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As reality quickly dismisses the holiday optimism that swept through markets last week, equity indexes are paring their gains and looking lower to reprice risk. The Yen is especially strong today as the carry traders give in to fear. This is likely the beginning of the next selling stage as outlined in my articles from last week. If I am correct, I expect we retest the 741 intraday lows and possibly break down below to the 600 area in the coming weeks and months.

Examining a longer term chart of the S&P 500 confirms that we are still in a falling wedge pattern, despite recent gains. Should the rally give way here, many traders will begin selling in to the weakness.

We could see the S&P climb as high as 900 without fundamentally violating this pattern. Support areas are shown with horizontal lines on the right side.

Why have we witnessed four up days of trading that rocketed from the lows of 741 to nearly 890 on the S&P 500? Is it the start of a new bull market? This would be a very pleasant scenario, but bear market rallies can last days or sometimes even weeks and months. The most violent rallies, like those as of late, are generally short lived. The last time the market was up four days in a row was April, 2008.

How are bear market rallies possible?

Lately we’ve seen anything from government appointments to bail outs of multinational banks significantly lend to positive momentum. This is quite a contrast from the traditional inspiration of good earnings or economic data.

Bear market rallies are not created by investors buying to commit capital in to a stock for the long term, but instead by short covering and trading. The short term horizon of the participants and the lack of fundamental positive catalysts usually lends to these rallies collapsing to worse levels than they had climbed from, rather than a constructive bottom forming process.

When will we see the bottom?

A) The worst must be over: House prices are still dropping, unemployment is rising, consumer sentiment pushing all time lows and credit availability is tight. There is likely another leg down coming in both commercial mortgage backed securities and consumer credit card defaults.

B) There must be a positive catalyst within sight: Green energy has been promised to be the next bull market. Is there demand for these measures when oil is at $50 a barrel? The other question is, after committing half of last year’s GDP to financial bail out programs, how will the Federal Reserve and US Government continue to finance their spending? More importantly, will foreigners continue to lend to a less credit worthy nation?

C) The Federal Reserve must complete lowering rates and change to a neutral or tightening bias: The next Fed move will likely be another rate cut. To Bernanke’s Fed, deflation is still a bigger threat and he has the helo running full time dropping cash. Until this reactionary behavior is over, there is no sign that we are out of the woods.

D) Businesses must begin buying back shares: Many buyback programs have been halted, not accelerated. We have not seen corporations step back in and buy back their own shares. We also haven’t seen many insiders provide substantial equity commitments in their companies as of late. This is an important component of building a sustainable bottom.

E) Risk indicators must begin to show signs of significantly decreased aversion: The Japanese Yen, crude oil, one and three month T-bills (and lately even the long bonds) have all shown us that the flight to quality and away from risk (or growth) remains. The VIX is still above 50 and has major support at 45. Even gold prices are back above $800. Fear still seems to be a greater motivation than greed.

What are the charts saying?

The above S&P 500 chart is not confidence inspiring. The trend lines illustrate the wedge patterns and the horizontal lines show major resistance areas.  Currently the stock market is bumping in to major resistance. My indicators confirm this rally is overbought and due for a correction soon. 

Where are we heading next?

Based off the above analysis, I don’t feel this rally will get much above 900. Instead, we need to retest the intraday low of 741 on the S&P in the next few weeks.  There will probably be support areas on the way down at 875, 850, 830, 800 and 776. If the 741 low doesn’t hold, 600 is the next level of major chart support.

If you’ve made some money on the rally, don’t fall in love with the upside.  Remember that we still have a lot of problems to work through.  Folks with investments should use this as an opportunity to raise cash. If you’re looking to trade this rally, you may want to begin adding to short positions.  FinViz.com has some great tools for screening stocks if you use technical analysis to find your trades.  Good luck and stay safe!

With a week full of potentially sour economic data and political uncertainty, the market may be poised to resume its downtrend and give back much of its gains.  See our chart of the S&P December 2008 futures:

The chart above shows the potential for the downtrend to resume as the futures have considerably weakened off their overnight rally, which retested Friday’s highs.  We have had a week of mostly gains, with back to back up days.  In this kind of bear market environment it is doubtful that the rally can last too much longer.

Coordinated efforts to stablize global markets are now underway by various international economic industrial and emerging powers.  Futures are up 3% in anticipation that this will increase investor confidence.  We may see an interim bottom formation as a result.  Watch closely and trade carefully.

After yesterday’s record-making sell off of equities, we see US futures rallying about 3% premarket today.  That’s less than half of what they lost yesterday in value, but it is an impressive gain.  I don’t think it will last, though.  We’re still in a bear market where rallies should be faded and this is no different.  Watch for weakness midday.

