Sunday, March 22, 2015

Market Analysis for Week of 3/23/15

"Back in 2009 if I went to the gym, I could bench press about 180 pounds, naturally.  And if I worked out every day for the last six years, I could probably bench press over 300 lbs by now.  But instead I took steroids, so now I'm in beast mode and I can bench press over 600 lbs!"  -said This Guy.

His name is 'Merica.  And the steroids he took are called ZIRP and QE.  So, how can you measure his real strength when all the data points are distorted by the steroids?

Here's what he looks like off the 'roids:

To be fair, his name could also be Japan, China, Europe, or any other nation with a central bank.  The sad part is he has cancer, but it's being masked by the steroids, so the doctors are misdiagnosing him with the common cold, and telling him the 'roids are making him stronger.  Unfortunately, if he stops the steroids his muscles will deflate and he'll have to deal a very painful situation that will take a decade to heal.  The good news is the human spirit is irrepressible and in the long run he will innovate a way to beat the cancer as his immune system naturally clears the excessive steroids to return him to health.  But what a painful journey it will be.

Here's a chart of the Fed Funds Rate dating back to 1955.  Take a look at the uptrend from 1955 to 1980 and then the downtrend from 1980 until the present and think about the overall economy that characterized each era.  You have the post WW2 baby boom from the beginning of the chart that not only unfolded in a mass simultaneous spending wave from the population expansion (i.e. buying houses, expansion of roads, cities, buildings...), but there was also an overall period of technological innovation that led to organic economic growth as loans from the bank were in high demand and issued hand over fist.  Not to mention Nixon's fateful mistake in 1971 when he unlinked the dollar to the restraint of gold and unleashed a tsunami of deficit spending that culminated in the 1980 need of Volker to slow down the runaway credit expansion train.

From that moment on, every time interest rates have gone up, they were forced to lower them again until finally reaching the zero bound in 2009, and then Bernanke's foolish attempt to get beyond the zero bound through QE.  What's really happening in this chart is an attempt to keep the baby boomer debt expansion and simultaneous spending wave going by making debt cheaper and cheaper when underneath the surface there is actually an extinguishing of debt as the new demand from the following generations is not sufficient to continually expand the credit in a natural way.  

Note the dramatic lowering of rates after the dotcom bubble burst to reflate.  And then the rate hike cycle from 2004-2006 as they attempted to slow down the housing bubble they were creating.

And now we're stuck at zero because the transmission mechanism of the Fed's futile attempt to expand the money supply to reflate their burst bubbles is all being funneled into financial products and not the real world, creating a third bubble.  I wonder what would have happened if Glass Steagall still existed?   What if the Fed bought bonds from banks who were restricted from using the free cash to speculate in the markets?  Would they have recklessly lent the money in the real world as they sought a yield by issuing loans to everyone who walked in the front door with a pulse and actually achieved inflation?  That also would have failed as the false wave of credit was unsupported by natural demand, but it's an interesting alternative world scenario that would lead to the same outcome: the deflation of a falsely created bubble that ends in depression.

The Fed will never create the kind of inflation they are trying to achieve because it's all going into the stock market.  There's your inflation.  Stock prices are up nearly 300% in six years.  If prices in the real world increased at that rate, the Fed would be forced to raise rates in attempt to slow down the overheating economy.  But since the entirety of the Fed's plan is some kind of magical "wealth effect" that occurs when you make rich people richer, they have no incentive to prick the bubble on their own.  I've heard a lot of comparisons to the Fed not wanting to raise rates too soon like 1937, but that's rooted in a misunderstanding of where we are in the process.  It's more like 1928.  The real correction of the excessive debt hasn't occurred yet.

To navigate the current market environment requires a proper diagnosis of three things: the real economy, the futility of the Fed, and the psychology of the market participants.  To understand the real economy you need to understand the unsolvable structural problems rooted in the demographic trends and globalization.  To understand the Fed you need to realize the difference between debt that is based in natural demand by the free market and debt that is forced into the market through central planning trying to compensate for the lack of the former.  To understand the psychology, you need to understand the bias of Wall Street for a bull market, how the broken transmission mechanism of the Fed's credit channel is funneling all the cheap debt into financial products, and how it is impossible to have sustained selling without the sustained fear of a real world crisis.

All of this is creating the greatest bull market in history with no economic legs to stand on.  Is anyone going to seriously make the case that the economy is overheating to such a degree that for the first time in 9 years the Fed needs to raise rates to slow it down?  And for the first time in 35 years, we are about to embark on a sustained rate hike cycle that will finally end the downtrend of interest rates?

