Sunday, February 1, 2015

Market Analysis for Week of 2/1/15

A brief comment about the Fed, then I'm done with them for awhile.  It occurred to me that they fit the definition of a crazy person.  Meaning, the map of reality that exists in their head doesn't match the real world outside of it.  The problem with ALL of the data points the Fed apologists are using to make their case for an improving economy is that they are all distorted by (and, imo, dependent on) ZIRP, QE, and the hope that the Fed knows what it's doing.  To back me up, I would point to the markets.  There is a massive amount of money that is all trading in a way that is opposite of the reality the Fed is trying to propose.  And if you pick apart the Fed's map of reality - like using the unemployment number as a reflection of "full employment" - you'd have to be willfully blinding yourself to not see the gaping difference between the map of reality the Fed is proposing and the map of reality the markets are proposing, particularly the bond and commodity markets.
So my last comments about the Fed for awhile is that it sounds like they are intending to raise interest rates later this year.  Are they bluffing, or are they crazy?  I've been pretty poundy on the tabley about the fact that it's never going to happen.  But that's because I'm listening to the message of the markets and the structural reasons at the root of the problem that they can't fix.  But the Fed seems to be operating from a different map.  If they believe their map is what is actually happening, maybe they are crazy enough for a token 25 or 50 bps rise.  But they're going to find out that they aren't in control anymore and it won't be long before they reverse back to ZIRP and likely more QE in 2016.  They might talk like they don't care what the markets do, but they'll start caring when the trillions in inflated stock prices starts to disappear and their wealth effect becomes a poor effect.  They created the box.  Now they have to live within it. 

My market comments will be brief because it's a whole bunch of I don't know.  I do believe there are inflection points approaching for several markets though. 

ES daily.  My overall bullishness about equities was based solely on a continuation of the positive reaction from the ECB QE last week because the fuel for the broad market has been QE.  However, we just put in a lower high and reversed back into selloff mode, so I'm thinking the fear is coming from the Fed's insistence that they can raise rates, which could easily turn into a downward spiral for equities (not to mention dozens of other reasons).   The only reason we're at the height we are is because it's been impossible to stay short due to the parade of Fed governors who emerge at the slightest downtick and cause a short squeeze.  So I have little confidence in either direction at the moment.  There are a few red flags though.

First, there's a head and shoulders top forming in the ES.  If this breaks down it should lead at least to the uptrend line from the Oct low currently crossing through 1900 area.  But equities have a way of suddenly reversing due to Fed comments, not to mention the Commercials like to cover shorts into high volume areas, which breakdowns tend to be.  So clearly the breakdown would happen under 1960.  I'd rather wait at support for equities to bottom with high volume buying coming in and play the bounce.  THEN I might be interested in the short side if it appears to fizzle out.  

Second, this selling has been different than other corrections, which were more like two days screaming down, followed by a day straight up, then screaming straight back down...  This selling seems to be spending a little more time, as if it's more of the big money sitting on the offer and unloading.  Do I know that for sure?  No I do not.  But it does have a different flavor to it.

Third, the Large Spec long position has been liquidating, which isn't slam dunk evidence by itself, but another red flag to be aware of.   One of the bigger red flags that could happen would be if a Fed governor comes out and tries to stick save the market by promising patience and the possibility of more QE, but the bounce only lasts a couple days and then rolls back over.  1960 is important.  And the 1890/1900 trendline is vital.  

NQ daily has a clear downtrend channel that will run into the weekly uptrend around 4000.  That is the battlefield that determines the next couple month, imo.  If we lose the uptrendline this will get very nasty very fast.  But I'm thinking we bottom there and break the channel to the upside.  It should be noted though I am currently flat and won't get hurt if I'm wrong.   

Gold had a perfect backtest of the 20-day EMA and a solid reversal.  It should at least climb back to 1300 and potentially to the downtrend line thru last year's highs that currently runs through 1320.  I would be very attentive if you're long at both of those spots.  So far it's doing everything it needs to do to be bullish.  However, the net long position of the Specs is over a two-year high and it's at a level where the market peaked twice last years.  (See next chart after gold.) 

