Happy, Healthy New Year!!

I would like to wish everyone a Happy and Healthy New Year!!

Now would be a good time to review my "11 Rules For Better Trading", and in particular, I will highlight rule #11 as we should try to keep things in perspective during this very difficult year in the financial markets:

Rule #11
Take care of yourself. No amount of money is worth it if your health is failing or you have managed to alienate yourself from family and friends in the process.

Lastly, I have posted a lighthearted video that reviews this past year's events.

Enjoy. See you in 2009!

Gold: Technical Update

When I last checked in on gold, I stated that the fundamental picture was obvious to everyone as central bankers were in a race to devalue their currencies. Gold soared on the Federal Reserve's commitment to do whatever it takes to solve the ills of the American economy.

In that article, I argued that the technical picture suggested a different scenario. The monthly chart had yet to break out; the weekly chart showed a series of lower highs and lower lows. Essentially, on the Fed news, gold had a strong bounce into resistance and into a downsloping 40 week or 10 month moving average. The technicals had yet to confirm a new bull market (by my methodology) in gold, and my conclusion at the end of the article was the following:

"While the price action has been strong and the fundamental story is plausible, the technicals suggest a pull back. For now and until confirmation of a monthly close over the trend line in figure 1 (or the simple 10 month moving average), this does not appear to be anything more than a strong bounce into resistance."

So as the month ends, let's revisit the technical picture in gold.

Figure 1 is a monthly chart of gold. The pull back that I have expected is occurring. Gold is unlikely to clear the down trending 10 month moving average (by the end of the month), but price is poking above the down sloping trend line formed by two consecutive pivots. This represents mixed price action for gold. The close below the 10 month moving average is still bearish, yet on the other hand, a close above the trend line (if it occurs) is bullish.{As I write this morning, gold remains weak leaving the end of month close in doubt.}

Figure 1. Gold/ monthly

Figure 2 is a weekly chart of gold showing the series of lower highs and higher lows. However, gold is in the process of making a higher high, and this is a positive.

Figure 2. Gold/ weekly

It is my belief that gold will pullback and then remount another assault on the 40 week or 10 month moving averages. It is also my belief that gold will be higher in 12 months than today. The price action is encouraging and longer term studies, such as the "next big thing" indicator, suggest that gold is setting up for a strong upside move. However, as we approach the end of the month, there has not been confirmation of a new bull market in gold.

Stay tune!

Key Price Levels: December 29, 2008

With prices failing at support on the QQQQ (NASDAQ 100 proxy) and IWM (Russell 2000 proxy), the price action is very mixed. Two weeks ago, the QQQQ and IWM barely and unconvincingly closed above resistance, and this became support, which has not held this past week. The break down wasn't convincing either, but this is the hand we are dealt - a low volume, news driven market. The SPY (S&P500 proxy) and DIA (Dow Industrial proxy) have been above key levels for several weeks now but have failed to clear the next level up.

Before looking at the charts to see the areas where the major indices will succeed or fail, let me give you some words on how to use these levels. As we all know, nothing is ever written in stone when it comes to the market. These key levels have been shown (via the back testing process) to be important areas of buying and selling. They are like road signs directing us to certain price criteria that must be maintained to meet the bullish (or bearish) case. So if the IWM closes the week below 47.58 (the nearest key price or support level), then I would say that this is a bearish development. As it turns out, the IWM closed the week at 47.55. Now I can also understand how one might want to wait before closing out their position as it doesn't seem intuitive that positions should be closed out based upon a penny or two. If this is the case, I would remain cautious; however, I would not stray too far from the methodology. Any downside pressure should be considered real. This approach would be consistent with my "11 Rules For Better Trading". Be data centric. Be disciplined but flexible!!

Key price levels are points where buying and selling are most likely to take place. With over 40 years of back tested data, I have defined these key price levels as a pivot point low occurring at a time when investor sentiment is bearish (i.e, bull signal). These key areas are shown with the red dots in figure 1, a weekly chart of the ETF proxy for the S&P500, the S&P Deposit Receipts (symbol: SPY).

Figure 1. SPY/ weekly

Now let's stay with figure 1, and focus on the price bars with the red labeling. These are positive divergence bars between a momentum oscillator and price. Positive divergence bars tend to occur at market bottoms and are of indicative of decreasing downside price momentum. They don't always lead to trend reversals, and more likely the highs and lows of the divergence bar will define a price range. A weekly close above the highs of the positive divergence bar will lead to higher prices (and is considered a breakout) and a weekly close below the lows of the positive divergence bar will lead to lower prices (and is considered a breakdown). The highs of the current positive divergence bar are at 90.13.

My interpretation of the SPY chart is as follows: the price action has been good with four consecutive weekly closes over 86.78. Currently, prices are trading to resistance levels as defined by the highs of the positive divergence bar. A weekly close below 81.78 would be serious technical damage. A weekly close below 86.78 implies weakness and increasing caution. A weekly close over the highs of the positive divergence bar at 90.13 would be bullish. As you can see, prices have probed this area but failed on a closing basis.

