A week ago I posted the market was showing vulnerability and within 2 days the SPX dropped about 15 points. Obviously that decline was very short lived and here we are back to slightly higher levels. Well, I'm seeing even more cause for ST concern this time around. The same rydex indicator I mentioned last week is flashing the same bearish sign. Adding to this is the volatility crush we are seeing in the VIX and its siblings the VXO, QQV and VXN. Another warning sign is the continued deterioration in bonds. Take a look for instance at TLT. It's close to the same level we saw in June whereby equities topped and eventually pulled back about 7%. And finally another bearish sign today was the very low total put/call ratio reading registered today which came in at 0.60. The last time such a reading was registered was in late August whereby the market had made a short term peak and then pulled back sharply about 3% a few days later. Let's also not forget the unfilled gap that lies below us.
Bottom line: the market is running on fumes here and is in danger of correcting again. As I've mentioned repeatedly, ST bearish signals in a strong bull market don't always bear fruit right away (especially during this unique seasonal period) and sometimes they bear no fruit at all. So, if you play the short side here or hedge, don't go whining like a bitch about Goldman Sachs propping up the market if things don't go your way. One thing's for sure is that it's definitely not a good idea to add beta here unless your holding period is measured in minutes or hours. Any further run up from here no matter how impressive is very likely going to be a false breakout and will get completely retraced and then some if we continue to see this "poor" market action i.e. collapsing VIX, low put/call ratio and weakening bonds.
I should have paid more attention in economic class for sure. But what do you mean by weakening bonds?
ReplyDeleteAre you saying there is not enough participation in the bond market causing the yield on the 10-year and 30-year to steepen a bit too much?
And how does that tie into the stock market?
rising bond yields are negative for 2 reasons. 1) they make equities less attractive on a valuation basis given that they compete with them for investor dollars
ReplyDelete2) mortgage rates are highly correlated to rates in longer term government bonds and so as bond yields rise mortgage rates tend to rise as well (there's other factors too) which obviously puts a braking effect on the economy given that it reduces the demand for debt.
Bond yield behavior is a bit of a tricky indicator. When they are very low it could signal a deflationary downward spiral which is bad for corporate profits and hence stocks. Therefore, a surge in bond yields from very low levels (like we saw earlier in the year) is actually a postive sign because it indicates that economy is inflating again or is set to do so in the near future.
But when bond yields surge to high levels, it could result in the choking of economic activity which is obviously bad for stocks too. Therefore, they need to be at the "just right" level. The question is what is "just right?". Who knows...but what I do know is that rapidily rising bond yields like we are seeing now tends to be a short term negative. I don't think we are at dangerously high levels yet overall but again, spikes like this tend to be a negative for equities in the ST but it's not the only thing I look at....it's more of a supporting indicator....i.e. if it confirms the message of other indicators then it gives me more conviction.