The only reason the Fed wants to raise rates is because they're backed in a corner and want to be able to reload the gun in the near future.  The last six years has proven that the Fed is incapable of creating inflation in the real world.  They are inflation impotent and there isn't any Viagra to help them get it up.  The deflationary wave they are fighting is too large.  Even if they go back to QE there are not enough bonds to purchase.  The government would have to return to multi-trillion dollar deficit spending.  And it won't work anyway.  We just tried that.  The experiment is over and it failed.

There's two things that are most important to get right over the coming years: the future path of the dollar; and the likely path of the Fed.  No one can know for certain if the Fed will be able to accomplish a pointless 25 or 50 bps rate hike.  That doesn't matter.  What does matter is understanding that it's impossible for them to normalize interest rates without bursting their own bubble.  So the Fed is on a leash when it comes to rates.  That is important for bonds.  

The dollar recently played out how I thought it would, although the flash crash was a surprise.  I can't remember the last time a market got so crowded to one side in anticipation of something that wasn't likely to happen.  The kind of volatility we've seen the last two weeks is typical of what happens when a lot of the big players are exiting and letting the trend followers push it back up only to sell into them again.  This is why I often say strong trends don't just stop and reverse on a dime.  There's an unloading period.  Note the distribution volume.  I'm thinking this is the start of a larger correction that will take us to the uptrendline around $93/$94.  I would think any bad data releases will be met with dollar selling because it pushes out the Fed.  Despite what Yellen says, there is zero chance the Fed raises rates for the first time in nine years at a meeting without a press conference, so that means the date for the possibility of their next mistake is June 17th.

There are three main reasons the dollar will likely bottom and go much higher:

1.  The Fed is incapable of creating inflation in the real world.  Ask Japan how that's working out.
2.  The Euro is based on a flawed union that is destined to fail.
3.  The dollar is the most widely used currency in international transactions.
Bonus reason: In the 2008 financial crisis the dollar was a flight to safety.  

Dollar daily.  I'm thinking we pullback and consolidate for weeks.  The point where I'd have to reconsider my view of the future would be if the dollar ever loses $90, which seems highly unlikely.

Euro weekly. I'm thinking the Euro could make it to 1.15/1.16 before rolling back over.  This would all be perfectly normal.  The Euro seems destined for all-time lows.

Clearly, commodities are responding to the dollar.  I would think gold and silver should maintain a bounce as long as the dollar keeps pulling back.  I'm staying small in my counter trend trades, which are dangerous.  I'm more interested in the resumption of the overall major trends, so that would be shorting gold from higher prices and getting long the dollar again from lower prices.  

COMP monthly.  There's no way we've come all this way and we're gonna stop short of the all-time high.  I'd be highly attentive to how it acts upon the pierce of it.  There's a good chance you'll see big money selling there and a pullback similar to what we just had.  So the breakout is guilty until proven innocent.  I do believe, however, IF we pullback from there, it will be contained and once price establishes itself back above the all-time highs, we will go much, much higher.  Like hundreds of points higher.  Why?  Because selling can't be sustained in this environment until there's a crisis and the Fed is in no hurry to create one.  Clearly, the degree of selling off the all-time high pierce, if there is any, would influence my opinion.  But I suspect it will be contained.  

NQ daily.  We might consolidate to build up energy for the run to new highs, but stocks will likely break upward sometime over the next two weeks.  

ES daily.  Same thing.  The upper channel hasn't broken in 3 years.  I'm looking to lighten longs at new highs and hopefully reload from slightly lower prices, which may be timed with the COMP pierce.  There's more room on the SPX cash, so it's just a matter of how we approach the new highs and what the price action is when we get there.  Maybe it happens on NFP day in two weeks.  The market seems more like it's in "two steps forward one step back" mode now that QE is over.  

Bonds daily.  There's no reason why bonds will have any significant selling ever again.  Not until the US defaults one day, but that's years away.  (By significant I mean the second half of 2013 selling, not the recent pullback, which, while severe, was normal.  The end of the 30-year uptrend in bonds is not likely to happen.  Deflation is the problem.)

TLT daily.  Just showing this to see how far bonds have to go to get to the recent high before the pullback.

Oil.  I could not be less interested in this.  It was a nice short to new lows. But whenever a market makes new lows or highs and can't hold it, red flags go up.  Mostly because that's often how big pullbacks happen and it's never possible to know the extent of the pullback with certainty, so I always err on the side of caution.

