Saturday, May 23, 2009

Stock Market Update 23 May 2009

Welcome to the latest installment of ECAM.

It has been quite an interesting week. There are certain times in a market when you look back and, in hindsight, you can pin point an inflection point that has consequences that reach far into the future. We may have seen such an event this week.

Specifically on Thursday we had a rare day when US stocks went down, US bonds went down (yields up) and the USD went down. I cannot remember a time when all 3 did the same thing (2 of the 3 "always" move inverse to the other on any given day). Something happened but what it was isn't exactly clear at this point. It was almost like the message went out that the world has decided to "sell the U.S." and, if that is the case, the next few months will be very interesting and could have a profound impact upon where you want to be invested.

It is widely known now that China, as the worlds #1 purchaser of U.S. debt, is unhappy with the current fiscal situation developing in the U.S. They have spoken on numerous occasions about their desire to move away from the U.S. dollar and U.S. debt to other sources of investment. In the past this wasn't possible because the Chinese needed to accept U.S. dollars in exchange for all the merchandise they produced and shipped to the U.S. consumer. However, now that the U.S. consumer is basically dead and China has turned to funding internal consumer demand for its products, it appears China may have the opportunity now to change the rules of the game and attempt to reduce it's reliance upon this relationship.

The Royal Bank of Canada recently revealed China is reallocating its wealth as Beijing fears the U.S. dollar is in a long-term decline. Premier Wen Jiabao has said in the past he is "worried" about the safety of the nation's estimated $767.9 billion in holdings of U.S. Treasuries. While China cannot eliminate the dollar as the predominant unit of exchange, it's seems like it is looking for ways to gradually wean itself off the dollar going forward.

Recently China has been buying more short-term U.S. Treasuries while decreasing the percentage of long-term Treasuries that it buys. It has also declined to repurchase long dated treasuries as they mature in favor of short term treasuries.

According to U.S. Treasury data, from August 2008 to March 2009, China purchased $171.3 billion of T-bills, debt that carries a maturity of up to a year, compared with just $22.9 billion of longer-term notes and bonds with a maturity of two years or more. At the same time, China also sold $23.5 billion of long-term agency debt.

As one commentator wrote recently, "The general trend is for less buying of long-term U.S. Treasuries ... like China is giving Uncle Sam a vote of no confidence. When traders wise up to what China is doing, it could send the U.S. dollar tumbling even further. That would be bad news for the United States ... but investors who hold commodities can help insulate themselves against the fallout".

The second thing China is doing is attempting to remove the U.S. dollar as a requirement for trade with other nations. China recently signed $95 billion in swap agreements with Argentina, Indonesia, South Korea, Hong Kong, Malaysia and Belarus. They are also in the midst of securing a deal with Brazil to trade goods and services between the 2 countries in the Yuan and Real as opposed to the USD. It is assumed they are doing so in an attempt to gradually make the Yuan an international currency accepted in the same way as is the USD, Euro, British Pound, etc. This way, gradually, China hopes to make the Yuan a truly international currency and, I believe ultimately many years out, possibly the next world's reserve currency. This will have a profound impact upon the USD in the future.

Putting this all together, you have China attempting to "distance" themselves from the U.S. currency and debt market. That is very bad news for the U.S. if that is the case. I think we may have seen the "footprints" of that move this week as I mentioned previous.

On to the charts. As you know, I have been waiting for a pullback in the recent stock market rise to allow me to buy back in at more reasonable levels. This pullback is currently underway.

The degree of the correction is open to debate. I will let the charts tell me when it is time to get back in.

The first charts are the charts for the S & P 500 Index. As always, click on the charts to enlarge.

SPX 6 month daily:

Since double topping on May 7-8 at the 930 level, the SPX has declined approx 6% to its current support level of 877. It is obvious this is a critical support level as seen on the chart. In addition, the well defined up trending channel was broken to the downside on Thursday.

What I find encouraging on this chart is the relatively benign correction given the huge upturn since the March bottom. This relatively small decline has worked off the overbought nature of the markets with the slow stochastic (slow STO) now having come from well above 80 down to its current level of 30.80.