Looks like the equity markets in the US are continuing the global sell off.  I doubt any legislation will patch up the hole left by the implosion unregulated OTC derivatives.   On the S&P 500 December futures contract (ES), my system shows 1176 as Support 1 and 1162 as Support 2 for today.  The pivot is coming in at 1198 and R1 is just about 1213.  This gives us a very large trading range for today, but really only room to sell off to as low as about 1150 (near the September lows).

Risk aversion from overseas is increasing as we see the carry trade unwinding dramatically from a high of near $107 overnight to $104.80 now.  The flight to safety of gold and bonds continues as equity investors are being punished for holding the lowest quality paper of the corporate capital structure during this crisis.  Gold is testing the key $900 resistance level.

With the global economy poised for a recession, it is no surprise that energy prices are dramatically lower on the day.  Oil and natural gas are off over 5% as traders speculate energy usage will contract and inventories may grow.

The now familiar weekend bailout is once again underway. The Congress is approaching an agreement, which is ultimately less awful than Paulson’s completely ambiguous blank check, but still not ideal.  If passed, the temporary boost of confidence could cause global equity markets to rally in the short term, but reality will catch up as the global recession looms.  I don’t think we’ll see anything but lower highs in the S&P, but we could see a 200DMA retracement.  Watch key resistance levels around 1250, 1275 & 1300 on the S&P.  If 1300 is broken, watch the 200DMA as resistance and look to build short positions if it is unsuccessfully tested.

We will probably see the bill pass by the weekend and with it will come a short term renewal of confidence that may boost equity indexes back to important levels of resistance at the 50, 100 and 200 day moving averages.  Overall, this is very bad news for the average citizen and their children who will foot the bill of the worthless paper that’s traded for cash.  US debt may face a downgrade as a result, causing further disruptions in credit markets and weakness in the dollar as foreign investors seek to diversify their money in safer investments.

Wall Street would have us believe that the rally is going to last, the bottom is in and today’s action with the Dow up at the high around 300 points shows us that certainly there is some positivity around the notion that the government will be the universal backstop to bad debt and other associated instruments.  Meanwhile, Washington Mutual’s stock is plummeting 30% at the lows of the day as the company struggles to survive.   If no one buys them, they will surely fail and cause another massive disruption.  Isn’t Washington Mutual the last savings and loan bank that has public stock?

We see equity indexes behaving as though the carry trade is back in full effect now.  As the Yen weakens against the  US dollar, we see funds pouring in to the S&P futures.  It’s a simple way for the Japanese central bank to support American market stability, while at the same time positioning their exports to be more attractive to American consumers.  Everyone wins, right?  Not if the rally is predicated on the notion that relief is within reach, which as of now it seems to be.

Remember that the SEC’s short selling ban expires October 2st and nearly 1000 companies will be open game for short sellers again unless the SEC creates new policy to address short selling.   October also brings the height of the ARM option loan resets to higher interest rates.  We could see a large spike in foreclosures and further deterioration of mortgage backed securities. There’s also the fundamental question of where valuations should be if we do return to a stable market.  Most traders would probably agree that given the deleveraging necessary to return to sustainable balance sheets, asset values are poised for further deflation.

We’ve seen bonds outperform nearly every other asset class, as the flight to safety has been fast and furious.  The short end of the yield curve is yielding 0.335%, which is actually up from the lows of the year.  The TED Spread is at record high levels, showing the stress in the credit markets is exacerbated by the uncertainty surrounding the corporate welfare bill for financial companies.  The current trend in equity indexes is lower with no sign of abatement.  Most emerging markets have been deeply affected, with China down 60% from the peak of last year to the trough of this year’s lows.  Russia’s financial crisis worsened to the point where the markets were shut down for days and in India and Brazil we’re seeing inflation continue to plague the central bank policy, causing an abrupt departure away from steady growth.

The world is in limbo right now.  Are we going to let institutions fail as capitalism would demand or will we socialize the entire free market in favor of stablizing a fearful world in the aftermath of the biggest asset inflation bubble in world history?  While the US Congress debates these issues the markets are deteriorating, as they should, given the uncertainty that forward-looking traders and investors have to factor in every day.

Right now we are on the precipice of the greatest global financial crisis the world has ever seen.  Most people are beginning to wake up to that.  We’ve seen some liquidation of mutual funds in retirement accounts, money markets become unstable because of Lehman’s collapse and AIG, the world’s largest insurer, have to be taken over by the US Federal Reserve Bank, because of balance sheet insolvency from “mark to make believe” accounting practices.  While legislators debate what implications this bill may have and how to oversee it prudently, I fear that this is by far the worst approach to solving a problem that stemmed from bad risk management and greed.  You cannot bail out the biggest banks with debt that is created out of borrowing at interest from the Federal Reserve and expect the problem to be eased.