Figure 2 is a weekly chart of the Dow Jones Industrial ETF proxy, the Diamond Trusts (symbol: DIA). The key levels and positive divergence bars are noted. Prices have yet to close above near term resistance at 88.36. A weekly close below 82.64 would be disastrous.

Figure 2. DIA/ weekly

Figure 3 is a weekly chart of the Power Shares QQQQ Trust (symbol: QQQQ). As mentioned above, the support zone between 29.72 and 29.36 failed. This is a sign of weakness and this level is now resistance. A weekly close below 27.63 is very bearish.

Figure 3. QQQQ/ weekly

Figure 4 is a weekly chart of the i-Shares Russell 2000 Index (symbol: IWM). As mentioned above, last week's support is now this week's resistance - just barely. Even though it was by a few pennies, a weekly close below this (47.58) level is poor price action. I would be cautious on IWM until further notice. Support levels are over 10% away at 42.48.

Figure 4. IWM/ weekly

The mixed price action along with the sentiment picture suggests caution. What is the impetus for higher prices? Until resistance levels are taken out in all the major indices, I will not be convinced that the recent rally (from mid November) is nothing more than a bear market rally.

Investor Sentiment: Sell Into Strength

This is the third week in a row where the "dumb money" is neutral and the "smart money" is bearish, and this is not a scenario that is generally supportive of higher prices especially with prices on the S&P500 under their 40 week moving average. The ideal situation for higher equity prices would be for the "smart money" to be bullish and the "dumb money" bearish (i.e., bull signal).

The "dumb money" or investment sentiment composite indicator (see figure 1, a weekly chart of the S&P500) looks for extremes in the data from 4 different groups of investors who historically have been wrong on the market: 1) Investor Intelligence; 2) Market Vane; 3) American Association of Individual Investors; and 4) the put call ratio.

Figure 1. "Dumb Money"

When combining the "dumb money" indicator with other metrics such as poor market internals and price under the 200 day moving average, we find that rallies tend to fail after 4 weeks of the "dumb money" indicator being neutral. Therefore, I would be a seller into rallies as the current set of conditions is more consistent with intermediate term topping action. In essence, we need to ask ourselves: what is going to propel prices higher? With sentiment no longer bearish (i.e., bull signal) and market internals lackluster, this bear market rally, which started in mid November, remains suspect.

When Can We Expect A Sustainable Price Move?

Most market participants seem to focus on picking that elusive bottom. You here it on CNBC all the time and just about everywhere you go after the market has a good pop off its lows: Is this the bottom?

Rather than focusing on the bottom, market participants would do well just to focus on when there will be a sustainable multi month -possibly multi-year - price move. Identifying the market bottom is hard enough even after the fact. On the other hand, being "in" at the bottom does have its benefits, and it is likely to result in significant market outperformance.

But this article isn't about picking bottoms. It is about identifying that sustainable price move. And to do this I will assume that a sustainable price move starts when prices cross their 200 day moving average. This doesn't mean that I am defining a bull market by price's relationship to its 200 day moving average. I am not. All I am saying is that at some point in a bull market prices will cross the 200 day moving average and stay above this level for a long time.

Wednesday's close on the S&P500 is at 865.42. The 200 day moving average is at 1192.92. The current price is 327.5 points (or 27.45%) below its 200 day moving average. Historic by any measure.

For the sake of argument, let's assume that the S&P500 closes at 865.42 for the foreseeable future. If this were to occur, then it would take 171 trading days (or about 8 months) for the S&P500 to cross above it's 200 day moving.

Or let's assume (as I believe), the market trades in a range as defined by the price swings of the last two months. The average price on the S&P500 since November 3, 2008 has been 879.6. The highs occurred on November 3 at S&P500 1007.51 and the lows occurred on November 21 at S&P500 741.02. There is a 25% spread between these highs and low marks. If for the forseeable future the S&P500 were to close at the average price (i.e., 879.6) seen over the last two months, it would take 163 trading days for prices to close above their 200 day moving average.

Predicting market bottoms is a difficult business. A sustainable, multi-year price move is likely to result in prices greater than their 200 day moving average. If prices were to stay within their current price range, it will take almost 8 months for prices on the S&P500 to be above their 200 day moving average. In essence, it is going to take time before a new bull market rally is upon us.

HAPPY HOLIDAYS FROM THE TECHNICAL TAKE!!

Gold v. EURUSD

In my previous post on gold, I provided a technical overview as to why I thought gold would undergo a pullback despite what seems like an excellent fundamental picture. The longer term picture suggests that gold is in a bear market, and last week's explosive upside move was nothing more than a strong bounce into resistance. When I made the "call", gold was probing $875, and since then, the precious metal is off about 5%.

Of course, this is all short term stuff, and admittedly, I believe that in 12 months gold should be higher than today's price; it just may take some more backing and filling before gold takes off from the launching pad.

One clue to the action in gold is to follow the movements of the EURUSD. In general, US Dollar weakness leads to strength in both gold and the Euro. Therefore, gold and the Euro tend to move together.

