Pop Goes The Weasel

I’m going to be fairly quick tonight, as things actually just got a lot easier on the charting front. First, after four failed attempts it was crystal clear to me this morning that we would not cave anytime soon. Glad I went into cash on Friday – great timing there IMHO. Anyway, the Yen had been ‘talked down’ overnight by the Japanese who are getting freaked out, and although it tried to rally a bit equities completely ignored that and kept on pushing blissfully higher. The situation in bonds is actually very interesting – somebody passed me this email which is currently circulating the City of London:

Gut wrenching declines in US and global equity markets during October coupled with bond market outperformance will undoubtedly require MASSIVE monthly asset rebalancing by US pension funds –- rotating OUT of bonds and INTO stocks. This may have a profound “short-term” impact on performance of risk assets since the required rebalancing appears to eclipse even the large rotation after the 1987 stock market crash. As a very simple example, we asked our quant colleague (xxx) to analyze a balanced portfolio targeting 40% domestic bonds (SBBIG Index) and 60% equities.

We assumed that the equity portion is comprised of 75% domestic stocks (MXUS Index) and 25% EAFE international equities (MXEA Index). The attached rebalancing calculations based on closing levels last Friday (Oct 24) suggest that US pension funds would need to reduce bond holdings by a WHOPPING -4.1% while increasing equity allocations by a corresponding +4.1%, all by the close of business at month-end on Halloween Friday (Oct 31).

Price action could be bloody scary given terrifying poor liquidity in these markets. For historical perspective, the second largest monthly bond-stock rebalancing rotation was 3.4% in October 1987. Most importantly, US equities did manage to stage a +10.5% during the last four trading days of October 1987 while bonds struggled. As it turns out, that marked the bottom for US equities for the next month and probably helped stocks find some needed footing in 1987.

Bottom line: BEWARE the potential bounce in risk assets due to bond-stock rotation this week. FX risk trades may also tend to recover a little lost ground.

I guess the secrets of high finance continue to escape me – stocks have sucked so fund managers are compelled to move their assets out of bonds to buy even more stocks. Some folks also mention the Japanese short sell ban plus the expected interest rate hike. Whatever – more band-aids on the pig won’t make want to kiss it. Nevertheless, money clearly keeps moving out of bonds, as the TNX closed at 38.2 today, which gives credence to the bullish case. Supporting the bears is that the spread between Moody’s BAA and the 30 year T-Bond yields appears to not be narrowing, which has been a very reliable indication of bullish rallies throughout the past few months. For instance, last time we the spread getting narrower was in late April and throughout May as we traced out intermediate (2) of primary {1} of c (a consolidation rally). Of course these things are not black and white and it is possible we keep rallying going forward and witness a narrowing of the spread as we climb wave (4).

Here’s a special chart for all of you Born Again Bulls out there. Baltic Dry Index is now in triple digits – nothing is getting shipped right now. I call that a perfect economic environment for sustained bull rallies 😉

The U.S. Dollar TED spread also keeps widening again – meh, probably doesn’t mean anything, does it? Who needs inter-bank loans anyway?

Let’s look at my obligatory SPX chart. If any of you leeches wonder why I didn’t jump in on a 900 Dow point rally: Mainly because I still see a good chance for the triangle case to play out as shown above. The wave count obviously changes (to something else) after today’s tape. And there is actually still upside potential left if we happen to continue on that path – I give it a 40% chance as of tonight.

Another possibility is that we have been tracing out a larger series of 1,2s and that we drop almost immediately and don’t look back – I’m giving this scenario also a 40% chance. The remaining 20% go to what the majority seems to be expecting at this point – a monster rally that won’t quit. Not impossible no, but I cannot give it more than 20% as of tonight. If we push up tomorrow the probabilities would obviously be skewed towards the upper range scenarios.

Gold is actually starting to resemble something I can count again. I have taken the liberty to put up some preliminary labels – they might change of course going forward. Yes, I still think we hit 600 and it seems the downside move should continue once we reach equality on wave (c). FYI – if we push down from here I might have to revise the lower target, as commodities have the nasty habit of painting extended 5 waves. FYI – equities traditionally paint extended 3 waves; doesn’t always happen of course but a good example is our recent {3} of 3 of (3) in the SPX.

BTW, I have kept the long term trend set to down tonight, but if we start rallying hard I’m considering to change it to up. Although we are in a secular bear market which should go for years I want to keep the definitions useful for us option traders. And a multi-week rally would be long term for most of us, n’est-ce pas? However, if it would help to add a ‘medium term‘ indicator in between the current two, please let me know. Perhaps I should put up a poll, so I can gather a consensus. Let’s try the democratic round first, before I impose my will on everyone else. Just like when it comes to the House voting for bailouts, right?

That’s it – I have to attend to my spousal duties now – tomorrow should be extremely interesting. For the record: I actually am hoping for the monster rally as it would be making things a lot easier for all of us. But that doesn’t mean it’ll happen – one can hope of course. Until tomorrow my loyal leeches.

Cheers!