Buy the Bounce?

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The market pulled back yesterday to those support areas and looking at this morning’s pre-market futures it looks like we are going to bounce and rally back. This rinse and repeat scenario can lead us into a false sense of security, in which we expect to buy every dip to ride the market higher.


Buy the bounce?

We can’t myopically focus on one stock or even one index in making a decision to buy the bounce. It is far too easy to be sucked into headlines or listen to CNBC which in many cases talks in broad strokes.

From the big picture monetary policy, nothing has changed. While “officially” QE has ended, it hasn’t really. The Fed continues to buy mortgages (MBS), bonds, keep rates at zero, and the monetary supply continues to remain elevated. This uber-easy monetary policy continues to fuel buying and borrowing, especially is the financial markets, as interest rates are low.

Stall?
Recently the market rally has seemed to have stalled. The closely watched Dow Jones opened the year around 17,850 and here we are today at 17,850 area. We have made repeated tries to break up above the 18,100 to 18,200 level, to no avail. The recent support/floor is in the 17,600 range, which we could get to and we may also make another attempt to break up above the 18,100 level. The other indices have similar patterns, only the broader Russell has done better since January, until yesterday.

Earnings Season
We are in earnings season and depending on who you listen to, this is either a strong earning season or there is weakness. Of course this depends on how you measure. If you measure solely from the bottom line (Profits or Earning Per Share – EPS), there have been some big beats. However, if you measure from the top-line (Revenue), it has been rather disappointing as we have seen a decline. Normally weaker top-line revenue is a huge alarm bell, indicating a slowing. Yet we need to take into consideration the strong dollar, which has impacted REVENUE on foreign earnings. The strong dollar has certainly played a factor into the earnings cycle, both top and bottom line. Thus we need to be careful in being far too cautious about the weaker revenue numbers and understand who much of an impact the dollar has had. One other factor to measure is sales (number of units sold); if this is stronger even it may indicate that top-line revenue is more impacted by the strong dollar rather than an actual loss in revenue.

While oil has made a run higher and that too has certainly impacted the cost structure, I don’t see a significantly strong rally in commodities to warrant a major concern on margin squeezing – yet! I say yet, because commodities continue to be a lager at this point, primarily due to the Fed monetary policy and now stronger dollar.

Best of Both Worlds?
We have what SEEMS the best of both worlds, zero interest rates and a strong dollar. Who could have imagine, if there was ever a combination to jump start an economy it would be free money that has strong buying power. While that is certainly tantalizing, it is also a hyper-addictive fuel injection that we can become easily numb to and it can lure us into a state of euphoria. Who knows how long it could last and if we can keep focused; we can certainly take advantage of it. However, we need to prepare when it is taken away.

The Fed talks about taking away the addictive drug of easy money, but I don’t think they will anytime soon. It is not part of their socialist-Keynesian nature, I also don’t think they have Volcker size cojones to do the right thing, if it means they become hated and blamed for an economic stall. Yet, if we continue to prolong this easy monetary policy, there will come a day in the near future where it will not be a choice of the Fed, but rather a force majeure in which austerity is forced upon us.


Prediction

I think we COULD be lining up for a correction if the following stars continue to align.

1. Dollar index (DXY) is showing weakness after a strong rally. If we see it break below 95 with any momentum, it will curtail buying power and could force in some margin calls.
2. 10-year yield pushing up above 2.2% could mean a lack of confidence in long-term easy money and a general feeling the Fed will be raising rates, which will trickle over into the equity markets.
3. Commodity rally. Oil is already pushing up against $60 a barrel. We haven’t seen the broader commodities rally – but any stronger move in commodities will crush margins.
4. Europe/US credit ratings – we have seen a couple more downgrades in debt. Chicago is having serious problems and few other places are kicking the can.
5. VIX gets below 12 and investors become too complacent and less concern – as we are lead to believe to buy every sell-off, because we believe it will be a bounce.

We are not there yet, but there have been some moves in the equity market and other signs that are showing there is a stronger possibility that the stars may align.

Fed Talk
Regardless of what the media or even the Fed says – I don’t think the Fed will become Hawkish anytime soon. In fact I would be surprised if we got a rate hike at all this year. We also have the 2016 election coming up and Obama can’t afford to let the economy stall if the Democrats are going to keep the White House. Remember, he has appointed every Fed governor and they are all of the staunch Keynesian nature. Not a single real Hawk among them now.


Courtesy of wikipedia

But if these stars align that brings selling pressure to the market, what will the Fed do? They are already running zero interest rates, they are already buying government bonds and mortgages, there is not much more they can do – unless they want to CONTINUE to follow in the footsteps of Japan. The next item would be to take rates negative and/or actually buy into the US Financial markets (perhaps S&P futures or something similar). Japan has done both already and to think we will not CONTINUE to follow in their footsteps is being blinded by recent history. Of course there is always more stimulus.

Time to buy Gamma!
I am not saying to sell everything you own, but with the VIX in the 13 range it would be wise to hedge positions and for those that want to ADD a bearish bias to an already bullish position, you can always over hedge. Premiums (VIX) is telling us that this is just a support level and we are going to bounce. The pre-market futures are already confirming that bounce. So perhaps everything I think or say is for not, but word to the wise – not everything is at it seems.


Support & Resistance

INDU 17,800
We bounced and now we could be on our way to try to make another attempt at 18,100. Futures are up in the pre-market.

NDX 4400
I would look at 4400 as short-term support, we crack down below 4450 and could make a run if the index gets back above that level. Expect some volatility – it’s earning season and we have seen some big moves in the stocks that make up this tech heavy index.

SPX 2080
The quick visit to 2080 saw us bounce back-up into the close. The pre-market futures are looking stronger and if that remains I think we could see the VIX fall back into the “no-worries” 13 range again.

RUT 1220
This seems like a broad support area and we could run back up to 1240. I would start to look at resistance at 1240-1250. Keep watching this index; it is the primary index to watch general market order flow. If it ends the day down, even if the other indices are moving higher – that to me is a warning sign for next week.


I don’t want to alarm everyone, but we are getting some initial indications that without further massive government intervention to keep the cheap money flowing and to expand margins – we could be in for a correction.

For the first time I think we are starting to see REAL signs of bubbles, rather than just presumptions. Volatility is starting to get low and everyone seems to be turning into bulls, even some of the most ardent bears.

2 Responses to “Buy the Bounce?”

  1. McRocket says:

    Thanks for this – for what incredibly little it is worth, I agree with your conclusions of a correction.

    The DOW has been basically for five months now and it seems clear to me that it cannot realistically go much higher without Fed stimulation.

    Btw – with the JApanese central bank buying ETF’s and seemingly intent on buying stocks once all the ETF’s have been purchased – do you think the Fed will eventually go down that path (direct ETF/equity purchases)?

  2. McRocket says:

    Jeez – I wish this blog had an edit button.

    I meant the DOW has been basically flat for about 5 months.