Every government and Fed bail out so far and in the foreseeable future relies off of using public funds to bail out private sector mismanagement of capital.  Suddenly the entire financial sector’s balance sheets are reminiscent of Enron and we’re celebrating this by rewarding their worthless paper with billions of dollars from an already heavily debt-burdened Treasury balance sheet. We can’t expect this one to be any different.  Sure it may address short term credit market confidence issues for just enough to get us through another quarter, and to a new elected government in 2008, but it is not a solution.  It is a bandage on a gaping axe wound.  Eventually limbs will have to be lopped off because the infection wasn’t handled by Dr. Ben.  This is what I fear is next.

Instead of stemming the risk taking, the policies suggested and enacted thus far have actually created the opposite effect.  We give banks easy access to cheap capital as the Fed cuts rates, the dollar weakens and all of these banks target commodities as an investment, instead of putting the money to work back in the US economy.  Of course their argument is that they have a fiduciary responsibility to generate capital for their investors, and that allows them to operate in a completely apathetic manner towards the overall wealth of America.  Instead, they invest in metals, energy, grains, etc and the rally is the biggest and boldest in decades.  It was no coincidence that when credit became harder to access, hedge funds started imploding and the banks that benefited from the rally on the way up started taking profit or reversing positions while the economy slowed down, that the rally completely ceased and reversed.  The correction, like the rally, was the unprecedented in its scale and veracity.

In the midst of incredibly expensive short term capital, market participants that relied off leverage to create profits are imploding left and right.  Many models, like the ones employed by Bear Stearns, Lehman Brothers, AIG, Washington Mutual, Wachovia, etc. will not function in a world where confidence has eroded because of excessive greed and terrible risk management.  Many smaller boutique firms that receive less media coverage have also been facing redemptions, funds have been closing down at an alarming rate.   At the end of the day, there are less market participants and those remaining have less capital to employ strategies.

Many elements of the market system are changing very fast.  Be careful trading.  The risk hasn’t been higher for a long time.  Short term strategies seem to be the most feasible, but keep your eyes glued to your terminal!  I’m keeping my portfolio in cash with occasional conservative short term trades when the opportunity presents itself.  Good luck!

Be ready for a surge in natural gas prices as speculators enter natural gas during what is shaping up to be an usually cold week in November.

Should this trend continue, natural gas may start to catch up with the momentum crude oil experienced as traders shift out of that expensive trade and in to the more fairly valued natural gas plays. For more information on natural gas, see the Moo Natural Gas Center.

UNG is poised for a rally. The three month chart suggests that the seasonal uptrend in natural gas is about to begin. UNG has broken out of its 50 day EMA and if this trend continues based on seasonal demand, storms damaging equipment and other factors, we’ll likely realize at least a 20-25% appreciation in value up from this $40 range that UNG is trading at. In addition, natural gas futures contracts are trading at a curve that suggests a generous appreciation in value. This suggests that investors believe natural gas will appreciate in value over what’s expected to be a bitter winter.

  Gold is outperforming the market by a large gap now. This is expected to keep up until gold potentially reaches $800/oz levels based on increasing US dollar weakness, fear driving traders in to safe assets (gold, bonds, etc) and away from stocks.

With the housing recession potentially spreading to other sensitive sectors, we see the potential for an economic slowdown being exacerbated by the ever weakening US dollar. Gold, which is a traditional safe haven in times of crisis and fear, is gaining strength. December 2007 futures are trading over $710/oz up from a low of $655/oz only several weeks ago. Traders that were short gold futures have covered or reversed positions and investors have been buying gold in large volume.

I would recommend buying gold on any weakness going in to the end of the year. We’ll see the dollar continue to weaken further, especially if the Federal Reserve cuts interest rates. This will cause traders to reprice gold higher accordingly.

Good luck trading!

Home builders have had a very rough run lately. It’s probably not over by a long shot either. Those engaged in the industry generally understood that residential real estate was overbought and inventories would eventually grow very large if building kept on pace. These same builders kept building at the same pace, all the while creating an astronomical number of unsold developed properties in their portfolio.

With the credit crisis stifling mortgages and home sales, these builders are in a very risky position with portfolio’s full of unsold homes that are now depreciating in value by the day. Without substantial rate cuts, the housing market will likely not rebound for a few years. This will force many home builders to sell their inventory at a discount and others to declare bankruptcy. It may be a good time to watch ITB (see below chart vs. CFC) and consider shorting it.

I’ve charted ITB against CFC because I believe they follow a very similar downward trend without support. CFC is guiding even lower and ITB is likely to follow as the situation worsens throughout 2007. Traders may want to short ITB and go long gold, US treasury bonds or Euros for a potential recession hedge. Good luck!

This morning, with tremendous support from the US futures, European markets and gold, the world optimistically awaits the Federal Reserve’s speech during the conference on housing and monetary policy in Jackson Hole, Wyo. at 10 a.m. EDT.

