Whither Bonds? Sell ‘em hard! When?

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The Technical Trader’s view: There are a series of critical breaks which may fuel a bear market from these rarified levels: Watch for those critical breaks beneath 111-09, 109-20 and 104-00:

1. MONTHLY CONTINUATION CHART:This long term US T Note chart is notable for the repeated failure of the market to get above and stay above the 120 level...And the market has just failed twice recently.If the market were to break down through the two lows at 104 a good, solid, Double Top would have been completed.
2. WEEKLY CONTINUATION CHART:That recent double refusal is all the clearer here.In the medium-term the possibility arises of a Double Top if the market can get beneath 111-0.5.But we feel it should also break the two supports from prior Highs at 110-31 and 109-20.5 before sellers can be sure that the market is truly weak. Look closer still.
3. DAILY DEC 08 CHART:The double failure beneath 120 on the week chart becomes a four times failure at the 117-00 level in the day chart.Note too, the exciting bear possibilities that have now arisen: A push down through the possible Neckline at 111-09 would complete a clear and powerful Head and Shoulders Top. All this has yet to happen.But the bear potential found in the long medium and short-term charts is unmistakable. Watch for those critical breaks beneath 111-09, 109-20 and 104-00.

The Macro Trader’s view: Usually during times of economic weakness, or outright recession, as now, bonds are seen as a bull trade. That is because as an economy approaches recession, inflation usually falls, or is forecast to. And although government borrowing (through bond issuance) tends to rise as tax receipts fall, and benefit payments increase, this doesn't undermine the bull bond trade for a good while since it lags the overall trend in the economy. Of course, as the recession ends then bonds may eventually begin to fall as private demand for money competes with the public debt. But this time the situation looks very different. True, after a long period of relatively strong inflationary pressure, inflation is at last set to ease, as the leading economies all enter recession. But unlike in other post WW11 economic downturns, government borrowing is not just set to grow, it is exploding. In response to the near-collapse of the global financial system, the US, UK, Euro zone and others have pumped huge amounts of money into their Banks by way of state capital injection. Additionally, they have made billions available to guarantee inter-Bank lending in an attempt to get Banks lending to each other again and to the wider economy. Modern economies cannot function without a steady and readily available flow of credit. The drying up of this over the last 14 months is largely responsible for the now un-avoidable recession. These actions mean that governments will not only need to borrow to fund previous spending commitments once covered by tax receipts, but need to borrow even more to finance the financial system rescue plan recently adopted globally. This is the heart of the problem: the market won’t just need to absorb increased sovereign debt from one or two struggling countries, but from virtually every leading economy in the world, including the United States. In the US, the situation is made potentially even worse by the government nationalizing Fannie Mae and Freddie Mac which saw US Government liabilities soar by $5.4T, almost doubling the national debt. While this debt to a degree is self-financing so long as mortgagees continue to service their mortgage, the risk a large proportion will slip into default is very real, or else these two firms wouldn’t have needed to be rescued. In the UK Gordon Brown and Alistair Darling have said the previous fiscal rules will be ripped up and the UK will spend its way out of recession. While this guarantees a substantial deterioration of the fiscal position, it isn’t even clear that it will work, since greater government borrowing acts ultimately to crowd out the private sector, which ultimately is the true creator of wealth. So, faced with a near certain explosion of new government debt issuance globally, we judge long-term bond yields are set to rise substantially, in fact unraveling the last 15-20 years of falling bond yields, as many of the conditions that drove yields down during that period are either no longer in play or are reversed. Timing for a bear bond trade remains a matter of debate, but we sense once traders become accustomed to the reality of recession and fully aware of sovereign debt implications, bonds will sell off hard. Mark Sturdy John Lewis Seven Days Ahead

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How far can the Euro (and other currencies) fall against the Dollar?

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The Technical Trader’s view: DOLLAR EURO MONTHLY CHART The drama of the Dollar is beginning to take centre stage in the markets. The clear failure of the market to hold at the band of support 1.3668-1.3812 has led to a fall against the Euro which spells the end of the weaker Dollar move from 2000. Our Key Trade subscribers have profited from the move. And although we think it looks extended short-term, we think it will go further. 1.20 looks to be the first support of consequence. DOLLAR EURO DAILY CHART: The detail of the market shows a possible head and Shoulders pattern that looks set to drive the market on down – perhaps as far as 1.18 or so.....(close to the long run support in the weekly chart) We have been profit-takers here (the recent leg almost exactly equal to the move from 1.60 to 1.39) But note the good resistance above the market at the low 1.3261, and then again at the Neckline. Even if it bounces we think the market is a sell. The Macro Trader’s view:

Given an economy that: • has been skirting recession for well over a year, driven by a housing market correction that began back in 2005, • has enjoyed a sizeable fiscal boost earlier this year and more recently, • has had to intervene in its financial sector in enormous size one might be forgiven for asking why the Dollar is as strong as it is, especially since the on-off recession is now definitely not only on, but likely to prove deep and protracted. The answer could simply be put as follows: ‘USA first in, USA first out’ but that wouldn’t fully explain what is now unfolding in the global economy. True, the US was the first economy to begin feeling the impact of the Sub-Prime crisis. Its origin after all, was the US. But initially many thought it would just be a US problem, worsened by the housing market correction that began in late 2005. That view enormously over-simplified the matter. The sub-prime bonds secured against sub-prime mortgages were purchased as investments by many other Banks globally; this insured the problem would be global in its reach. But because the initial impact did indeed appear confined to the US, the Dollar weakened greatly against the other major currencies. The UK economy, which completely avoided the 2001 recession, was at first viewed as bomb-proof, although that view has long since changed. And the Euro zone economy, with its greater reliance on manufacturing rather than services/housing market activity, looked even more immune. Now, a year of financial market turmoil and dislocation has almost brought the global financial system to its knees, requiring a global rescue plan designed to recapitalize the Banks of the major economies. No economy looks immune and indeed a severe recession is not only expected in the US, but also in the UK and now the Euro zone. So, although the situation in the US is far from showing improvement, traders are focused on the relative deterioration of the other major economies as measured against the economy of the US and they don’t like what they see. Hence the US Dollar is now embarked firmly on a new Bull Run which has still a long way to go. How far can it go? Well, just look at where Dollar Euro was before the Dollar began the its recent bear trend, now ended, and that will give some guidance. Subscribers to the Macro Trader’s guide and the Technical Trader’s guide and Seven Days Ahead’s Key Trades product have benefited from our detailed analysis of this market and only today taken a 583bp profit. Mark Sturdy John Lewis Seven Days Ahead [For the complete and illustrated version of this and future Updates be sure to sign up at www.sevendaysahead.com]

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The unfolding drama of Stocks – more to come?

[For the complete and illustrated version of this and future Updates be sure to sign up at www.sevendaysahead.com] The Technical Trader’s view: MONTHLY BAR CHART It is worth studying the long-term chart with some care: The Head and Shoulders Top has certainly overreached its minimum target of about 980. The market has deeply penetrated through the support from the prior High at 954. The 767 low has yet to be reached. It seems to us likely that, in the absence of any other support of consequence, the market wants to test that crucial level. If so, and that 767 level were to break, a perfect Double Top would have been formed. Check out the consequences of that.... DAILY CHART: If completed the Top has a minimum move down to 380 or so. That’s a large move – which so far is purely conjectural. But worth bearing in mind. (Especially since the Nikkei has already traded very close (7710) to its 2003 low (7600) and remains very close) In the S&P, what if the current yo-yoing around the 950 level creates some sort of a continuation pattern? What are the chances of that? DAILY CHART: The shorter-term Head and Shoulders chart in the Dec 08 contract has been driving the market over the last 15 trading days. That H&S too, has achieved its minimum target - more or less the level of the larger H&S pattern in the continuation chart. But the important question surrounds the unfolding character of the price action over the next few trading days. Watch for a possible Triangle: we need another High - around 1000 would be ideal - and then a break of the lower diagonal that has already been created.... Watch and wait! The Macro Trader’s view: Equities are currently suffering one of their most volatile periods in a very long time. Traders began frantically selling stocks globally a few weeks ago as serious concerns emerged over whether the global financial system would survive in its current form and as a result the Dow Jones suffered its worst sell-off since the 1929 crash. But as has been widely reported, the launch of a ‘Global’ rescue plan for the Banking industry has broadly allayed fears of collapse and on Monday of this week, the Dow Jones enjoyed one of its largest point’s rallies ever, with other equity markets following suit. But the initial euphoria soon gave way to worries over global recession. Although the financial system was no longer deemed at risk of collapse, as governments pumped money into their ailing Banks via part nationalization, the plan was seen as too late to prevent recession in the developed economies. Indeed, despite interest rates in the US of only 1.5%, that economy is now seen as recessionary and, along with the UK and Euro zone, analysts expect it to be a worse recession than any other post WW11. Interest rates are expected to fall further, including those of the US, possibly at this month’s FOMC meeting. Despite the help given the financial system and expectations of further rate cuts, equities remain volatile. It now seems clear that the powerful rally in equities earlier this week was little more than a short covering rally, which turned negative on Wednesday. And even though stocks are trying to rally today, they aren’t much above the lows of the week. Looking ahead, we judge economic data is likely to remain weak: today’s US Housing starts were the lowest since 1991 which was the last deep recession. Yesterday’s industrial production and capacity utilization were also weak and the Fed’s Yellen and former Fed Chairman Paul Volker both said this week the US was in recession. Current Fed Chairman Bernanke is saying the US economy faces serious threats. In short, the financial market rescue plan has prevented the Banking industry from collapsing, but the financial crisis had already been running for over a year, and so the damage to the economy is already done. In the UK and Euro zone the situation has been made worse by the Bank of England and ECB keeping rates too high for too long as they failed to recognize the severity of the threat to economic activity until it was too late. The current situation argues strongly for a continuing bear market in stocks and that is what we expect. Worse still, when the recovery does start it is likely to be anaemic, meaning it could take a long time before a solid Bull market in equities emerges. Mark Sturdy John Lewis Seven Days Ahead [For the complete and illustrated version of this and future Updates be sure to sign up at www.sevendaysahead.com]

