Posted on 04/03/10 at 2:40pm by John Nyaradi
This week we went to “Red Flag Flying” status, expecting lower prices ahead. Aside from our primary technical indicator shifting to a bearish posture, numerous technical indicators and fundamental elements are flashing red in spite of the euphoria in the general financial press.
On March 31st, we entered a couple of inverse ETF positions in our Standard Portfolio, one inverse ETF in our leveraged portfolio and bought an S&P put option in a new options trading system that I am sending to Standard and Pro members.
To better understand why we shifted to a “short” posture let’s look at some of the factors going into that decision.
Our primary indicator is a proprietary long/short momentum indicator that went to a “sell” signal this week.
To confirm that indicator, I also look at a number of other technical and fundamental indicators to give us the highest probability of success. Some of these are widely followed indicators and some are exclusive to Wall Street Sector Selector.
Chart courtesy of stockcharts.com
In the S&P chart, we see the RSI at highly overbought levels in the top display, with above 70 becoming overbought and subject to a correction. At some point, these conditions generally will correct themselves with a substantial price decline which you can see occurring recently in November, 2009, and again in January, 2010.
In the bottom display, one of the most reliable indicators I know of, MACD, has just shifted to a “sell” signal, indicating declining momentum and the possibility of a decline ahead, just as previously occurred in November and January.
Also, a glance at the Russell, Wilshire and NASDAQ indexes all present similar pictures and confirm substantial weakening and what very well could be a topping out of the current rally.
We also look at various market breadth indicators and investor sentiment indicators as well as the VIX and find extreme complacency and bullishness on all fronts which supports and adds validity to our primary thesis of lower prices ahead.
And then as a final step, I look at macro conditions and fundamental trends that could confirm or weaken our overall view of market conditions. These include but are not limited to interest rate movements, economic reports, news and corporate earnings as well as oncoming events that are just around the bend but could impact market prices over the next few weeks.
After all that analysis is complete, I look at and choose the particular Exchange Traded funds and now option positions that could offer us the highest likelihood of success and potential profitability.
Looking At My Screens
Regarding fundamentals, two charts are particularly scary. One is from Credit Suisse and is reprinted below.
This chart depicts the monthly mortgage rate resets and you can see how these peaked in 2007-2008 in the red box on the left and set off the sub prime debacle that eventually led to the worldwide financial crisis that still bedevils us.
What’s scary about this is that after a lull in 2009, we see another spike in mortgage resets coming in 2011 and 2012 framed by the red box on the right. This time the culprits are not sub prime loans but Option Adjustable and Alt A loans resetting that could easily trigger another round of foreclosures, bank failures or “too big to fail” actions by the U.S. government.
Judging from the carnage we saw the last time the graphs on this chart were this high, a return to these levels could easily be the catalyst for a double dip recession which would almost be certainly worse than the one we’ve just been through because unemployment is worse, more national debt, etc, etc. Finally, to make matters worse, the Fed terminated their $1.25 Trillion mortgage buying program on April 1st which will create a further drag on this market.
The second scary chart is what’s going on in the U.S. Treasury market as evidenced in the chart of the U.S. 30 Year Treasury Bond below.
Chart courtesy of stockcharts.com
This frankly is a truly terrifying chart because, as you know, Treasury prices move inversely to interest rates and so as interest rates rise, Treasuries drop in price. In late March you can see the huge gap down in Treasury bond prices as interest rates rose sharply and that trend continued this week and even on Friday in response to Friday’s unemployment report.
As you know, rising interest rates usually spell lower stock prices and this sharp reversal in the direction of interest rates is a serious development as this could easily affect the fragile recovery underway, not to mention the real estate market, both commercial and residential, both of which are still in critical condition.
Last week’s Treasury bond auctions were weakly received and started the jump in interest rates. Further problems lie in supply/demand metrics as we’re issuing record amounts of debt this year including more than $40 billion this coming week starting April 5th. With the Fed out of the mortgage market and China scaling back its holdings of U.S. debt for three months straight, interest rates could continue to rise as the “bond vigilantes” look like they’re about to take control of this critical game.
So, adding it all up, these are treacherous times in spite of all the happy talk we get from the general financial media.
The View from 35,000 Feet
This week the news was mixed again as the bulls and bears struggled for domination of the markets. On the upside, the Case/Shiller housing price index showed improvement along with an improving consumer confidence report and the much ballyhooed employment report on Friday indicated that north of 150,000 jobs had been created in March.
On the negative side of the ledger was the fact that nobody mentioned that we need 100,000 plus monthly new jobs just to hold even and so unemployment remained steady at 9.7%, that the jobs created fell far short of consensus estimates and that U6 unemployment, the “full” unemployment reading of unemployed plus underemployed rose to 16.9% or about one in six people not employed or not working as much as they want.
But probably most dismal of all was the fact that long term unemployed ranks swelled to 6.5 million, that is people who are jobless 27 weeks or beyond, and a gain of more than 400,000 for the month or 44% of all unemployed, an all time record.
No matter how you slice it, these are not pretty numbers.
Other negative news focused on the Chicago Purchasing Managers Index declining, factory orders dropping and construction spending declining.
Finally, let’s throw in some dribs and drabs like commercial real estate loan losses kicking in to the tune of a half trillion in 2011, the ongoing Greek tragedy and drama that will return to center stage in mid April when 15 billion worth of Euros will have to be refinanced and a new national health care plan that will be “fully funded.” (When was the last time the Federal government fully funded anything?)
Sadly the litany goes on with greater numbers of Americans filing for bankruptcy protection in March than at any time since October, 2005, when the bankruptcy codes were tightened, a total of more than 158,000 filings in March alone, or nearly 7,000 per day, and states and municipalities edge closer to the brink of default as tax revenues continue to shrivel.
Where is the Easter Bunny when we really need him?
What It All Means
What it all means is that, in my opinion, all the happy talk about “happy days are hear again” (the theme song from the Great Depression) is based on a foundation of skating on very thin ice and that we are traveling through very dangerous days with the very likely possibility of a double dip recession lurking like an iceberg in the path of the U.S. Titanic.
However, no matter what happens or what we read, we will stick with our indicators and go with the flow of the market in whatever direction it takes us. One can never underestimate the madness of crowds and the power of the Federal Reserve.
The Week Ahead
The week brings some important economic reports including:
Monday: March ISM Services, February Pending Home Sales
Tuesday: FOMC Meeting Minutes, February Consumer Credit
Thursday: Initial Unemployment Claims, Continuing Unemployment Claims
Friday: February Wholesale Inventories
Sector Spotlight:
Leaders: Gold Miners, China, Russia
Laggards: Biotech, EAFE (Europe, Asia, Far East)
I was in Germany this week where the soccer playoffs were filling the bars and restaurants with cheering fans and where patience is growing thin with the Euro and European Union and their troublesome friends in the Club Med countries.
Now I’m home for the holiday weekend and wish you peaceful days and happy times with your families and friends. Spring is here (although it snowed in Bend today) and I look forward to continuing our work together through these interesting times.
Wishing you a great weekend wherever you may be,
John
http://www.benzinga.com/205571/red-flags-and-scary-charts
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