August 30th, 2011
In the July 20 issue of Macro Tides we presented the chart below with the following analysis. "It appears that the S&P is tracing out a 5 point triangle, as denoted by the A, B, C, D, and E on the chart below. While not necessary, there may be one more dip below Monday’s low at 1295, before a substantial rally above 1,370 commences. If this analysis is correct, the S&P should not close below 1258." In the July 31 Special Update, we said, "If the S&P drops below 1,258, it will likely drop under 1,200 in short order, before a rebound develops."
After the S&P closed below 1,258 on August 2, we moved our managed accounts 100% out of the market on August 3. The S&P plunged 54 points on August 4, dropping below 1,200 in the process. Although we were wrong about one final rally above 1,370, we were right in understanding the importance of 1,258 on the S&P. Sometimes knowing when we are wrong is more important than being right. Our recommended purchases of the S&P 500 ETF (SPY) on June 13 @ $127.89, and on July 29 @ $128.91 was stopped on August 3 at $125.00.
Our investment model suggests that the secular bear market that began in 2000 has resumed, and the cyclical bull market from March 2009 has ended. We will note that the model dipped into bear market territory between June and August 2010. The market then held, and reversed higher, after the Federal Reserve indicated that it would undertake QE2. Our model turned bullish on September 3, 2010.
Chariman Bernanke made the QE2 announcement in a speech at the Federal Reserve Bank of Kansas City‟s Economic Symposium in jackson Hole, Wyoming on August 27, 2010. Coincidently, this year‟s symposium is being held on August 26. We suspect investors will be hoping (praying?) for a repeat performance. The anticipation of his speech may help the market to hold up until then. If you didn‟t do some selling when the S&P broke 1,258, we recommend selling into any strength in coming days. After a breakdown, the market will occasionally return to the "scene of the crime". In this case, that would be 1,225 - 1,250.
We think it is unlikely the Fed will begin QE3 so soon, which should prove disappointing. We expect the S&P to fall below its recent low at 1,101. The low in March 2009 was 666 on the S&P, and the peak of the cyclical bull market was 1,370. The 50% retracement level of the rally is 1,020. The range between 1,020 and 1,050 should provide some support.
Given our negative outlook for the U.S. and global economy, we think the Fed will be pressed to eventually undertake QE3. Our guess is additional weakness in the U.S. economy, a break down in the European banking system, and lower stock prices will act as the catalyst.
We expected the yield on the 10-year Treasury bond to remain range bound, between 2.6% and 3.65%. In the June letter we noted, “If the economy grows as slowly as we expect in the second half, and the risk of a European debt crisis remains visible on the horizon, there is no compelling reason to sell Treasury bonds.” The resumption of problems in the European Union, and the breakdown in the stock market, caused the 10-year yield to break below 2.6%. It subsequently fell to 2.03%, which matched the low in December 2008. The decline in bond yields was all the more remarkable, since it happened after S&P lowered the credit rating of the U.S. As long as the yield is below 2.7%, we view it as a warning sign of further banking problems in Europe, and economic weakness in the U.S.
In our May letter we recommended going long the Dollar via its ETF (UUP) at $21.56, and in June recommended holding the position. In our July 31 Special Update, we suggested adding to the UUP position below $20.91, which was triggered today, August 17. Use 20.74 as a stop.
In the June letter, we suggested aggressive traders establish a small short position at $1,550, and add to it at $1,587.00. The stop at $1, 648.50 was triggered.
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Macrotides is a monthly subscription newsletter written by a wealth manager associated with a major Wall Street investment bank. The author’s firm has requested that he not use his name to avoid any incorrect implication that his views might reflect those of the bank. The author has written investment advisory subscription newsletters based on macroeconomic analysis and market technicals for more than 20 years. Enquiries can be made at firstname.lastname@example.org.