Why we are out of the market

THE TECHNICAL TRADER'S VIEW:

• The Technical Trading Guide has been a bear of the Eurostoxx index since July 1st. In that period the index has dropped from 3400 to 2663 or 21%. We have been short of the FTSE the S&P and the Nikkei for much of that period as well.
• In the Market Update sent early yesterday morning we pointed out that the risk return of selling stocks was no longer attractive and so advised going square of all stocks for the first time in three months.
• In large part this is because of the fulfillment of the target of a very clear pattern in the S&P 500 index:

DAILY CHART The achievement of the 1000 target is absolutely clear. Of course targets are minimum target for moves, but the loss of impetus after the achievement of a target renders markets more vulnerable to short-covering and therefore changes the risk-reward of the trend-following trade. In addition look carefully at the long-term charts ... There are at least two other good technical reasons for covering stocks shorts at these levels... MONTHLY CHART: Note the close proximity of the horizontal support from the prior high at 954 in 2002. Look closely too at the target of the large H&S pattern in the long term chart... The target of that pattern too has been exceeded. And the same logic as that used above holds good... This is why we are out of the market in stocks. THE MACRO TRADER'S VIEW After a very successful long Short Sterling trade in our Key Trades recommendation portfolio, (see http://www.sevendaysahead.com/investor-guides/ktguide.php) we closed it out yesterday for a total profit of almost 100bp, we are now standing aside from both interest rate markets and equities. Stock markets remain incredibly volatile even now, and have exhibited great volatility for many months. Indeed subscribers will know that we have been long term-bears of equities - about which see above. But, understandably, traders have found it very difficult to enter trades that were swiftly taken out by large intra-day swings. These were caused by great uncertainty over the fate of the global financial system, which had seen stalwarts of the US and UK Banking establishment either fail or require Government rescue. But even now after both the US and UK authorities have launched massive independent and structurally different rescue packages, stock markets remain unpredictable. We are no longer bears but neither are we bulls: - Equities have tried to rally, but even now are again trading lower, and - Inter-bank lending, so crucial to the entire financial system and global economy remains frozen; even after a coordinated 50bp rate cut from leading Central Banks. So what next? US treasury Secretary Paulson warned only yesterday more Banks could yet fail, and the rescue plans will take time to work and percolate through the plumbing of international finance and re-awaken economic activity that is on the brink of the worst recession since before WW2. This leads us to exercise caution. The crisis isn’t resolved; we are experiencing a lull even though much has now been done to improve the situation. Now the UK recession looks like being bad, previously it looked like being a disaster with the real risk of one or more major Banking institution going bust. The good news is that that scenario no longer looks likely since the Governments of the UK (and US) are poised to either take a direct stake in the leading banks or cleanse their balance sheets of ‘toxic’ debt. For now though, interest rate markets are giving back some of their gains, which may offer better buying opportunities for another bet on lower rates - in the future. That is why we are now square. We sense we will soon be able to re-establish good interest rate positions at more favourable levels as markets move from worry over the financial system, to focus on the coming recession and its impact on the real economy. We doubt whether the risk return in stocks will encourage fresh positions anytime soon. Mark Sturdy John Lewis Seven Days Ahead [For the complete and illustrated version of this and future Updates be sure to sign up at www.sevendaysahead.com]

Cotton bears target lower after latest support failure

During Jul/Aug the fall in Cotton prices had slowed notably, and bears had looked tired. However, a break of key support in early Sep gave them a new life lease, with the risk that the downmove would accelerate. The Commodity Trader’s view