I have no idea how much oil will respond to a potential multi-week dollar pullback since oil has fundamental reasons to go lower, which is why I'm not interested at the moment.  Too many conflicting forces for me.  I still think we haven't seen the lows in oil, but until I feel like the dollar has bottomed, I'm fine with missing out if oil keeps going down without me.  I'm hoping oil retraces higher and offers a better shorting opportunity that is timed with the dollar bottom.


Sunday, March 8, 2015

Market Analysis for Week of 3/9/15

The dollar go boom.  I'm still thinking it reaches the mid $99 handle.  If the price action allows it, there might even be an opportunity to get short for a sizable pullback just below that $100 level.  Because it's counter trend I would need a high to get put in and a retest that fails.  Then you can use that high for a small risk with potential big reward.  In the bigger picture I do believe for multiple reasons that the upside in the dollar is going to surprise a lot of people.  But a lot of that is going to come from a flight to safety rather than a sustained rate hike cycle, which is impossible.

I'm thinking the Euro bottoms when the dollar approaches $100 and the pullback will last a couple months.  It's likely the Fed removes the word "patience" at the meeting in 10 days because the "strong" jobs number is forcing their hand, but since the economy is actually very weak under the headlines, Yellen will downplay any rate hike and may even take June off the table.  So what we could see is continued dollar strength into and through the announcement,  but the possibility of a reversal during her press conference.  Take this with a grain of salt.  I'm just trying to envision a scenario that causes the dollar to temporarily top out.  This is one way.  I think it's important to anticipate things before they happen, but you have to be willing to let it go if it doesn't happen or if price doesn't confirm it.  The best trades are when you envision a scenario ahead of time, and then it happens, and price acts exactly how you expect it to.  Those are trades that give you opportunity to push open profits.

Gold is going way lower.  I thought we might see a bigger bounce from the $1200 area, but it never happened.  If the dollar does pullback from $100 for awhile, I could see gold putting in a double bottom at $1130 for a sizable bounce, but I wouldn't trade the long side of gold without a small defined risk.  It certainly doesn't have to bounce just because the dollar pulls back.  It could easily blast through $1130 into the 1000 handle.  A test of the downtrend line could offer a small risk entry around $1180.

Gold weekly.

Gold daily.

I'm leaning toward stocks selling 5% or so till the Fed meeting.  Maybe NQ 4220/30 area.  Fed week is options expiration, so if we get back into last year's rhythm, how about the idea that we bottom out after the Fed (or that Thursday) and have a vol crushing rally into Friday and then into the Spring to pierce Nasdaq Comp all-time highs?  

The ES has the 50-day EMA at 2064, so a close through there would open the door all the way to the 200-day and trendline around the 2000 area.  If things accelerate and go through there, I'd expect a stop run under all those lows and a reversal.  I don't think we've seen the highs in stocks yet.  But it'd definitely a time to err on the side of caution.    

Oil looks like it's starting to roll back over.  It's holding beneath the 50-day like the dollar held above its 20-day, which means large sellers are defending it.  So it's going to take some kind of massive change in sentiment to get through there.  I don't see it happening.  

While I figured bonds could pullback this much, I'm surprised they actually did.  I think it's approaching overdone, but I'll wait until after the Fed to see how they react.  Bigger picture, I don't think downside prices in bonds are sustainable.  First, even if the Fed makes it to the point where they can pull off a token 25 or 50 basis point rate hike to take a little heat off of them, there's just no way the economy can handle a full-on rate hike cycle back to historical normal levels.  I don't even think they can make it to 1% before they have to retreat back to zero and they're going to be in no hurry about hiking.  Bonds don't have to worry about interest rate risk.  

I expect a massive flight to safety bid in bonds and the dollar when the stock market has even the normal and inevitable 20% correction, let alone the collapse of the current financial system that we're heading for.  I used to think the Japan default would be the cause, but I'm warming up to the idea that it will come from a China implosion. Either way, the US is not an island of strength in a sea of economic woes.  We're in big trouble, just less than the rest.  When they go down, we go with them.  And tons of money will flow into the dollar and US bonds.  To think the economy can handle a full-on rate cycle increase is kinda silly.  There's a reason why interest rates have trended down for the last 30 years.  There's no economic Renaissance.  There's a multi-decade asset bubble suppressing reality. If the economy was actually strong and in need a rate hikes then bonds would be in trouble.  But it's not.  

Here's the chart for notes because the bond chart is all screwed up from the rollover gap. 

In short, this "strong" jobs number is scaring everything into thinking the Fed will hike sooner, and while they definitely want to change forward guidance to give them more freedom, I'm thinking she pushes out expectations in the press conference and that could be a turning point into Spring.  We will see.