As per my previous post, I hypothesized that the 1040 low would be revisited before the summer was over and now here we are...a lot quicker than I expected. Apparently the reason for today's beating is concern regarding China as Chinese leading economic indicators have shown the smallest gain in five months. Seems like a pretty flimsy an excuse for such a steep sell-off doesn't it? I mean, it seems as if everyone is expecting and even welcoming a cooling down in the Chinese economy and it's not as if leading indicators have dropped sharply...they still showed a gain! There's other concerns that have been building up as well. Corporate bond spreads around the globe have been rising and CDS spreads in Europe are flaring up again. It seems apparent to me that the market was on its way down anyways and the China news was simply an excuse to get it down.
The sharp drop we've seen in the market lately is what tends to happen when you have a combination of deteriorating structural conditions combined with weak handed technical types holding long positions with a lack of bears pressing shorts (another thing I have noticed lately). I warned about how the market had been rising via gap up action driven by these weak handed technical types and how such types will bail en masse the instant the market goes against them. It's not a good sign for the bulls when ST overbought conditions result in steep sell-offs like this. In bull market conditions like we've seen prior to May, such ST overbought conditions were either ignored or resulted in mild pullbacks/sideways action. This is yet another sign that the market that has changed stripes since May.
Notice how the market has once again conveniently and neatly bounced near the 1040 low (so far today). This is the 3rd time now. I'll say it again...I will not trust such bounces because they have an “artificial" feel to them. Remember how I quoted a strategist a few weeks ago who said that a break of 1040 would signal the end of the bull market since March of 2009? IMO, we need to see such a break in order to have any hopes of a genuine low. We need to see white knuckle fear and capitulation from weak bulls like that strategist and I'm sure there's more like him out there hanging on to their longs by a thread....they need to be wiped out.
The 10 year bond yield has dipped below 3% today. There's 2 ways to look at this. 1) It means the bond market is signaling deflation is coming i.e. signficant economic weakness or 2) an emotional flight to safety which makes stock prices more attractively valued. I'd guess it's a combo of both but I'd put a bit more weight into 1).
In the past I've mentioned how the yield curve was the best economist in the world and the best single leading economic indicator. Last year I mentioned several times how the steep yield curve was very bullish signaling good times ahead. With the 10 year bond dipping below 3%, the yield curve is still steep technically speaking, but we are in an odd situation whereby we can't get the traditional warning of a recession from the yield curve because it can never get flat or inverted given that the short end is at 0% (it's extremely unlikely the 10 year bond yield would ever get anywhere close to 0% even in a depression...although it did happen in Japan) With the 10 year yield below 3% I have to admit that this could be a bad signal for the US economy. Low government bond yields are a good thing because borrowing costs tend to drop along side with them and stock prices are more attractive on a relative value basis vs. bonds. But "too low" a yield may signal that serious deflation is ahead which is very bad for corporate profits and thus the relative value vs. bonds is simply an illusion because corporate earnings may be heading south in a major way. This is the weakness of the so called "fed model" which determines the fair valuation of equities by comparing the earnings yield to the 10 year government bond yield.
I've mentioned in the past that I keep an eye on government bond yields as an indicator for equities. It's a tricky thing. Generally, rising bond yields are bad for equities and falling bond yields are good for them but there are times when the opposite is true. I explained above when falling bond yields can actually be bearish for equities. Rising bond yields can actually be bullish for equities as well when it is occurring from low levels because it signals that deflation concerns are abating i.e. the economy is anticipated to grow. This is what happened in early 2009.
Bottom line: Since May began, volatility has risen substantially and any upside progress has been done in a shitty way i.e. via gap ups and morning strength which can't be trusted as sustainable (in my opinion). The latest ST overbought condition has resulted in a significant bearish "bite" which is a change in character for the market. This is bear market behavior and so we have to assume that at the very least we are in a prolonged correction phase. Untill such behavior changes I have to respect a potential for bearish resolution to this consolidation phase we are seeing (a bullish resolution is still on the table) and the best thing to do is step aside or take ST trading positions (although it will be difficult and frustrating to capitalize). I've chosen the former for now. I'm too busy, distracted and not confident enough right now to do the latter. The only bullish thing about today's action is that there's a big gap to be filled on the upside now. I said the same thing about a month ago when the market gaped down on the poor payroll figure. Eventually that gap did get filled...but there was additional downside first and it took some time.
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