Developing Patterns in the Major Indices

Ok, ok, enough guys!

Sheesh. First, let's dispell a few things, the most important of which is that there's something particularly bullish about the chart pattern of the last couple of weeks.

Let's study it together eh? The best way to figure it out.



Here's our S&P500. Notice a few things.

1. The high was 1540, on June 4th. We have not been back there since, intraday or otherwise.
2. We attempted to get there on the 19th and 20th, and failed, rolling over and heading down.
3. We then attempted again to rally back up yet again Tuesday, Thursday and today. Today we once again failed to get to the 1540 level; in fact, we stuck a pin at it @ 1532.40, but couldn't hold. There were actually two runs taken at it today, neither of which held up.
4. It appears we are establishing a downtrend channel - lower highs and lower lows. I am not yet convinced on that, because we have only two pips on the bottom channel. We need one more, but I don't think we're going to get it - we're either going to break out to the top or we're going to roll over and fail right here!
5. Stochastics are severely overbought and are starting to roll over today on the fast, losing their "Buy" (10 over the slow) today; in other words neutral.
6. RSI is rising however, on the first retest we failed here. If we fail here again, we should head lower convincingly and the channel hypothesis looks good.
7. Since June 4th the DMI has been in bad shape. We got one small incursion positive on the failed previous retest mid-month, then dropped back negative. While this "drift up" looks good note that the this is not so much the falling upper boundary, not the rising lower one. This isn't particularly bullish, especially considering that it has not managed to cross (yet) this time around. Until mid-June, the last time we spent any material amount of time below the line on the DMI was during the February selloff.

The Dow has an essentially identical pattern.

The Nasdaq's pattern is a bit more positive. Specifically, Stochastics are pinned at the top (overbought), the DMI has diverged positive and the MACD has gone positive as well, albeit not strongly so. But the RSI is, as of tonight, right where it failed on the 4th of June.

Now let's add a few more things.

According to Dow Theory, the Transports must confirm a move higher in the Industrials for a rally to be "good". This last happened on the 4th of June. Since then the Transports have been stuck below their resistance level prior to that high, being unable to penetrate it. Confirmation DENIED.

Oil is heading higher. So are real interest rates. The 10 has a very interesting pattern; here's a full chart on the yield. You'll have to scroll this one a bit to see it all.

This chart is a little "busy", but let's try to go through it.

There are two channels and one price support line on the main image. The first channel is the more highly-sloped one that runs from early May until the break in early June.

The second channel is the longer-term trend channel, which was established back in March It wasn't evident until recently, when we got the breakdown from the top and retested the lower boundary which held, at which point it became evident.

The third is a price support line from roughly the same origin point back in early March.

What these show is that we've got a trendline if you will that was established back in March. We have been oscillating about it since roughly the second week in April. This wasn't recognized by anyone until it broke out, and then was falsely read as a parabolic rise by everyone (myself included.)

But in fact its not - it is in fact a much more important trading channel!

Further, the DMI on the 10 has not lost its "advance" marker since May 14th, or more than six weeks! This is clearly more than an "abberation".

Here's a 10 year chart of the 10's yield (puns!)

This is a bit tougher to see, because the last couple of months are all scrunched on the right side. But it shows a clear 10 year downward sloping pattern - The Bull Market in Bonds - which was violated convincingly at the 5.0 level.

More importantly, we retested that 10 year trend channel and held above it.

We must therefore consider that Bill Gross is likely correct, that we have a confirmed secular (not cyclical!) change in the bond market, and that we are headed for higher rates.

I can't come to any other conclusion from this price activity. You had your little movements within the larger trend, but that is now over - we've changed the primary trend on rates.

This is a sea change.

Now what does this mean for the economy and equities? Trouble.

Why?

Because right now the economy is basically hanging by a thread - consumer spending and low interest rates. If real rates rise from here, given the leverage (debt) that households have taken on, it will not only thrash what's left of the housing industry but will also thrash consumer spending.

This is different from the mid 90s, when job growth was running at +300k/month, wages were expanding strongly, and so was productivity. Now we have quite-low job growth, stagnant wage growth, a high debt overhang in the consumer sector and declining house prices.

This is, ultimately, our nemesis. As the Dollar declines, imports become more expensive. This lends artificial support to the price of oil and it threatens us with a severe and immediate interest rate rise if it precipitates trouble with China's dollar-denominated bond reserves.

Consider this, if you're a foreign bank. If you bought treasuries when the dollar index was at 120, which it was as recently as early 2002, how much have you lost simply on currency? Answer: THIRTY-THREE PERCENT!

How do you think those foreign nations like those apples? Something to think about eh?

This makes things very, very difficult for The Fed. It is also why we have rates going up, ultimately. The dollar is being thrashed and unfortunately this means people need to be paid more to keep your debt around, and ultimately, to support the dollar - unless we want to have this little problem attracting foreign capital in our markets, since there's a history of a 30% FX loss over as little as five years!

Something else to think about:

If you bough the Dow in another currency in 2002, you may actually be underwater today due to the FX change!

Guess what?

This all happened - and will in the future - whether or not The Fed likes it!

In fact, The Fed could cut rates to zero and all it would do is add to the dollar problem - real rates would not materially fall!

So now we have "The Bernacke Ball Vise." He's hosed, to be blunt, and so are the markets.

Higher rates, recognizing actual inflation, are here and will be staying. Real inflation has to come down worldwide - not just here - and our dollar will ultimately have to be defended.

Now in a world where the economy is just plain ripping, this isn't so bad. But our economy isn't ripping - its more kinda limping, although there are signs its picking up.

As I see it, we're about to get squashed like a cockroach on the kitchen floor at 3:00 AM.

Remember, historical norms for 30 year mortgage money are between 7.5-8%. We're one hundred basis points plus below that level. Trends DO revert to (at least) the mean!

So should we see a "rip roaring" advance next week, take off your broad-based market shorts and lick your wounds, consider taking your profits on the specific sector stuff you've done short (e.g. homebuilders) if they advance as well (although I wouldn't be the least surprised if they resume their plunge Monday), and either trade long only until you see internal divergences in the market during the run or sit in cash.

There is a train coming down the tunnel with its lights off and the US Economy and markets, both credit and equity - the train going the other way merrily barrelling along at 80mph - are going to hit it head on!

If you've got a scenario that avoids this, let's hear it. Take it over to the forum; I'm locking responses on the Blog for this one as I suspect it might get a bit "lively".