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WEDNESDAY a.m.
August 6, 2003
Breaking Down
by David Nichols
The bigger "Macro" picture is now starting to turn a little ugly on the bullish majority, and a palpable sense of fear hit the market surprisingly hard yesterday afternoon. The late-day swoon -- that seemingly came out of nowhere -- is being directly attributed to a very weak reception to a U.S. government bond auction.
This is why I've been droning on a bit about bonds lately. The massacre in fixed income markets -- which dwarf equity markets in size -- was bound to have a concussive effect throughout financial markets of all kinds. The destabilization of fixed income markets -- with interest rates shooting down and up with reckless abandon -- can't be a good thing in general, despite what the bulls will argue about this auguring a pick-up in the economy.
Bond prices are tumbling (sending interest rates soaring) because there is too much supply, and not enough buyers. That's a pretty obvious statement, to be sure, but important enough to warrant saying out loud. People that control vast sums of money want out of bonds, and many of them have been trapped in big leveraged positions (the "carry" trade). Now that the government is coming in with tremendous amounts of new supply -- because of ballooning deficits that need to be financed -- nobody has much of an appetite to step up and buy this new paper.
Both bonds and stocks plummeted yesterday, following that weak auction. There's also now a growing disenchantment with the Fed, with outright negative quotes about Greenspan even appearing in the New York Times, of all places. Things have not been as rosy for the Fed and their plans to engineer financial markets ever since Dr. Greenspan hemmed and hawed his way through recent Congressional testimony.
A major problem could be ahead if this growing disenchantment with the Fed mushrooms into full-scale loathing. It could happen, and happen quickly -- as we saw yesterday afternoon. Once confidence is lost, it doesn't come back easily.
So now we're looking at a market that's broken down quickly from its last trip above that incredibly stubborn 1000 level on the S&P 500. As I predicted weeks ago, I think this 1000 level (plus or minus a few percent) is going to be the upper limit for many, many years, exactly as the 21,000 level on the Nikkei has contained the upside in that market for years.
I also think a trip down to 600 on the S&P 500 is coming over the next 9 months or so, with the VIX rising to 70 or even higher on an intra-day spike.
I realize this makes me the weird kid in class. But there is real disaster potential in the monumental build-up of bullish sentiment following this latest rally, which has only been heightened by the market's ability to extend sideways here at the top, and not just completely fall apart as it's done so many times before. We saw the first real hint of what can happen to the majority yesterday when perceptions start to change.
What's it going to take to turn all these bulls back into bears, and make every last person walk away from the equity markets "for good this time...?" About 600 on the S&P 500, would be my guess. But man, is that ever going to be a great buying opportunity. We could shoot right back up from there in no time flat.
At some point soon, it's going to get really crazy out there in the equity markets, just as it has in bonds. Most people are going to get bucked right off the "stock bronco" for good, and are never going to want to get back on. But for those with courage and a strong grip, it could be a crazy profitable ride to glory. We'll just have to try to do our best over this coming period, as it's not going to be easy.
But let's get back to the here and now, because this dire scene isn't necessarily unfolding right at this moment. But keep in mind that it could be the start of such a sell-off, which absolutely nobody is expecting. So that's why it should be on your radar. The market seeks out the least-expected path. It's our job to ascertain what the majority thinks about the equity markets, and to try to get positioned as best we can on the opposite side of this opinion.
So far the half-position in the Rydex Tempest Fund (RYTPX) -- a leveraged bearish mutual fund -- which I recommended a while back (and am still stubbornly holding on to) is still underwater, but now rising quickly to the surface. I haven't thrown in the other half, because it's generally not a good idea to "average down" a position that isn't working out.
But now the S&P 500 has closed right at 965 -- spot-on the "neckline". Technicians everywhere know that a level of strong resistance, once breached, can become staunch support.
The VIX jumped up more yesterday, with most of the rise coming during the afternoon melt-down. Fear hit the market pretty hard in that short stretch following the disappointing bond auction, and the VIX closed at the highs of the day, indicating real demand for protection in the options markets. The "fear virus" proliferated quickly, and is now close to becoming a full-blown selling epidemic.
So if the bulls are going to make a stand, now is the time to do it. If the market doesn't bounce here at support, with conditions already reaching oversold wash-out levels in the short-term, then those counting on a return of the glory days of the bull market have a big problem.
We'll go in on the other half of a Rydex position if the selling epidemic indeed proliferates from here.
Sentiment Dashboard
by Adam Oliensis
SENTIMENT TANK: Filled by 12 points to 26% full of negative sentiment breaking the downtrend and hitting important horizontal levels from early June.
SHORT-TERM: Turned down yesterday afternoon after struggling to turn up early in the day and failing.
MID-TERM: Progressed 8 points to 47% in its decline phase with confidence jumping up to 3 (out of 7).
LONG-TERM: Progressed 2 points to 11% on the decline side with confidence jumping to 2 (out of7).
BOTTOM LINE: As we suggested a while back, it has taken a test of 965 to the downside to engender a real spark of fear. Will that spark catch fire and set off a full-blown conflagration? Now is the time for the bears to be pouring gasoline and throwing matches. If the bulls can douse the spark here (at the June highs on the tank) then they may turn back the flames. Otherwise lower prices are in store.
Se não receio o erro é porque estou sempre pronto a corrigi-lo
There's no bull side and no bear side. JUST THE RIGHT SIDE!
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