Additionally, note the volume on this decline has been very light (not a single sell day with volume > 50 day moving average). This tells you there is no panic to sell but just a lack of buy pressure that is letting the markets currently drift down from overbought territory. This is bullish.

In an "ideal" world you would expect price to decline 10-15% from its current top before resuming the next uptrend. Even better would be a retrace to the 38.2% Fibonacci level at 829.71. Whether we get there before the next upturn is open to debate; we'll have to wait and see.

SPX Ichimoku:

I've shown the Ichimoku charts once previous. They are not well followed by many technicians but I have come to use them a lot over the years.

While there are 5 different signals available on one chart, the one I find the most useful is price action above/below the main red line. It can be seen that level is currently at 878.50 and represents a very good level of support for the SPX. Should that level break it would be expected price would fall to challenge the area of support defined by the Kumo "cloud" below.

SPX 1 month daily:

In this chart I have taken the SPX and brought the scale into 1 month to more clearly define the candlesticks and supporting technical readings.

The current support at 878.94 and resistance at 930.17 are clear. What you want to look at is the dotted line we crossed yesterday and closed totally below today. That dotted line is the midpoint line of the Bollinger Bands. The key thing to understand about Bollinger bands is that they are an algorithm that defines prices 95% of the time. In other words, over a given period price will remain within the upper and lower Bollinger bands 95% of the time (allowing a push above the band 2.5 % of the time and a push below the bands 2.5% of the time).

As a "general" rule, when a candlestick closes totally above the BB midpoint, it has around a 70% chance of continuing upwards to attempt to tag the upper band. The opposite is true should the candle close totally below the BB midpoint. This occurred on Friday as can be see.

Should this rule hold true, we can expect the markets to continue down from here to attempt to tag the lower BB (currently at 854.91 and rising).

SPX 3 year weekly:

Our 3 year weekly chart once again confirming this still must be considered a bear market rally.

-The 13 week EMA has not crossed above the 34 week EMA
-The full STO is overbought (>80) and appears to be turning back downwards
-The previous weekly high in 2008 of 943.85 has not been broken to the upside

One of the key developments the past week was the action on the USD. See my comments below.

USD 6 month daily:

The rally in the USD ended at the beginning of March at 89.62. Price fell rapidly in March to 82.63 and then began to climb. This topped at 86.87 and began a new decline, setting up a descending channel clearly seen on the chart.

On Friday, May 08 price broke below the 200 day moving average and the support line at 82.63. It rose to the upper downtrend line of the small internal channel but was unable to break the downtrend and resistance at 83.10. From that point all hell has broken lose with the dollar dropping 5 straight days in a row for a 3.55% loss this week.

The outlook technically for the dollar is not good. I would expect given the severe oversold nature currently the USD to find support near the 79 level (the bottom of the channel) before recovering. As such, selling the dollar at this level would be a mistake.

USD 2 year daily:

A 2 year view of the dollar shows the break of the uptrend line concurrent with the support line at 83.60. Price is currently near a support congestion zone of 79.96-80.38 combined with the 50% Fibonacci retracement level of 80.16. With the extreme oversold nature of the USD currently, I would expect this level to hold and the USD to rebound. However, if that does not happen the next support is 77.85 (concurrent with the Fibonacci 61.8% level of 77.93) followed by a fall to the bottom at 70.70.

I will be watching the USD action early next week to decide whether I will exit the USD or continue to hold it.

USD Point and Figure Traditional:

The PnF chart backs up the bearish USD when price fell to 82. It currently projects a target of 73.00

USD 3 year weekly:

The 3 year weekly chart shows the decline last week and the current Fib support levels well. My greatest fear with respect to the current decline of the USD is not necessarily the price decline (retracements are a part of any advance) but the fact the 14 week RSI has broken below 50. This should not have happened if this was a "normal" retracement within an ongoing bull market rally so there could be something more ominous lurking (ie. China as discussed previous). I think the previous support levels discussed have to be watched seriously and any breach will be a signal to exit all USD positions.

U.S. 10 year treasury yield 6 month daily:

While not a part of the provident fund, I think you all need to understand that interest rates in the U.S. are going up (affecting borrowing on real estate, corporate loans, etc). This is not because Bernanke/the FED want them to (they are working like hell to do everything in their power to keep them down) but because THE MARKET has decided it is time.

