segmenting involves identifying categories of buyers so that markets can be better understood.

I've often wondered why investment managers don't make a habit of segmenting. In his letter last week, John Hussman takes a shot at it. Dr J proposes four categories of investors and their influence on supply and demand in the current market dynamic.

Fundamentally oriented long term investors are value conscious investors with time horizons of a decade or more. They prefer to buy stocks when valuations are at secular lows. At secular bear market troughs, P/Es have historically fallen to the 4-6 range and dividend yields rise to 5-6% or higher. While stock prices are off 10% from their highs, aggregate valuations are still far from the levels that suggest deep value. As such, fundamentally oriented long term investors are not likely to be a major source of buying demand at current levels since prices do not yet look intriguing to this group. If markets continue to fall, then this group is likely to scale bids as prices suggest compelling value.

Fundamentally oriented short term investors are value-conscious, but in what Hussman calls in an 'erroneous and myopic' way. This group often takes cues from forward P/E multiples which often provide deceptive signals of value. Forward multiples tend to be overly optimistic and cause this group to buy much higher than the long term group discussed above. They are likely to see recent price declines from last month's highs as a buying opportunity. Thus, this group surely constitutes one source of demand currently.

Technically oriented long term investors look at long term chart patterns and other technical indicators to assess secular bullish and bearish trends. Currently, this group is undoubtedly quite concerned over multi-year breakdowns in index and individual stock uptrends. In fact, as prices broke through major support levels, this group was more likely to be a source of supply as sell stops were elected below these support levels. Currently this group is trying to assess direction of the next multi-year trend. After the major damage that has occured in many technical indicators, technically oriented long term investors may be prone to see the next multi-year trend as being lower. Thus, this group may be a persistent source of supply from these levels.

Technically oriented short term investors are also chart watchers, but their time horizon is measured in hours, days, or weeks rather than in years. After the meltdown in prices over the past week or so, many in this group saw markets as oversold in the near term and due for a bounce. This group has likely been a major source of demand over the past few sessions.

I find this a useful framework for determining who may be on either side of the trade currently.

Which of the four 'buckets' do I fall into? Well, under this scheme I participate in multiple categories. While I my strength and interest is primarily as a fundamentally oriented long term investor, there has been little for there to do from the long side. As such, I have been attracted to shorter term fundamental and technical opportunities. For example, I was buying them in the hole last week into what appeared to be an oversold market in the near term (technically oriented short term investor category).

Of course, that source of demand has already become a source of supply as I have been piecing out inventory as prices have moved higher...

Personally, I'm trying to once again elongate my horizon as the short term space seems pretty crowded.

position in SPX

Banning Short Selling in Europe

As anticipated, various EU countries have banned short selling. France, Spain, Italy, and Belgium have thus far thrown their hats in the ring.

Short selling bans are a common interventionary tactic during market declines. The rationale is usually along the line that short sellers are 'unfairly' driving prices 'artificially' lower, perhaps by spreading false rumors or information. This is a subjective judgment, of course. It presumes that bureaucrats can judge the 'correct' price level or the accuracy of information.

In reality, markets are always better evaluators of price and information quality. Good judgments are rewarded and bad judgments are punished.

When short sales are removed from a market, the market actually becomes less liquid during periods of decline. This is because short sellers provide an important source of demand when they buy back securities to cover their position. Absent that layer of demand, markets are likely to fall harder.

We saw precisely this back in Fall 2008 when short selling was selectively banned in US markets. After an initially short covering rally on the announcement of the ban, markets resumed their decline with increased intensity. Less liquidity, deeper elevator shaft.

European markets are seeing similar short covering today. In a vacuum, this is decidedly bearish. Think it thru: What is likely to occur if longs still want to get out of positions and there are no short sellers to buy?

position in SPX

CSCO Double Bottom?

After being up a percent then down more than a percent in the premarket, futes turned around and went green, thereby facilitating a gap higher at the open. The indexes pretty much never looked back and once again we saw a 5%ish range. Close: Dow +423.

I believe that makes 5 consecutive days where major indexes have ranged 5% or more.

Lots of folks suggesting that yesterday's melt constituted a successful retest of Monday's low--meaning that the worst of the selling is past.

Perhaps. My sense is that there is big leverage that wants to leave the system. As such, I want to sell rallies.

Consistent w/ yesterday's plan, I nibbled in some SPX short into today's rally. Also but a little SLV.

The big gainer today was Cisco (CSCO) that bolted about 15% higher on a better than expected earnings report.

While other stocks have been retracing some of their gains off the 2009 lows, CSCO has made a round trip. With the selling earlier this week, CSCO has basically given it all back during its recent decline.

