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I’m no fixed income expert, let’s just get that clear off the bat.  But I’m no fool either, I’ve studied and learned from the best in the game and if I know anything I know that the boys on the credit desks have higher IQs than the hustlers on the equity floor.  It’s funny, at some firms (cough cough Lehman, cough cough Bear) the fixed income boys don’t even speak to the stock jockeys!  I’ll save this rant for another day, but let’s just say my buddy who does risk management for Goldman’s dealings in the financial sector has the ear of both and isn’t afraid to lock them in a room together.  Goldman wins not just because they are the smartest sons of bitches on the street, they win because they work as a team, but whatever, moving on.

My point here is this, fixed income, and forex for that matter, often lead equities.  Large moves in bonds and CDS often telegraph large moves in equities.  I want to focus a little here on the micro aspect of how bonds have telegraphed moved is equities over the past few days.

The chart below shows the movement of treasuries (gold), high grade corporate bonds (red), and high yield corporate bonds (green) over the past five days.


The real selling in equities didn’t start until Tuesday but as you can see in section #1, treasuries and high grade corporates ticked up into the close on Monday along with selling in high yield.  This choreographed the quick slide in equities Tuesday morning.  Treasuries and high grade corporates continued to rally into Wednesday afternoon as equities were slaughtered, but something interesting happened Wednesday into the close.  As equities finished on the lows, in section #2 you will see high yield tick up hard into the close with treasuries and corporates selling off hard.  Once again, Wednesday afternoon’s action choreographed what was to take place Thursday morning as equities opened strong and stayed strong all day, closing at the highs.  But once again, high yield sold off into the close and both treasuries and corporates rallied as seen in the beginning of section #4.  Selling commenced in earnest today as high yield tanked again and treasuries and corporates caught a bid.  And yet again, into the close today we saw high yield tick up as equities closed in brutal fashion.  Treasuries also sold off into the close.

So what does this mean?  Well, if the pattern holds we should see another bounce on Monday.  Does this say anything about the larger trend in equities, no.  Is it an interesting little piece of info that you can use on Monday, yea.

Moving on…..

The GDP # on Thursday morning was complete bullshit, the government is fucking with the numbers, like normal.  I’m not one of those conspiracy theorists who believe our government is evil or has ulterior motives or what not.  But I know fudging when I see it, and the government has fudged so many numbers over the past few years that it’s laughable.  How many times have the job loss numbers been revised up?  Look, you may not be able to trust anything that comes out of the government anymore, a problem in its own right, but I still understand why they do it, I would too if I were in their shoes.  Just as in the market where buying begets buying and selling begets selling, the government is trying to cause a positive feedback loop by making everything look nice and rosy.  There was a negative feedback loop that took place last fall into the spring with housing and labor and equities and spending and housing and labor and equities and spending and……..you get the point.  So in March the government decided enough with this honesty crap, and took matters into their own hands.  Since then we have seen bullshit number after bullshit number, and guess what, it’s worked to some extent.  The financial system is no longer in danger of complete collapse, 500,000 people aren’t being fired every month, and people are out spending money again.

What’s the reality?  Companies aren’t hiring and continue to show zero growth on the top line, people have no money to spend because their unemployment insurance is running out, and housing prices are not done going down, you can bank on this.

So why do I bring this up, because it may be significant to how investors perceive the fed’s willingness to raise rates.  The reality is that the fed isn’t raising rates any time soon.  But if investors start to see what they perceive as a significant up tick in the economy, they may begin to think the fed is closer to removing the liquidity that has driven this equity rally.  Perception is reality people.  So we are left with this paradox, if people believe the government will raise rates because the economy is getting better, they will sell equities.  If people believe the government will keep pumping money into the system because the economy is still weak, the party continues.  That GDP number on Thursday was an upside surprise, which was immediately met with buying, but as you saw today, the market gave it all back, and some.  The reflation party may be over.

The US Dollar is in full control of this market, as it has been for months now.  But over the past week the $USDX has obviously changed its tune by breaking out of the down trending channel it had been trading in for quite some time.  I’ve said before, to get me bearish on the market I would have to see the dollar break its down trend hop above the 50 day moving average.  Well, we’re half way there.  The Dollar has definitely broken the down trend, but we have yet to see a clear breakout.  The short dollar trade is still crowded, and if we see a push above some important levels we could see some major destruction in risk assets.


What’s the other scenario?

We could see the $USDX roll back over and trade in a more neutral range for a while.  In this case equities would stabilize.  Either way, we’ve seen the lows in the US Dollar for a little while, at least 2 months in my estimation.  Out of this consolidation we could see new lows in the $USDX or a very important bottom in the dollar which would signal a long period of decline for risk assets.

So where do I stand longer term?  I don’t think we are going to see a huge surge out of the dollar and dumping in risk assets just yet.  My overall macro view says that deflation is going to take place again with real wages, housing prices, and consumer spending taking another leg down.  Always remember though, trade what you see, not what you think, the market doesn’t give a crap what you think and will abuse you for not being flexible.

It’s hard to do technical analysis on the VIX Index because it has no supply and demand.  What it does have though is the psychology of certain levels being important.  When levels that have been tested over and over again are breached, you better pay attention because it means the trend is changing.  We saw a monster trend change in the volatility index today as it broke through it upper 20 and 55 day donchian channels (highs).  The VIX also broke through the 200 day moving average.  All you have to do is look back to last September to see what happened when the VIX sent this signal, pretty obvious.  Will we see that kind of move again, not a chance.  Do you have to be aware of this breakout, yes.  This broadening triangle formation from July through October is also a prominent reversal pattern, the lows put in last week look like a final shakeout before the rally.

So where are we in equities?  At a very precarious point indeed.  If the market breaches today’s low over the next 20 days it will give me a sell signal (not a short signal) on large cap equities.  I’d say the system works pretty dam well getting you in at 96.12 and out below 103.44 from July through October.

For the record I have been pounding the table the past few days on the fact that this dip was a buy until Wednesday’s lows were taken out.  Well, I was wrong and the market has now kicked the dip buyers in the balls for the first time since July.  Congrats to those of you who got short, I am still crying a bit over not taking the short entry in $X, steel looks like it’s headed for the abyss.

Lastly, please watch this interview (via slopeofhope)

httpv://www.youtube.com/watch?v=wiYJfLZKRek&feature=player_embedded

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