• WEEKLY CHART – CONTINUATION: In the Commodity Trading Guide we had been looking at possible support around the 76.4% 56.70 level (see next chart too). This has not held, due partly, we believe, to the fresh energy that bears have derived from the early Sep break of a key support line (see Daily chart).
• WEEKLY CHART – DEC-08: On the weekly chart of the front month we had noted the ’98.45-71.65’ equality target off 84.04 Jun high, at 57.25 – not far from that 76.4% level. It has not been effective, so the next target on the list lays around 51.60, the 2.618 swing off prior 71.65-84.04 upleg. Looking at the daily chart…
• DAILY CHART – DEC-08: In recent Commodity Guides we had mentioned the risk of a downward acceleration should the (former) key support line fail. This appears to be taking place, and on this chart note two bear channel base projections that currently converge below the 50.00 level – potential support if other levels fail. At this stage the first bull sign would come from a recovery through that old support/return line plus more recent falling resistance line. Any sellers on upticks would likely place stops above this resistance, i.e. above 65.00.

Philip Allwright Mark Sturdy Seven Days Ahead [For the complete and illustrated version of this and future Updates be sure to sign up at www.sevendaysahead.com]

Will the Dollar’s strength continue?

[For the complete and illustrated version of this and future Updates be sure to sign up at www.sevendaysahead.com] The Technical Trader’s view: MONTHLY DOLLAR EURO CHART The Dollar has pulled back hard - but we think it may well find good support at the band 1.1875-1.3812. Note well the intersection of the rising diagonal with the horizontals. If that whole area of coincident support were to break the market would feel very vulnerable – nest stop 1.1875. MONTHLY CABLE CHART: Cable too, is approaching a vitally important level of support. But we would be buyers of the Dollar only on a clear break of 1.7365..... Will these levels against the Euro and Sterling break? Look elsewhere.... MONTHLY AUS/ DOLLAR CHART: The Aussie Dollar Cross shows what can happen. It is a broadly similar pattern as, for example, Cable - but the breakdown is far more complete. It doesn’t follow that the Sterling and Euro will collapse, but the odds favour that outcome. The Macro Trader’s view: After an impressive bull run which began back in July, culminating in a high on September 11, the Dollar reversed so abruptly, that it wasn’t clear whether the bull run had foundered or it was merely correcting. Indeed, so far did it correct, that the bull run began to look as though it had only been a correction within the previous long Bear market that traders had judged over. But the Dollar was reacting to great uncertainty in the US financial markets: Lehman brothers had collapsed, Merrill lynch had sold itself to Bank of America and AIG was nationalized. The financial system seemed on the brink of collapse. This was only heightened when Treasury Secretary Paulson announced a rescue package that the House of Representatives rejected after very intense negotiations among policy makers, legislators and the Administration. But that rejection seemed to mark the end of the Dollar’s recent period of weakness. Traders recovered from the shock of rejection and assumed a deal of some sort would be agreed and turned their attention to other major economies. What action were authorities taking in the UK, Euro zone and elsewhere to protect their banking system? In short: none. Their strategy seemed to be little more than to pray that the US passed a rescue plan that included foreign Banks, and as several Banks around the world failed and needed either rescuing or propping up, the Dollar gained strength; so much so it has made new recent highs. So where now for the US economy? In our view the Dollar remains embarked on a bull run. The price action of recent weeks has been a correction, and with or without the rescue plan (which we think will eventually be agreed in one form or another) we judge traders will continue to favour the US currency over its competitors, as both the UK and the Euro zone are on the threshold of recession. And other leading economies are beginning to feel the strain of a US economy that is no longer acting as the consumer of last resort. Already China is failing to fulfil contracts to buy Iron ore since demand has dropped recently, denting the argument that the economies of India and China would be able to keep the global economy moving forward. The global financial system faces challenges that will force leading economies into recession. The Dollar is a buy because the US Government is at least acting proactively in trying to repair the damage rather than hope someone else will do it for them. Mark Sturdy John Lewis Seven Days Ahead

The US vote suspense is ... irrevelent

Whatever happens in the Congressional vote the stock markets look sure to go lower. Note well what happened in the Far Eastern stocks overnight: the sight of export-led economies still anticipating a massive slow-down in Western markets.

The idea that US and European stock markets have discounted the recession coming our way looks unlikely. The Dollar's rise is signalling that Europe will comes over the spotlight next....and though the European short rate markets are beginning to anticipate that rates will fall, their stock markets surely remain very vulnerable. I'm deeply grateful to those buyers to whom I sold two (heavily discounted) properties earlier this summer ...

Mark Sturdy

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