Now, with today's big move, it appears that CSCO may have put in a classic double bottom. As always with technical analysis, it will look 'obvious' with hindsight.

position in CSCO, SPX, SLV

Gappy Gold

Need to record the gold move for reference purposes.

As noted previously, gold can essentially be viewed as a bet on social disorder (monetary, social, etc.).

Gold is above $1800/oz in the after market.

position in gold

Just another 500 or so pt range day in the Dow today--all of it to the downside. Premarket futes starting heading south on chatter that one or more French banks were in trouble. After the opening bell, markets lost 300-400 Dow points before an afternoon rally closed the gap to about -100.

But then that rally totally fell apart, such that markets knifed thru the intraday lows on their way down in the last hour. Closing bell: Dow -519.

The market's dynamic is readily felt when assuming a trading mindset. Stocks are generally going down easier than they are going up. The temptation is to short 'em, but not only are we deeply oversold but there is also intervention risk, such as a local or worldwide ban on naked CDS sales.

Bottom fishers keep buying stocks at what seems to be 'low prices' only to get their heads handed to them when the indexes break lower in monolithic fashion.

This keeps the shorts out and the longs trapped in declining positions--a wholly bearish situation.

Also, let's keep in mind the background macro picture which portrays a massive deleveraging event underway.

As such, my inclination is to look for short side entries. The first situation I'll consider is if we happen to open green tomorrow. The risk, of course, is that we scream higher and don't look back. That's acceptable to me here given that I'm still long some stock (e.g., CSCO, MSFT).

At any rate, my general game plan as it stands is to sell rallies.

I'm also interested in adding to my SLV position. There has been a big disconnect between gold (moonshot) and silver (sold but trades relatively firm) during the past week. Clearly, market participants are wondering whether any paper currency will be worth anything--and until they do that they're piling into gold (as they have for thousands of years). My sense is that silver may play some catch-up here.

position in gold, CSCO, MSFT, SPX, SLV

Turnaround Tuesday

Another N-V-T-S trading day. Last night the Dow futes were down about 300 but in the span of a few minutes in the early am prior to the bell, futures reversed higher and were up about 1.5%.

After the opening bell markets rallied a bit and then oscillated in front of the FOMC statement. Kowtowing to the market's need for speed, Uncle Ben & Co indicated that the Fed would keep interest rates at zero until at least mid 2013 (the 1st time I've ever seen a specific time frame expressed here). The Fed also promised to employ various 'policy tools as appropriate' depending on economic conditions.

Initially, markets didn't like this statement and the indexes drained to the tune of about -2%. Then, in classic 'the first move on FOMC day is a head fake' fashion, stocks reversed and ripped higher, ending on the high tick. The Dow was +429 with the SPX and COMP up 4-5% each.

Once again, we saw intraday range of more than 5%...major league volatility.

I was busy parsing out trading inventory into that late day lift. If we continue higher I'll hold more for sale.

It is my growing sense that we are entering a significant downleg--meaning that rallies should be sold rather than bought. The word circulating in my crowded keppe is 'deleveraging.' Over the past few days, we've witnessed what happens when market particpants want to deleverage in a big way: a tidal wave of supply.

I am having my doubts whether central banks have enough sandbags to stem the tide if deleveraging continues. There is so much debt and leverage out there that if risk appetites wane, I'm just not sure central banks will be able to hold it all together.

Think about it this way. In the last few days we saw all of the market gains realized during QE2 get washed away.

What does this imply about the size and effectiveness of another round of Fed intervention?

position in SPX

Waterfall Decline

The answer to the $trillion question turned out to be a), the 'elevator shaft' scenario. US markets gapped lower by over 2% and, save for a few rally attempts here and there, basically sank throughout the day.

In the last 30 minutes, margin calls intensified the selling, sending the Dow to a -600 point day. The SPX was off almost 80 handles.

Last Friday I put back on a small SPX short position which I let fly into the morass this afternoon. Stocks are going down very easily here.

Indeed, downside bets may be getting too easy. What we've witnessed in the past week is a 'waterfall decline' which is self-explanatory by the image above. And contrary to the waterfall imagery, markets rarely move in a straight line without relieving some pressure.

About two weeks ago the SPX was tickling 1350 and appeared to be tracing out a reverse head and shoulders pattern (bullish). The SPX has shed about 17% since then, which qualifies as a multi-day crash.

While I sense that, ultimately, the indexes have more work to do on the downside, I'm warming to the risk/reward of a long side trade. Technically, the SPX has some support right around here. Moreover, trend exhaustion indicators are suggesting high probability of a near term 'trend reversal' in all major indexes. And bullish percent indicators now show levels that favor upside rather than downside.

As such, I did some buying in big cap tech this pm.

