Summary
The CNBC crowd voiced disappointment over yesterday's stagnant stock market. However, that yesterday's session contained no follow-through to last week's price spike means absolutely nothing -- yet! Meanwhile, the bond-market rally continues at an interesting albeit increasingly dangerous point in time.
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Stocks
Using my seven-measure stock-market tracking group as the proxy, the following table tells the story we must continue to watch at the moment.
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SELECTED STOCK-MARKET RETURNS
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02/07 2004
2005 High 02/07 Vs.
Close Close /Date 2004 High
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NYSE Comp. 7201 7254 12/30 -0.7%
S&P 500 1202 1214 12/30 -1.0%
Wilsh. 5000 11851 11988 12/30 -1.1%
DJIA 10716 10855 12/28 -1.3%
Value Line 397 405 12/30 -2.0%
Russ. 2000 637 655 12/28 -2.7%
NASDAQ 100 1529 1625 12/29 -5.9%
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Average -2.1%
Median -1.3%
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If the above numbers look an awful lot like the ones in the table in yesterday's missive, they are. Through last Friday's close, the respective average and median results were 2.0% and 1.3%. Yesterday was a big nothing!
But maybe nothing was really the beginning of something? Time will tell.
Last week's price spike put some of the more visible bellwether measures within easy striking distance of their 2004 highs, which were also the recovery highs for the secular bear market commencing in early 2000. (Yes, I still classify it as a secular bear market, because that is what I continue to believe it is.)
Important market down-legs usually begin as failing/failed rallies. Here, however, you have to be careful in the way you measure things. The market could exceed the prior highs -- not by too much, though -- as the ultimate "fail" was falling into place. This is where you begin blurring formations a little, by intersecting with the potentially deadly "broadening top" pattern.
This pattern denotes a distribution phase. And distribution phases precede liquidation phases. And liquidation phases are flat out ugly! The problem with detecting them, though, is that critical pieces of the puzzle are falling into place on the ever-important "margin," and marginal events are difficult to detect.
As for Interest Rates...
Government bond dealers go into this week's February refunding auctions in suspect technical shape. More so for the auctions of five- and 10-year notes tomorrow and Thursday than for today's three-year note auction.
Dealers generally like to establish a short position in front of auctions, which helps materially in facilitating distribution. However, the bond market's strong performance recently likely has disrupted this traditional strategy. Thus, unless there is legitimate retail demand for the $51 billion in new securities the Treasury will auction, government dealers may wind up long a large portion of the week's refunding auctions in their own accounts.
(I'll have a piece out later today on the results of today's auction of $22 billion in three-year notes.)
While thinking about why this rally persists and continues to configure the way it does, one horrifying but plausible thought has crossed my mind. Could it be that hedge funds, instead of simply calling it a day and unwinding their carry trade in Treasuries, are instead extending maturities? In other words, as they are being squeezed by higher borrowing costs because of the Fed-induced rate rise at the front end of the curve, hedge funds are simply buying longer-dated Treasuries to maintain positive spreads?
If so, they are buying greater volatility as they extend their maturities. In turn, this is wonderful as long as the volatility is reflected in higher prices. But when things finally turn in the other direction, as they surely will, the sell-off these leveraged positions is capable of producing could be absolutely breathtaking!
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