Figure 1 is a monthly chart of the EURUSD cross rate. Last week's Federal Reserve announcement "to do whatever it takes" saw the US Dollar plummet and the Euro and gold sky rocket. Like gold, the EURUSD cross rate failed at resistance levels - in this case, an upward sloping trend line and the down sloping 10 month moving average. The bear market for the EURUSD remains intact. The EURUSD, like gold, will need more backing and filling before old and significant resistance levels are taken out.

Figure 1. EURUSD/ monthly

Key Price Levels: December 22, 2008

Despite the sentiment picture (which is not supportive of higher prices), the price action remains sluggishly fabulous. The QQQQ (NASDAQ 100 proxy) and IWM (Russell 2000 proxy) have finally closed the week above key resistance levels; it wasn't convincing but they are above. The SPY (S&P500 proxy) and DIA (Dow Industrial proxy) have been above key levels for several weeks now but have failed to clear the next level up.

So let's look at the charts to see the areas where the major indices will succeed or fail.

Key price levels are points where buying and selling are most likely to take place. With over 40 years of back tested data, I have defined these key price levels as a pivot point low occurring at a time when investor sentiment is bearish (i.e, bull signal). These key areas are shown with the red dots in figure 1, a weekly chart of the ETF proxy for the S&P500, the S&P Deposit Receipts (symbol: SPY).

Figure 1. SPY/ weekly

Now let's stay with figure 1, and focus on the price bars with the red labeling. These are positive divergence bars between a momentum oscillator and price. Positive divergence bars tend to occur at market bottoms and are of indicative of decreasing downside price momentum. They don't always lead to trend reversals, and more likely the highs and lows of the divergence bar will define a price range. A weekly close above the highs of the positive divergence bar will lead to higher prices (and is considered a breakout) and a weekly close below the lows of the positive divergence bar will lead to lower prices (and is considered a breakdown). The highs of the current positive divergence bar are at 90.13.

My interpretation of the SPY chart is as follows: the price action has been good with three consecutive weekly closes over 86.78. Currently, prices are trading to resistance levels as defined by the highs of the positive divergence bar. A weekly close below 81.78 would be serious technical damage. A weekly close below 86.78 implies weakness and increasing caution. A weekly close over the highs of the positive divergence bar at 90.13 would be bullish. As you can see, prices have probed this area but failed on a closing basis.

Figure 2 is a weekly chart of the Dow Jones Industrial ETF proxy, the Diamond Trusts (symbol: DIA). The key levels and positive divergence bars are noted. Prices have yet to close above near term resistance at 88.36. A weekly close below 82.64 would be disastrous.

Figure 2. DIA/ weekly

Figure 3 is a weekly chart of the Power Shares QQQQ Trust (symbol: QQQQ); prices have finally cleared the upper reaches of the resistance zone as determined by the key support level at 29.72 and the highs of the positive divergence bar at 29.36. It wasn't a convincing show of strength as prices are just barely above (only 14 cents) , but it is a close above a key level nonetheless, and this should be bullish. 29.36 is now support and a weekly close below this level is a sign of weakness.

Figure 3. QQQQ/ weekly

Figure 4 is a weekly chart of the i-Shares Russell 2000 Index (symbol: IWM). Resistance levels at 48.26 have been taken out on a weekly closing basis, so this now becomes support. A weekly close below this (47.58) level is considered bearish.

Figure 4. IWM/ weekly


As we approach this holiday shortened week where light volume should be the rule, the major indices and their ETF proxies are providing a mixed picture. The QQQQ and IWM have finally closed above their most immediate overhead levels but realistically, I have to ask: where is the conviction? The SPY and DIA appear to be further along in the bottoming process but have failed at the next resistance levels. As discussed previously, sentiment is mixed. As always, we give the market the benefit of the doubt, yet of course, we should be on the alert for failures at our key price levels.

Investor Sentiment Is Neutral

With the "dumb money" neutral and the "smart money" bearish on equities, it is unlikely that equity prices will gain much traction in the coming weeks. The ideal situation for higher equity prices would be for the "smart money" to be bullish and the "dumb money" bearish (i.e., bull signal).

The "dumb money" or investment sentiment composite indicator (see figure 1, a weekly chart of the S&P500) looks for extremes in the data from 4 different groups of investors who historically have been wrong on the market: 1) Investor Intelligence; 2) Market Vane; 3) American Association of Individual Investors; and 4) the put call ratio.

Figure 1. "Dumb Money"

The "smart money" (see figure 2) refers to those investors and traders who make their living in the markets. Supposedly they are in the know, and we should follow their every move. The "smart money" indicator is a composite of the following data: 1) public to specialist short ratio; 2) specialist short to total short ratio; 3) SP100 option traders.

Figure 2. "Smart Money"

In sum, this is the second week in a row where the "dumb money" is neutral and the "smart money" is bearish, and this is not a scenario that is generally supportive of higher prices especially with prices on the S&P500 under their 40 week moving average.

Leading Economic Indicators Continue To Show Weakness

The leading economic indicator (LEI) from the Economic Cycle Research Institute continues to show weakness within the economy.