You have to remember that the motivations behind what drives the "paper" futures market is not the same as owning the physical metal, which is essentially an insurance policy against inflation and a currency crisis.   The futures market doesn't go long because all fiat currencies eventually fail.  And they have buying capacities which are more determined by market sentiment, not to mention they actually have to deal with unrealized PnL.  Meaning, they have to cut positions eventually, which shapes the psychology of their strategy on the profit taking side too.  You also have to keep in mind that the crazy run in 2011 was based in the unknowing of the inflationary consequences of QE, plus the geopolitical events at the time, including the Middle East flare up, the tsunami in Japan, and the downgrade of US debt by S&P, all of which acted as catalysts for a blowoff top of the decade long bull run.  I personally believe the physical metals will be very valuable one day, but I don't know that for certain, and I have no idea how long that will take, or the path it will take because I also believe there's more need for hedging physical risk than there is for speculating.  

If you look at the COT positions in silver at the time, most of the move in the $40s to its peak at $49 was the rare Commercial short squeeze.  They lost control of the market.  Ever since, though, they've capped every peak as the Specs run out of bullets.  There is a great danger of that happening again soon.  If gold can clear the downtrend of last year's highs at $1320, it opens the door to the $1525 breakdown, but based on positioning it's at least time to be cautious.  I've played the long side lightly lately and fairly short-term.  But I will be looking for an opportunity to get short in the battleground of $1300-$1320.  That area is another inflection point just like the $1220s.  Failure there and it could be the top.  A breakthrough there should lead to a big move and renewed interest from outside money.  Either direction, you just have to know your risk of where you're wrong.  I personally like to see a high get put in and then use it for my risk point. A lot of times it will consolidate near the intraday high it just put in and have one last blip that falls short.  That's the ideal entry for me, using just beyond the high as my stop.  Sometimes it can be as little as a couple of points.  Trading is much less about knowing what's going to happen and much more about finding the inflection points.  A true inflection point will lead to a very profitable trade even if you're wrong by simply reversing directions.  

Dollar daily.  The Spec long position here is at a record.  Likewise for the short position in the Euro.  So while that is always dangerous, the difference between gold and this is simply the sentiment.  I still think the dollar goes much higher, but I hate being in trades that get this lopsided in positioning.  With NFP this Friday, sometimes they use a news event to take profits, which leads to a spike down that others buy up.  It's just a matter of how much tolerance you have for pullbacks if we have one.  I personally have very little tolerance for pullbacks, which is what I'm trying to improve on the most as a trader.  I have no answers here.  Bigger picture it's going higher until the Fed starts backing off, which doesn't seem imminent, although a tumbling equities market could change that.  Like everything else if you find a low you can use as a risk point, you take it and move to breakeven when you can.  

Euro monthly.  Like the dollar I don't know if we pullback further or not.  But I do believe the next spot is the 1.07 low and eventually parity, possibly beyond.  Greek turmoil will only help in this regard.

Oil had that strong move to close Jan above $47, except it happened on Friday and not Wed.  I missed it.  I have no interest in this.  No idea what happens from here.  There are still a ton of Spec longs in this market, so it's important to see if there's any follow-through to the upside this week.  If we roll back over, I agree with the people who've been saying we won't see a bottom until there is complete long side capitulation as stubborn funds blow up.  You have to be aware that they did get their Jan. close, though.

Bonds weekly.  I'm thinking they should test those highs, especially if equities breakdown to their possible support points.  I'm currently thinking equities will bottom and at least make a sizable run back up, which may coincide with bonds piercing to a new high and reversing.  It's just an idea.  I'm not interested in playing bonds short, but I will be watching closely if we pierce to new highs and reverse, so I will be trailing a close stop.    

My overall philosophy is that every year there are times when things seem fairly obvious and it's your job as a trader to reasonably push it to maximize the opportunity, and then there are times when things are shifting and there's way more uncertainty so you have to change gears and slow it down, unless of course you're selling volatility.  Sometimes the most profitable trade is not taking one.