The question is whether this recent action is because of:

a) central banks deciding to get out of US debt instruments, or
b) the 1st signs that inflation is returning to the US.

The key to understand in simple terms:

1) rates move inverse to price. If rates are rising, bond prices are falling.

2) the FED sets short term rates but all other rates are set by the market. If the market decides there is low risk in government bonds (or low expected inflation going forward), money flows into bonds raising prices and lowering rates. That is what Bernanke wants to see and when the market was not responding in March he elected to print money and purchasing HIS OWN BONDS (known as quantative easing) in an attempt to put a false floor in price (and therefore a false ceiling on rates).

3) up until recently he was able to keep yields below 30.54 (3.054%). The breakout in early May was followed by massive FED purchases to push the rate back down. That lasted a few days but rates spiked up again on Thur and Fri to new short term highs. Has Bernanke/the FED lost control of the 10 year yield?

What you want to take away from this is THE MARKET has either decided to call Bernanke’s bluff or it senses inflation returning to the market.

What is clear is that there are a large number of debt holders (China again?) who are basically saying to Bernanke; you want to buy your own debt, it can have it. This sudden supply of debt for sale has driven bond prices down (large supply, small demand pushes prices down) and therefore rates are rising.

Under the other possible scenario (the return of inflation), the recent strength in gold supports the argument that inflation is returning. If so, this could have a huge long term negative effect on the U.S. stock markets, bond markets and real estate. You need to watch this close.

I have had a number of subscribers ask me to do an ECAM blog on gold. I plan on doing so in the very near future as I am a big believer in holding physical precious metals (gold, silver) as an essential part of every portfolio.

U.S. 10 year treasury yield 3 year weekly:

A 3 year weekly chart to show how rates have rocketed up while the FED has done all it can to attempt to keep rates down. This week’s blast through strong resistance at the 32.81 level (3.281%) is a very worrying development.

Anyone owning US long term bonds/bond funds would be wise to exit these positions.

Lehman International Treasury Bond ETF 6 month daily:

With the potential drop in the USD, I have begun to look again to the Fidelity International Bond fund as a possible place for cash (plan "B") should the current stock market rally fizzle out.

A good proxy for our bond fund is the Lehman International Treasury Bond ETF. A reminder that international bond funds do well only when the USD is weak/in decline. It offers you the protection of being in "international" currencies with the added yield provided by holding the government bonds of non-US countries.

The 6 month chart shows a nice bottom in March (coincident with the bottom in the stock markets) yet it has diverged upwards even as the stock markets have declined. A break above 52.56 late last week was very bullish.

Lehman International Treasury Bond ETF 3 year weekly:

A 3 year weekly view of the same fund. A symmetrical triangle has formed and a break above the upper descending trend line would be very bullish for international bonds.

Food For Thought:

Some of you may have heard the old Wall Street saying; "Sell in May and go away". Here is an interesting chart of the SPX going back to 1950 giving the simple rates of return in the market for each and every month.

Keep this chart in the back of your mind if you decide to put money into the stock market at this point. I do every time I invest during this time of year.

Bottom Line:

No changes to positions. Still approx 12% in equities (due to ongoing monthly provident fund purchases and current market rise) and 88% in "nervous" USD cash.

I will blog if I make any changes immediately.

**Strategic allocated percentages are as per how funds were originally allotted. Due to market fluctuations and ongoing equity monthly purchases these amounts vary several % from that posted (refer to current % holdings).

Legal Disclaimer: The content on this site is provided without any warranty, express or implied. All opinions expressed on this site are those of the author and may contain errors or omissions. NO MATERIAL HERE CONSTITUTES "INVESTMENT ADVICE" NOR IS IT A RECOMMENDATION TO BUY OR SELL ANY FINANICAL INSTRUMENT, INCLUDING BUT NOT LIMITED TO STOCKS, OPTIONS, BONDS OR FUTURES. The author will reveal his current market positions and holdings but actions you undertake as a consequence of any analysis, opinion or advertisement on this site are your sole responsibility.


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