Figure 1 is a monthly chart of the S&P500. The orange line in the second panel is the LEI data; the yellow "box like" indicator is an analogue representation of economic expansions and contractions as determined by the National Bureau of Economic Research (NBER), which is the official body that declares the starting and ending dates of a recession. The indicator in the bottom panel is a simple 12 month rate of change of the LEI data.

Figure 1. S&P500 v. LEI/ monthly

Point 1

Recessions occurred in 1970 (not shown on chart), 1974, 1980, 1982, 1991, 2001, and 2008. Recessions are typically heralded by the 12 month rate of change of the LEI significantly below zero. The current value of the indicator is at its lowest level ever, yet more importantly, it shows no sign of turning up. This suggests continued economic weakness and a prolonged recession.

Point 2

With the LEI data heading lower and the stock market heading higher, this divergence is noteworthy. We should see the rate of change indicator move higher as a confirmation that higher stock prices are sustainable.

Point 3

In the 1970, 1974, 1980, 1982 and 1991 recessions, the stock market's low occurred during the recession. The 2001 recession ended prior to the ultimate bottom in the stock market. Stocks don't always turn up prior to the end of the recession.

Long Term Treasury Yields: How Low Is Too Low?

Yields on the 10 year Treasury bond have fallen by nearly 20% in three days. Yes, these are unprecedented and historic times.

As yields have fallen, many observers have wondered: "How low is too low?" It just doesn't seem plausable that investors would pay for a longer term bond yielding such paltry returns.

Of course at some point in time, this move in yields will exhaust itself. It would not surprise me if we are coming close to that point. Figure 1 is a monthly chart of the yield on the 10 year Treasury (symbol: $TNX.X). As you can see, yields are approaching the bottom end of a trend channel that has been in place since 1987.

Figure 1. 10 Year Treasury Yields/ monthly

So to answer the question: How low is too low? It doesn't seem that yields will go much lower.

In recent posts, I had stated that yields on the 10 year Treasury were prime for a secular trend change. That is still the case, but further analysis suggests and as I have stated several weeks ago, that possibility is still several months away.

A Slightly Different Take On Gold

The fundamental reasons for higher gold prices have been brought to the fore this past week as the Federal Reserve has pulled out all the stops and opened the monetary spigots. Printing presses are turned on; the currency gets devalued; investors flock to gold as a store of value. Gold bugs envision gold at $1500 next week as the "big one" has arrived.

That's the story behind the story. However, the technical picture appears to suggest a different story. See figure 1, a monthly chart of a continuous gold futures contract.

Figure 1. Gold/ monthly

With a monthly close below the pivot point (labeled #1), gold entered a bear market. This was an "m -type" top. Four months later, gold is now peaking above a down sloping trend line and is trading just below its simple 10 month moving average. A monthly close over the trend line and the 10 month moving average will reverse the bearish trend. A monthly close above the pivot point (labeled #1) is very bullish. As we are not at the end of the month, the bullish signal has not happened yet.

What has happened is best seen on a weekly chart of gold. See figure 2.

Figure 2. Gold/ weekly

The March, 2008 highs are labeled with a #1 and the October, 2008 lows are labeled with a #2. The current upswing is an exact 50% retracement of the down draft that occurred from points #1 to #2 or the high to lows. Furthermore, the pattern of lower lows and lower highs is unlikely to be broken with this upswing.

So let's summarize the following for gold: 1) a new bull market has yet to be confirmed; 2) the current bounce is an exact 50% retracement into a down sloping 10 month moving average or 40 week moving average; 3) the pattern of lower highs and lower lows is intact.

While the price action has been strong and the fundamental story is plausible, the technicals suggest a pull back. For now and until confirmation of a monthly close over the trend line in figure 1 (or the simple 10 month moving average), this does not appear to be anything more than a strong bounce into resistance.

Key Price Levels

Key price levels are points where buying and selling are most likely to take place. With over 40 years of backtested data, I have defined these key price levels as a pivot point low occurring at a time when investor sentiment is bearish (i.e, bull signal). These key areas are shown with the red dots in figure 1, a weekly chart of the ETF proxy for the S&P500, the S&P Deposit Receipts (symbol: SPY).

Figure 1. SPY/ weekly

Now let's stay with figure 1, and focus on the price bars with the red labeling. These are positive divergence bars between a momentum oscillator and price. Positive divergence bars tend to occur at market bottoms and are of indicative of decreasing downside price momentum. They don't always lead to trend reversals, and more likely the highs and lows of the divergence bar will define a price range. A weekly close above the highs of the positive divergence bar will lead to higher prices (and is considered a breakout) and a weekly close below the lows of the positive divergence bar will lead to lower prices (and is considered a breakdown). The highs of the current positive divergence bar are at 90.13.

My interpretation of the SPY chart is as follows: the price action has been good with two consecutive weekly closes over 86.78. Currently, prices are trading to resistance levels as defined by the highs of the positive divergence bar. A weekly close below 81.78 would be serious technical damage. A weekly close below 86.78 implies weakness and increasing caution. A weekly close over the highs of the positive divergence bar at 90.13 would be bullish.

