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Friday, 16 May 2014

The Great Brain Robbery

The decline yesterday was dramatic, but not sufficiently dramatic in my view that we should now assume that the spring high was made on Tuesday. Bears will need to follow through and close below 1850 SPX before that assumption can reasonably be made.

I'm just looking at SPX and bonds today but I will just mention that the low on RUT yesterday was at 1082.53, still in the lower range I gave yesterday morning for a possible bullish recovery, and that NDX didn't break rising support from 3414, though it came very close to testing it. There is a strong argument that this decline has limited the scope for further upside however, and if we should see a strong recovery from yesterday's lows then I would mention that something often seen at significant highs is a sharp spike down before the main slightly higher high. This is a common way to set up a double top.

On the SPX 60min chart the 50 hour MA was broken yesterday morning and then the breakaway gap at 1878-80 was filled. That kills off the idea that a new impulse move upwards had started with that level as the breakaway level for the move. The next level of support is the last low at 1859.79, and then rising support from 1737 in the 1850 area, which is now key uptrend support. If we see a bounce today I would put my bull/bear level at 1878-82, as that would be the retest level for broken rising support from 1814, and also the likely range to break back over the 50 hour MA, which closed at 1882.70 yesterday and is currently declining. SPX 60min chart:
No real damage has been done on the daily chart as yet. The daily middle bollinger band was broken, but that isn't bearish because SPX followed through to test the daily lower band. The low was two points higher than the lower band and I would score that as a technical hit. There was a pinocchio below the 50 DMA, but SPX recovered back above it before the close, and you can see from the chart below that  there were similar pinocchio/recovery candles at both the 1850 and 1859 lows, both of which were followed by strong rallies to higher highs. As long as SPX neither opens nor closes significantly under the 50 DMA it is still unbroken support. SPX daily chart:
Yesterday was a very significant day on bonds, as we have reached an important inflection point that I have been watching for since calling a breakdown and short opportunity on TNX on 7th January (at 29.61). You can see that post here, and the TNX chart I posted that day here. I was looking for a move to test possible double-top support at 24.71, and the low yesterday was 24.73, so that double top support is now being tested. If we see a break down through double-top support then the pattern target will be 19.06. TNX weekly chart:
On the TLT projection I did at the same time, though not posted then, I was looking for a move to broadening wedge resistance and after four slow months of inching towards that it was reached and very slightly broken yesterday. I'm leaning towards a break down on TNX and break up on TLT here, and if we see that I'll do another projection for the next few months. That may not be quite as accurate as my January projection which was so close in price and time that I never even had to adjust the arrows. TLT daily chart:
This move on bonds was easily predicted from the pattern setups and (duh) looking at what happened to bond prices and yields at the ends of both QE1 and QE2. The move itself has been slow and frankly rather boring, but what has been very interesting is what it has shown about the enormous strength of the almost universal belief that QE depresses bond yields.

There is some reason for this belief. It makes sense that the Fed buying lots of bonds would boost bond prices and depress yields, with an expectation that would be reversed at the end of the buying period. Furthermore we are told often by the Fed that QE depresses bond yields and that the end of QE might trigger a dangerous rise in bond yields. It all hangs together well and is backed up on a daily basis by talking heads talking about this relationship as though it was a known fact.

The trouble is that as soon as you actually look at the data, it is obvious not only that there is nothing to demonstrate such a relationship, but further that the price moves in QE1 and QE2 are very strong evidence of the opposite, that QE historically has boosted bond yields and depressed bond prices. Why is this the case? Hard to say, and I don't generally pay much attention to fundamentals, but perhaps because Fed intervention in the bond market is more than cancelled out by non-government investors exiting the market, and there is an obvious rationale for that. If there is truly a multiplier effect from Fed bond purchases that disproportionately drives/attracts buyers into equities from other sectors, then perhaps many or most of those new buyers of equities come out of the bond market,  which would then depress bond prices and boost bond yields. That may not be the reason but that would be logical.

What is clear from this powerful belief is that very few analysts have troubled to look hard at the data, and the consensus view on bond yields has been so entirely wrong over the last few months that the very few analysts actually basing their forecasts on the data have been regarded as crazed voices in the wilderness. The reaction to my bond forecasts over the last few months has been better than if I had suggested that the Fed was being run by reptilian aliens and that QE was an alien plot to bankrupt the world in order that the human race could be farmed for food, but not an awful lot better. I have had quite a few people point out to me that I must be mistaken because everybody knows that bond yields would rise as QE3 tapered off, and then seem uncomprehending when I replied that there was no actual evidence to support that belief.

This belief has also been strongly supported by the Fed, but that doesn't mean that the Fed were lying. More likely they were also relying on analysts that weren't checking the data, as almost everyone seems to have been doing. Everyone assumes that the Fed must employ competent analysts but there's not much to support that view from their forecasting record. My own view is that people just assume that the Fed know what they are doing because the alternative is just too scary to allow them to sleep easily at night. That too fits the historic data somewhat better.

Anyway, just in case there are any huge bond funds reading this post, then I would add that I have called all the big turns on bonds correctly over the last few years, and can demonstrate that easily from my blog archive. I'm a busy man but in the event that I was offered highly lucrative consultancy work forecasting future bond moves then I might well be able to squeeze that into my schedule :-)

As for SPX today bulls need to hold the last low at 1859.79, and that should hold if we are to recover to new highs. If that breaks then very important trendline support is in the 1850 area, as well as the 1850.61 low. If we see a close below those then my view would then be that the spring high was most likely made on Tuesday, and the next obvious target would be at 1814.

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