June 2013


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This week’s report is just about to be written. I have just finished downloading the COT data. Last week the COT chaps seemed to get back on track, actually the last couple of weeks have seen them get back onside of a tricky period in the market.

This week will see an important week for the markets. Do we bounce and essentially resume the bull market, or do the bears sell-the-rip and send the market lower?

That is the question that I will specifically address this week.

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I haven’t really had time to pay too much attention to flippe-floppe-flye. Where does he sit currently?

Now, it isn’t always the case, but typically when the mob is leaning one way, the exact opposite is about to happen. Too many of you misread the signals by what is stated on this blog, penned by an eccentric, professional money manager with almost two decades of success. What I am pointing to, rather, is overwhelming bearishness in a particular sector, like social media 6 months ago, Apple right now and gold after yesterday’s close.

The pattern keeps repeating itself and it’s always hard to bet the other way.

I don’t mean to tout my algorithms again; but it was built for this very thing: mean reversion. When the crowd is too bullish or bearish, the algos pick up on it and register overbought/oversold signals. The system weeds out the weak signals and pronounces the ones to pay attention to.

The ppt must have finally got one right. The bounce is no big deal, that was pretty much always on the cards.

More to the point is this: is the bounce the buy-the-dip opportunity [passed by], or, is this just a bounce that offers the chance to sell-the-rip?

I’ll have an opinion after I crunch the numbers on the COT. They forecast correctly, a buy the dip trade. Are they back on song? I’m not too sure, but after crunching the numbers I’ll have a better idea.

At the moment, just watching the market trade, I’m leaning with the bears. I have nothing that anyone else already has, it’s just a feeling.

Where does flippe-floppe stand? Who knows, he changes every post. All that really interests him is having the latest post in alignment with the market so that he can sell a few more subscriptions.

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I received another version of the assignment yesterday to have a read of. This version, like my other colleague, found that both items were chattels and could be removed.

Have I on that basis changed my mind? Absolutely not. To my mind their arguments do not stay on point to the specific details that form the basis of the legal question. They both drift off into arguments that while they have merit are not focused on the specific question in relation to the law.

After the assignment is marked I’ll put up all the details and the arguments put forward.

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chart

The title is from a Motorhead track. Think Bernanke has won? Maybe. But until the market breaks above the MA’s and holds, and they gradually turn up, don’t count your proverbial chickens.

There has been damage done to confidence and that in the market is a dangerous area to lose control of. The Fed have been back-pedaling all week, trying to re-spin Bernanke’s gaffe. We’ll see next week if they have succeeded.

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This is a court of law, young man, not a court of justice.

Oliver Wendell Holmes

And so it seemed with the Federal Reserve policy announcement last week, followed very closely by Bernanke’s interview. The Fed statement reiterated the same policy that they had churned out over the previous meetings.

Bernanke however changed the rules. Instead of 6.5% unemployment, now 7% was going to be close enough. Well the markets were less than impressed, and puked up pretty much everything.

Bonds continued to rise into Friday. The stock market had a little short covering rally, with sellers taking profits, but it was not the bulls stepping up to the line…they already got steamrollered at $160 on the SPY

Well the COT traders I’m guessing, bought last week in anticipation of a benign Fed statement. Indeed they got it. The Fed Futures had accurately predicted nothing much until towards the end of next year, again, policy wise, that is what they got. Then Ben opened his mouth.

This week the COT traders are still buying. They are at +22.5% on the index. Do they know something that the rest of the market doesn’t? At this point, I doubt it. I continue to monitor, but I am not trading their prediction.

There is a general feeling that increasing yields help the financials. The FT is not so sure. What then might be the risk?

Banks borrow short and lend long. In a rising rate environment the loans lose value more quickly than the short end. Held to maturity, with quality credit risk, this can work out fine.

With questionable credit risk, and/or leverage that creates a margin call, this strategy kills banks. We saw it most recently in 2008. Would banks be stupid enough to do it again? So soon? Of course. Bank CEO’s are some of the most stupid out there.

Therefore with a surprise from the Federal Reserve from their policy statement, yields are rising and rising fast. The speed of the rise could well create margin calls. With the excess reserves held at the Fed, this [you would think] should not be a problem…unless the leverage is too high again.

Earnings season will identify the bad banks [if there are any again] as those in the know, and holding common stock get out. There could be some earning’s surprises in store coming up.

For this week however it means that the uncertainty in the markets will remain. Nothing really was sorted out with last week’s Fed policy, and the technical damage done to all markets was significant.

This break of technical levels will not quickly resolve. It will take some time to test various technical levels and if the bulls are to prevail, re-establish confidence. At the moment, the bulls have lost the initiative as their credo, the Bernanke Put, has been washed away.

Remaining market neutral is the sensible option. Profit is available in either direction of trending market movement.

The trade this week only extends out to November. I would have preferred a longer expiry date, longer is always better in a credit spread. This is the risk with the position.

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I think there has been some pain with leverage. These are entities which are leveraged sometimes six, sometimes eight, sometimes ten times. It’s hard to imagine that all of them could be operating in good shape with interest rates on mortgage-backed securities having risen 140 basis points (1.4%) now from their low of the year that was set in the first quarter. Once you get a move of ten points on something that generally trades within a range of a couple of points, it’s hard to believe that there wouldn’t be some leveraged player that is feeling a great deal of pain. Those are the ones that end up with the involuntary redemptions and those could lead to the extension of the selloff. I think that’s partially what’s happened in the last several days.”

“It’s something of a liquidation cycle certainly. There’s a metaphor for what’s been happening in the last couple of weeks. It goes back to 1994, when the Fed under Greenspan raised the Fed Funds Rate by 25 basis points (0.25%). It didn’t seem like much of a move but it changed … people psychologically, and ultimately their behavior. This time, it’s not the Fed Funds Rate, it’s the statements about quantitative easing. What it did is we got people to alter their behavior and to invest more than they’re typically comfortable in investing – in stocks, in emerging market bonds, in high-yield bonds – in all financial asset classes. Indeed, that was the intent, wasn’t it? That was the intent, partially, of quantitative easing – was to alter behavior, and to get people to invest more than they typically would. Hold less cash, for example, than they typically would. Well, when people are holding less cash than they’re typically comfortable with, and markets start to move against them, not surprisingly they say, ‘Hey, I went to get back to home here and get back to my comfort position.’ which means liquidation. It’s a metaphor with what happened with Apple.
“What’s happening in the market is that a one-sided overinvestment leads to off-sides market. Therefore, it is something of a liquidation cycle.”

10yr

So for the moment the heat comes off of the Treasury market. Will they stabilise, has the Federal Reserve intervened? Who knows at the moment. This however is why stocks are currently having a little rally.

Go figure – the sell-off the Treasury market has seen since early May is actually already worse than what went down 20 years ago, as ISI’s Ed Hyman points out in a note to clients this week.

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The thing is, even if the Treasury market does stabilise, that does not mean that the stock market will stabilise. It could be in for a deeper correction yet.

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