Figure 2 is a weekly chart of the Dow Jones Industrials ETF proxy, the Diamond Trusts (symbol: DIA). The key levels and positive divergence bars are noted. Prices have yet to close above near term resistance at 88.36.

Figure 2. DIA/ weekly

Figure 3 is a weekly chart of the Power Shares QQQQ Trust (symbol: QQQQ); prices are currently probing the upper reaches of the resistance zone as determined by the key support level at 29.72 and the highs of the positive divergence bar at 29.35. A weekly close over both of these levels would be very bullish and likely catapult the markets into a mutli week rally. For now and until further notice, the current price action in the QQQQ is suggestive of a bear market rally into resistance.

Figure 3. QQQQ/ weekly

Figure 4 is a weekly chart of the i-Shares Russell 2000 Index (symbol: IWM). Resistance levels are noted and like the QQQQ, this is nothing more than a bear market rally unless these levels are taken out on a weekly closing basis.

Figure 4. IWM/ weekly

The major indices and their ETF proxies are providing a mixed picture. The SPY and DIA appear to be further along in the bottoming process as key resistance levels have been taken out already. The QQQQ and IWM have traded back to prior areas where selling commenced and old breakdown areas (or resistance levels) have not been convincingly taken out.

Market sentiment is also mixed, and market internals remain lackluster despite a 10% move in the S&P500 over the last 3 weeks ( on a weekly closing basis). Until resistance levels are taken out in all the major indices, I will not be convinced that the recent rally is nothing more than a bear market rally.

Investor Sentiment

The "dumb money" or investment sentiment composite indicator (see figure 1, a weekly chart of the S&P500) looks for extremes in the data from 4 different groups of investors who historically have been wrong on the market: 1) Investor Intelligence; 2) Market Vane; 3) American Association of Individual Investors; and 4) the put call ratio. The indicator is now in neutral territory. Typically, when this sentiment indicator is at bearish extremes (i.e., bull signal), gains in the stock market occur at an accelerated pace as those on the sidelines chase prices higher. For example, on a closing basis the S&P500 has gained about 10% over the last 3 weeks of time while sentiment was bearish. With sentiment now being neutral, the pace of gains (momentum) should begin to flatten out.

Figure 1. "Dumb Money"

The "smart money" (see figure 2) refers to those investors and traders who make their living in the markets. Supposedly they are in the know, and we should follow their every move. The "smart money" indicator is a composite of the following data: 1) public to specialist short ratio; 2) specialist short to total short ratio; 3) SP100 option traders. The “smart money” remains bearish on equities, and in fact, this is the first time since 1990 (about 45 signals) where the “smart money” did not turn bullish while the “dumb money” was bearish. Over the past 18 years, the “smart money” has always confirmed the unwinding of bearish sentiment as prices move higher. This has not happened yet. In other words, the “smart money” appears not to be buying into this rally yet.

Figure 2. "Smart Money"

In sum, the sentiment picture (“dumb money” plus “smart money”) is less supportive of higher prices.

Key Price Levels On The SPY

In the article "Key Price Levels To Watch" I stated the following:

"Last week's key buying level for the SPY was 86.78. As long as the SPY held above 86.78 on a weekly closing basis, then the rally, which started two weeks ago, was sustainable. Friday afternoon's rally brought the SPY back above this key level. I would become suspicious of this rally if this level (86.78) did not hold on a weekly closing basis."

As of mid morning, the SPY has closed the opening gap down and prices are back above $87. Of course, the close will be important.

Just one word on how to use these levels. As we all know, nothing is ever written in stone when it comes to the market. These key levels have been shown (via the back testing process) to be important areas of buying and selling. They are like road signs directing us to certain price criteria that must be maintained so that the bullish case remains alive. So if the SPY closes above 86.78 today, then I would say that the market is still bullish.

Now I always get this question: suppose the SPY closes at 86.77? This would be bearish (per my methodology) but I can also understand how one might want to wait before closing out their position as it doesn't seem intuitive that positions should be closed out based upon a penny. If that is the case, I would remain cautious, and I would not stray too far from the methodology. Any downside pressure should be considered real.

This approach would be consistent with rules #2 and #3 of my "11 Rules For Better Trading". Be disciplined but flexible!!

Figure 1 is a weekly chart of the SPY and the key price levels are noted.

Figure 1. SPY/ weekly

Short Term Outlook

Figure 1 is a daily chart of the QQQQ. The indicator in the lower panel is a short term composite oscillator constructed from the following data series: $VXN, put call ratio, NASDAQ advancing and declining issues, and NASDAQ up volume and total volume. Extremes in each data series are sought, and the indicator oscillates between overbought and oversold.

Figure 1. Short Term Indicator/ QQQQ

The indicator is now diverging negatively from price. In other words, price has moved higher while the indicator has moved lower. The negative divergence bars are noted by the red markers on the price chart.

What is the significance of negative divergence bars? Negative divergences generally indicate slowing upward price momentum, and this is exactly what has happened as prices ran into resistance levels as determined by our key levels. See article from December 8, 2008, "Key Price Levels To Watch".