A wild card over the next day or two is the FOMC meeting. Cratering markets are exerting big time pressure on the Fed Heads for another round of QE. Past Fed interventions have invited huge amounts of risk taking behavior steeped in moral hazard. All this risk is looking once more for a bailout from the Fed.

The money pouring into gold (north of $1700/oz today) is betting that Uncle Ben & Co will do the deed and keep moral hazard in play.

position in select big cap tech, gold 

S&P Downgrades US Credit Rating

After markets closed on Fri, S&P announced that it was downgrading the United States from the top shelf AAA credit rating to AA+.

In its report, S&P based its rationale on the recent turmoil surrounding the debt deal which the agency said reduces clarity on US capacity for reducing spending and controlling debt.

The chatter that I have heard this weekend in the wake of the downgrade has been bearish. e.g, 'expect another 6-10% down in markets over the next couple of weeks.' Indeed, that could occur.

On the other hand, it is possible that some of the decline that we saw last week was market participants pricing in the downgrade. In such case, it shouldn't be surprising that we actually rally now that the news is out.

In any event, all eyes will be watching the action early in the week for more clues.

position in SPX

Fast Market

The intraday moves continue to be eye popping. Deleveraging combined with high frequency trading is the likely culprit.

Currently, this is the consummate 'fast market.' Intraday range on the SPX has been about 50 handles today...

During the earlier lift, unwound much of my long exposure that I bought in the hole yesterday. Still holding some Microsoft (MSFT) and Merck (MRK) that will be held for sale if prices continue to firm.

My sense is that if prices don't squirt higher pretty soon, then very near term oversold conditions may be worked off as a function of time rather than price, and we'll head toward SPX 1125.

Even if we should we rally back up toward SPX 1225, Boo the bear will likely lean against this level pretty hard.

positions in MSFT, MRK, SPX

Ugly Day

Ugliest stock market day in quite a while. The 'wide and loose' price behavior brought back memories of 2008.

Major indexes were down 4-5% with the Dow off 512. After a morning surge below SPX 1225 tripped some sell stops, the S&P regained the 1225 level in late morning at early afternoon, or about a 2.7% loss. Lots of folks, your truly included, were watching to see whether that 1225 level would hold.

It didn't. Once 1225 was decisively breached in the early afternoon, then selling brought out more selling. My sense is that leveraged index players were being carried out on stretchers in droves today, and the action late in the day had the feel of margin calls.

Those margin calls drive forced selling--the good gets sold with the bad. As such correlations among risky assets approach 1.0. Great example of this today.

Significant support now rests below at 1125 and 1025.

I wound up covering my S&P short on the break below 1225 in early afternoon--prematurely as it turned out. However, markets are very oversold in the near term. The SPX is off more than 10% in just a few short sessions. Volatility indexes are going vertical--with the VXO up 45% today! Jason's sentiment gauges are suggesting extreme near term pessimism.

Because I had been battling this chunky short position for quite some time, I decided to book a decent trade, clear my head, and look at the situation with a fresh set of eyes.

The afternoon melt actually found me buying some of my favorite large cap names into the afternoon abyss--for a trade. I think this tape has unresolved issues to the downside. But in the uber near term, I think Snapper (a.k.a. snap back rally) has a decent chance of making a cameo appearance.

If Snapper doesn't show tomorrow (Friday), then people will surely start pondering the 'crash' scenario going into the weekend.

position in select large cap stocks

Big Move in Treasuries

Wow, you don't see moves like this in long bonds every day. Long dated Treasuries are up about 5% in a couple of days.

Suggestive of investors who want to get out of risk in a hurry.

no positions

Debt Deal Rally MIA

After yesterday's 'pop and drop' on the debt deal news, we suggested that those positioned for a post-agreement relief rally were hoping that the best was yet to come.

With the benefit of hindsight, yesterday's gap higher may have been it.

The Senate's passing the debt bill today was immediately sold. The SPX closed on its lows, down about 2.5%, on its largest volume in a month. The SPX has now cut decisively below its 200 day moving average. Support rests below on the '25s': 1225, 1125, 1025.

Outside markets have been on the move as well. Gold screamed $30 higher today after the debt passage news was announced. Long bonds rallied again, with 10 yr yields down about 10% in three days. The Swiss franc has been on fire, hitting new highs for the move almost daily and up about 5% in three days. Nearly all foreign markets are retreating. The German DAX, one of the strongest performers worldwide, is off about 6% from yesterday's intraday high.

Add it all up and you get waning appetite for risky assets amid a macro context built on ever increasing piles of debt.

position in SPX, gold

Gold and the National Debt

Interesting projection of gold alongside US public debt. Should the relationship hold, loading $2.5 trillion more onto the debt pile implies that gold 'works' to $1950.

Gold is marking another new high today. Seems the markets are doing the math...

position in gold, GLD