Currently S&P futures are up about 1%, gold is up about 1.5% and the German DAX is up 1% all in anticipation of good news.

Why is the world optimistic about this? Let me present a few views:

1) President Bush has stated he will expand the government’s role to deal with the subprime mortgage credit crisis.

2) Ben Bernanke is expected to at least give traders and investors clarity about his views on the economy. There is also (somewhat irrational) speculation that Dr. Bernanke will give indications on his Federal funds rate policy decision at this speech.

3) Bond rates indicate traders expect a rate cut in the short term.

4) A lack of volume because of the upcoming holiday makes the US market very volatile.

5) The weakness of the Yen has lent strength to US markets as the carry trade may be winding up again.

All of this is important to consider today. What does it mean?

If the Fed speech gives no clear indication of policy or interest rates we may see market weakness. That market weakness may be exaggerated to the downside because of the low volume. This weakness may be temporary, as President Bush will be speaking around 11AM EDT regarding the subprime mortgage credit crisis. It will be very important to watch bond yields and the Yen today for signals.

Alternatively, if Mr. Bernanke gives the market a high degree of transparency in his speech, and it gives markets the indications it wants to hear about a rate cut, we will absolutely see an unprecedented rally.

My advice? Watch and wait. If you are an experienced trader you may want to trade the speech.

We saw gold drop $14 this week, gold stocks were punished and the market showed a lot of fear and trepidation. With such volatility, you might ask, why do I think gold is good? It’s simple.

That’s right, simplicity. That makes an asset attractive. For the past two years gold has outperformed the S&P 500, Dow Jones and NASDAQ.

If this isn’t enough for you, however, you should note a few very significant facts:

1. Gold trades in US dollars. That means when the dollar is weak, gold is strong. The dollar has strengthened recently because of a “lack of liquidity”. Liquidity usually refers to US dollars flowing in and out of different equities and other asset classes. When it dries up, that means there are less “dollars” (whether in hard or soft form) in the system. This creates a temporary boost in the value of the dollar and temporary weakness in gold.
2. India and China are now the world’s largest consumers of gold and their appetites are likely to keep expanding. This creates more demand and pressures the supply, thusly raising prices.
3. Gold is the world’s oldest asset and is only gaining in popularity and probably the world’s most liquid asset.
4. Hedge funds bought gold as an appreciable asset, not fully understanding the implicit lack of hedging this creates when other funds mimic the same behavior.  Gold was oversold this week because of investors having to cover their losses in other assets by selling their profitable investments.

Gold is now ready to rebound and it closed today bullishly up $9.70 in to the weekend, indicating investors are willing to stay in their positions. Gold stocks rebounded positively as did the precious metals indices. The overselling that occurred mostly to cover losses is over and the bargain buying has already begun.

The next step is for the Federal Reserve to cut interest rates in September (or sooner). Once this happens, the dollar will further weaken because of the increased availability of credit (which is essentially virtual money flooding the system). This weakening dollar and increased availability of credit encourages investors to flock back towards gold, stocks and other oversold assets.

It may just be time to buy some gold ETFs (IAU, GLD), futures or stocks (AUY). Have a Mooriffic weekend!

It’s important that every investor realize that we are not limited to stocks, mutual funds, ETFs and bonds. There are other asset classes, such as commodities and currencies (forex) that offer profit, too. Trading anything requires consistency and a system to be regularly successful. The same systems that analyse stocks are applicable to intraday trading of foreign exchange futures.

Remember that this is a very speculative play that requires sophisticated technical analysis skills and an established system to successfully trade.

The first system is bottom trading a downward trend (note that the EMA is moving downward). That means, if we see the Euro become “oversold” (or if it’s sold on very high volume, and dips below the lower Bollinger band) it is likely due for a technical rebound upwards. Because of the weakness at this point, I only hold the Euro until it peaks the EMA and sell the futures contracts there. This is a bullish sign, but it’s also a point of resistance.

The second system is momentum trading. I trade the upward trend, purchasing futures contracts as it moves above the moving average, which you will notice is establishing an upward trend (notice upper/lower bands). As the Euro crosses below the EMA again and the bands begin to widen indicating increased risk, I sell.

Gold trades myopically based on fear and greed, generally not taking the larger picture in to consideration (long term: weakening dollar, US economy slowing, inflation growing). As such, opportunities arise to exploit fear and greed to yield a high profit.

As you can see in the image below, gold oversold based on fear this morning that the market would collapse based on credit concerns. I bought here $675.00 because I felt gold, being down about $20 from the day before, was oversold.

As you can see, it quickly rallied to $686.00, where I sold, because I felt the rally was overdone by traders relieved by the Federal Reserve injecting $19B in liquidity to banks suffering from a lack thereof.

That’s basically how the fear/greed trade works. This is a single trade that can span minutes, hours, days, weeks, even months and years depending on your strategy and outlook.