Backtesting shows that negative divergences will generally define a price range with the lows of the divergence bar defining the bottom of the range and the highs of the divergence defining the top of the range. A close below a negative divergence bar, when that divergence bar is below the 200 day moving average, generally portends lower prices. {This used to be one of the exits for shorter term swing strategies I used to trade.}

The positive, if there is any from today's market down draft, is that the gap has been filled from Monday's open.

More On Long Term Treasuries (Part II)

A nice discussion with PIMCO's Bill Gross on Treasury bonds from Bloomberg video which can be found at this link.

My technical take is that 10 year Treasuries are several months away from an important market top.

Recent articles on bonds can be found at this link.

Market Action: It's All Over The Place

Market action is all over the place this morning continuing the feeling by many that there is very little consistency to the markets.

10 year Treasury yields opened up over 3% and are now in negative territory.

Crude oil was up over 5% but now that too is in negative territory.

Gold is up almost 4% but it is running into resistance levels at $800. Gold has carved out a range between $750 and $800.

Equities are up and holding onto their gains but even here the action is inconsistent as small and mid -caps stocks far outpace large caps.

Foreign developed and emerging markets are strong.

Large intra -day price swings favor the short term trader, but does little for the trend follower who requires a little less volatility. Hang in there as this too will pass.

More On Long Term Treasuries

I have suggested that the next bubble to "pop" may be in long term Treasury yields. After all, yields on the 10 year Treasury are at 50 year lows. I think the secular trend change (if it does come about) for higher yields is probably several months away. In the interim, yields should find support at the lower channel line. See figure 1, a weekly chart of the 10 year Treasury yield.

Figure 1. 10 Year Treasury Yields/ weekly

You can link to a video of Tony Crescenzi, Miller Tabak + Co. and CNBC’s Rick Santelli discussing the possibility of a bubble in bonds.

One Up, One Down

Two companies in the news today are FedEx Corp (symbol: FDX) and Texas Instruments (symbol: TXN). In both cases, profit warnings were issued and guidance was cut. But the market's reaction to the bad news was different for each stock. In early afternoon trading, FDX was down 15% and TXN was up 5%. One was up and one was down. So what gives?

Figure 1 is a monthly chart of FDX. FDX has made a round trip and now trades back to its 2003 break out point. FDX has already probed below these levels and is showing no signs of stabilizing. FDX should be an early cycle stock in that it should be a leader as the economy turns. For FDX, this is not a launching pad to a new bull market.

Figure 1. FDX/ monthly

Figure 2 is a monthly chart of TXN. The September, 2002 lows are being probed, and this seems like a good place for a bounce. I am not sure why TXN should be up and FDX be down when the news is similar. As we all know, the market has it ways. Maybe the technicals are offering some clarity.

Figure 2. TXN/ monthly

Update On Copper

I last looked at copper on December 3, 2008, and I made the following argument: "when I look at a chart of copper and extrapolate this to the global economy, I can safely say that the US is not on the cusp of a new bull market. Any rally should be of the multi week variety and likely sold at resistance levels." But let's take the analysis one step further.

Since our note, copper is down about 6% yet US stocks as measured by gains in the S&P500 are up approximately 4%. Infrastructure plays have been hot as a President Elect Obama touts a stimulus package geared towards rebuilding roads, bridges, schools and public works. Top infrastructure plays, like Fluor Corporation (symbol: FLR) and Foster Wheeler (symbol: FWLT), are up over 25% in 3 days of trading. If infrastructure plays are the new leaders of the "bull market" one would expect confirmation from copper. But this isn't the case. The divergence is noteworthy, and continues to put in question a rally led by past market leaders.

Copper has yet to stabilize. A monthly chart is shown in figure 1.

Figure 1. Copper/ monthly

Key Price Levels To Watch

In the article "Bull Factor: Reversal Of Price Failures", I spoke of key levels where buying and selling would most likely take place. A key support level is a pivot point low occurring at a time when investor sentiment is bearish (i.e, bull signal). Over 40 years of back testing suggests the following with regards to these key support levels: 1) these areas are good low risk buy points; 2) breaks of these key levels can lead to accelerated price moves lower; and 3) reversals of these breakdowns typically lead to moves higher. These key areas are shown with the red dots in figure 1, a weekly chart of the ETF proxy for the S&P500, the S&P Deposit Receipts (symbol: SPY).

Figure 1. SPY/ weekly

Last week's key buying level for the SPY was 86.78. As long as the SPY held above 86.78 on a weekly closing basis, then the rally, which started two weeks ago, was sustainable. Friday afternoon's rally brought the SPY back above this key level. I would become suspicious of this rally if this level (86.78) did not hold on a weekly closing basis.

Now let's stay with figure 1, and focus on the price bars with the red labeling. These are positive divergence bars between a momentum oscillator and price. Positive divergence bars tend to occur at market bottoms and are of indicative of decreasing downside price momentum. They don't always lead to trend reversals, and more likely the highs and lows of the divergence bar will define a price range. A weekly close above the highs of the positive divergence bar will lead to higher prices (and is considered a breakout) and a weekly close below the lows of the positive divergence bar will lead to lower prices (and is considered a breakdown). The highs of the current positive divergence bar are at 90.13.

My interpretation of the SPY chart is as follows: the price action has been good with a weekly close over 86.78. Currently, prices are trading to resistance levels as defined by the highs of the positive divergence bar. A weekly close below 81.78 would be serious technical damage. A weekly close below 86.78 implies weakness and increasing caution.

Figure 2 is a weekly chart of the Dow Jones Industrials ETF proxy, the Diamond Trusts (symbol: DIA). The key levels and positive divergence bars are noted.

Figure 2. DIA/ weekly

Figure 3 is a weekly chart of the Power Shares QQQQ Trust (symbol: QQQQ); prices are currently probing the upper reaches of the resistance zone as determined by the key support level at 29.72 and the highs of the positive divergence bar at 29.35. A weekly close over these levels would be very bullish and likely catapult the markets into a mutli week rally. For now and until further notice, the current price action in the QQQQ is suggestive of a bear market rally into resistance.

Figure 3. QQQQ/ weekly

Figure 4 is a weekly chart of the i-Shares Russell 2000 Index (symbol: IWM). Resistance levels are noted and like the QQQQ, this is nothing more than a bear market rally unless these levels are taken out on a weekly closing basis.

Figure 4. IWM/ weekly

The major indices and their ETF proxies are providing a mixed picture. The SPY and DIA appear to be further along in the bottoming process as key resistance levels have been taken out already. The QQQQ and IWM have traded back to prior areas where selling commenced and old breakdown areas (or resistance levels) have not been convincingly taken out.

Long Term Treasury Yields: The Next Bubble?

In a recent post, I suggested that long term treasury yields had the technical characteristics of an asset class where a long term secular trend change could be at hand. See figure 1, a monthly chart of the 10 year Treasury yield. The chart goes back to 1965 and includes a bear and a bull market for bonds. The indicator in the lower panel is our "next big thing" indicator that seeks to identify those times when a secular trend change is highly likely. (Of note, this indicator works across multiple markets.)

Figure 1. 10 Year Treasury Yield/ monthly

The "next big thing" indicator is in the zone where we would expect a secular change in the trend, but so far, price confirmation (i.e., yields greater than the 10 month moving average) has not happened. Yields on the 10 year Treasury are at all time lows and are less than 3%!

Various explanations have been offered for such an anomaly and include a flight to safety and liquidity and the government's plan to back mortgage securities. Regardless of the cause, in the end, such one sidedness is unlikely to be rewarded. The question in my mind is this: are Treasury bonds the next bubble to burst?

While confirmation for higher yields (and secular trend change) seems to be off in the future for now, it would not surprise me to see higher yields in the near term. Figure 2 is a weekly chart of the 10 year Treasury yield, and last week's down draft in yields is now at the lower end of a down sloping trend channel. Typically, one would expect a bounce at this juncture.

Figure 2. 10 year Treasury yields/ weekly

Lastly, one caveat: higher yields will likely be associated with higer stock prices as money comes out of bonds and flows into stocks. I don't expect a trend change anytime soon (in yields), and I am not expecting higher stock prices to lead to a new bull market.

Copper

For the last 12 months I have been following copper as a proxy for world economic growth. As the US weakened in the early part of the year, the BRIC countries remained strong, and decoupling of US growth from global growth had its proponents. This turned out to be proven false, and only came to be widely accepted in the fall.

Copper had made new all time highs as recently as May, 2008, but it could not hold on to them, and in fact, prices reversed back through the breakout point or support levels in August, 2008 confirming the start of the bear market in copper. Coincidentally, this was just prior to the devastation in US stocks and in equities in emerging markets.

On August 4, 2008, I had written an article entitled, "Debunking Global Growth". From the article I quote:

"For months now the hopes of investors have been kept alive by the notion that global growth will bail out the US economy. We are told that global growth has decoupled from the US economy. But I think this theory of decoupling – where the US economy and world economy function independent of each other - will be debunked.

We know the US economy is in a recession or on the brink of one as the GDP numbers and employment data showed this past week. Furthermore, US equities have been in a bear market for 8 months now. We know the US economy has many obstacles to overcome including but not limited to: 1) the housing crisis; 2) the credit crisis; 3) consumer retrenchment; 4) lack of a coherent energy policy; and 5) inflationary pressures. All this is known and unlikely to be worked out anytime soon. But what isn’t widely accepted is that the global growth story is failing as well, and I believe this is the next and newest risk for US equities.

Why do I think that the global growth story is over?"

The answer was copper, our barometer of global growth.

So 4 months later what is copper "saying" about the world economy?

Figure 1 is a monthly chart, and it isn't a pretty picture. Copper is still not showing signs of stabilizing and it continues to make new lows. Furthermore, support levels remain some 30% away!!!

Figure 1. Copper/ monthly

I remain constructive on the US markets in the short term provided key support levels hold. See yesterday's article, "Bull Factor: Reversal of Price Failures". However, when I look at a chart of copper and extrapolate this to the global economy, I can safely say that the US is not on the cusp of a new bull market. Any rally should be of the multi week variety and likely sold at resistance levels.

Bull Factor: Reversal of Price Failures

In looking solely at the price action, there is one factor that I view bullish. This is the reversals of the price failures in the S&P500 and Dow Industrials. I define price failures as breaks below key support levels. What is a key support level? A key support level is a pivot point low occurring at a time when investor sentiment is bearish (i.e, bull signal). Over 40 years of back testing suggests that such breaks of these key levels can lead to accelerated price moves lower; reversals of these breakdowns typically lead to moves higher. See figure 1, a weekly chart of the S&P500; key support levels are noted by the red dots.

Figure 1. S&P500/ weekly

Look at point #6 and we note a break below one of these key support levels and the subsequent cascading fall in prices. The close below the key support level at point #7 led to a 15% drop in the S&P500. This key support level then becomes resistance. But hold on, last week’s rally re-captured this key level and this is bullish. This also occurred in the Dow Industrials, but it did not occur in the NASDAQ or Russell 2000.

But hold on again, Monday's slaughter job put prices back below the key support level on the SPY but not on the Dow. The key level for the (SPY) comes in at 86.78. A second consecutive weekly close over this level would be bullish. Failure to capture this level implies caution.

Figure 2. DIA/ weekly

Figure 2 is a weekly chart of the DIA. Support, which comes in at 82.64 is holding nicely. A weekly close below this level is ominous. Buying in this region makes sense as it appears to be a low risk entry.

Lastly, I should reiterate that the NASDAQ 100 and Russell 2000 did not capture their key levels, which continue to act as resistance. For the QQQQ's, resistance is at 29.72. For the IWM, resistance is at 47.58. These ETF's traded right to these levels last week but failed to breakthrough.

Market Sentiment

The Investor Sentiment Composite Indicator has been bearish for two weeks running, and this is a bullish signal. Back testing shows that this is the optimal window for buying. See figure 1, a weekly chart of the S&P500, for the indicator.

Figure 1. Investor Sentiment Composite


While the Investor Sentiment Composite Indicator (or "dumb money") shows too many bears, the Smart Money Indicator (see figure 2) has yet to turn bullish. In fact, the "smart money" remains bearish. In 18 years of data and in over 45 signals, the Smart Money has confirmed the Investor Sentiment Composite Indicator in over 95% of the cases. By this I mean, we need to see the "smart money" turn bullish as a confirmation of the “dumb money” turning bearish. Typically, lower prices will make the “smart money” turn bullish.

Figure 2. Smart Money

S&P500 v. LEI

Figure 1 is a monthly chart of the S&P500 versus the leading economic indicator (middle panel, orange line) published from the Economic Cycle Research Institute ( http://www.businesscycle.com/). Recessions are indicated by the vertical gray bars and the graphic in the lower panel are the official expansions and contractions as determined by the National Bureau of Economic Research. The LEI continues to head lower and shows no signs (at this point) of reversing. This divergence is noteworthy.

Figure 1. S&P500 v. LEI/ monthly

Long Term Treasury Yields

In recent commentaries, I suggested that long term treasury yields had the technical characteristics of an asset class where a long term secular trend change could be at hand. The prime fundamental driver would be that the U.S. government would need to make its sky rocketing and newly issued debt more attractive to its foreign buyers. So far this trade, which I had expected to last at least 18 months, has not worked out.

This past month, Treasury yields have dropped (as bonds have risen). This is essentially the flight to quality and liquidity trade. As stocks do poorly, bonds have defied the skeptics and risen in price. Or to put it another way: when folks wonder how low can stocks go, they also should be wondering how low yields on the 10 year Treasury can get. Yields are within a stones throw of their all time low.

The technical set up that has been reversed can be seen in figure 4 a monthly chart of the 10 Treasury yield. The indicator in the lower panel is our “next big thing” indicator that seeks to identify those times when a secular trend change is highly likely. Last month, Treasury yields closed above the 10 month moving average and above a down sloping trend line. This seemed to be confirmation that the trend for yields was reversing. One month later, yields have reversed lower to close below the 10 month moving average, the trend line and below a pivot low point (marked with red arrows) that should have served as support. This level comes in at 3.432% yield and now represents resistance. A monthly close above this level would mean that Treasury yields are likely to move higher.

Figure 4. Long Term Treasury Yields/ monthly


The only technical positive is the possibility for a double bottom, which I have highlighted before. Yields could reverse at this level, but confirmation of a reversal would only take place on a monthly close above resistance at 3.432% .

Extrapolating bond market strength to stock market weakness, one might suggest that lower yields (higher bond prices) continue to imply ongoing flight to quality and flight to liquidity. In other words, stocks aren’t expected to rise as long as money flows into bonds. As hard as it is to believe, bonds remain attractive. The yield is not attractive but in this deflationary environment they are attractive. Treasury yields are still on the cusp of a secular trend change, but it appears we will need to wait a little bit longer for yields to move higher. The price action does not suggest higher yields anytime soon.