Panic in the Bond Market, Did Bernanke Just Kill the Homebuilders?

By: Investment_U

Zach Scheidt writes: Stock prices for major U.S. homebuilders are under pressure as investors worry about higher interest rates. If you’re invested in these stocks, you should worry, too.

Fed Chairman Ben Bernanke indicated recently that the Fed will soon begin to reduce its $85 billion-a-month bond purchases, and end them all together by the middle of next year. The news sent shivers through the bond market, driving prices lower and pushing interest rates higher.

Higher mortgage rates clearly spell trouble for homebuilders. Homebuilder stocks have already started to decline in response to these higher rates, but they could have much further to fall. Let’s take a look at how vulnerable this group could be.

Panic in the Bond Market
To understand how the Fed’s actions could dramatically affect the homebuilder sector, we first need to understand the magnitude of the Fed’s influence on the bond market.

The artificial demand for Treasury bonds and mortgage-backed securities created by the Fed has propped up prices – and by definition, higher bond prices equates to lower interest rates.

Not only has the Fed been buying bonds, but the $85 billion monthly commitment has influenced other money managers to step in and buy these bonds as well. It makes sense for institutional investors to buy “safe” assets when the Fed has publicly implied that it will do what is necessary to support prices for these assets.

If you’re an institutional investor, whose job is tied directly to the performance of the securities you own, and you hear that the Fed – your strongest ally up to this point – is now pulling out of the market, what are you going to do?

At the very least, you are going to reduce the amount of new capital that you invest in Treasurys or mortgage-backed securities. And many of these managers are selling positions rather than waiting to see how far bond prices will fall.

According to the latest reports from Freddie Mac and Fannie Mae, yields on mortgage bonds have now reached their highest level since August of 2011. And this has happened before the Fed has done anything! All that has happened so far is that the Fed has announced that it might reduce its level of purchases later this year. Imagine what could happen once the Fed actually implements these new initiatives.

Trouble for Homebuilders
It doesn’t take too much imagination to realize how higher interest rates affect homebuilders. The industry is just getting back to a profitable state, after suffering huge losses in the wake of the collapse of the housing bubble.

Today, homebuilders are finally getting back to their old ways:

•Buying large tracts of property.
•Investing hundreds of millions in developing new communities.
•Building “spec” houses in anticipation of new demand.

All of this just in time for a rate spike that figures to dramatically reduce demand for new homes.

And if the interest rates weren’t bad enough, two other issues present significant challenges for the homebuilder sector.

•Employment is weaker than you think. Sure, the unemployment rate has been slowly declining for the last few years. But the quality of the new jobs being created is much lower than the quality of jobs that were lost, and wages are lower. The New York Times refers to this phenomenon as “the hollowing out of the work force.” Highly paid professionals are still pulling in very attractive salaries. And there are now jobs available for food service workers and other low-paying positions. But jobs for middle class workers are very hard to find.
•Rental rates are dropping in many major real estate markets. Rents had been increasing for several years because of demand from individuals who couldn’t qualify for a home purchase, making homebuying (for those who can qualify) more sensible. But private equity companies have spent billions buying up distressed properties, renovating them and leasing them. There is now a glut of rental properties on the market in many cities, depressing rents. The equation changes for prospective buyers as rents get cheaper and mortgage rates go higher.

Ancillary Businesses Also Affected
Investors should also be aware of the trickle-down effect that higher mortgage rates will have on industries that are directly connected to the housing sector. Specifically, I’m watching stocks like Home Depot (NYSE: HD), Lowe’s (NYSE: LOW), Williams-Sonoma (NYSE: WSM), Pier 1 Imports (NYSE: PIR), and other home renovation/decor companies.

If you’ve ever moved into a new home, you know that there are a myriad of shelves to be hung, furniture to be purchased, pictures and curtains to be hung, and more. There is a thriving industry built around consumers who are moving into new houses and “settling in.” (Not to mention the fact that Home Depot and Lowe’s have institutional contracts with most of the contractors engaged in building the homes).

The majority of these stocks connected to the homebuilding industry have rallied sharply over the last few quarters. You can find a good list of these companies by looking at the holdings of the SPDR S&P Homebuilders (XHB) ETF. Morningstar also has a helpful starting list of these stocks. Investor sentiment has been strong, but is now shifting due to the domino effect stemming from the Fed’s bond purchase decisions.

Take a careful look at your portfolio to see what stocks might be affected by a decline in the homebuilding industry. Consider buying puts or selling short in order to profit from a decline in homebuilder stocks and other stocks directly related to this industry.

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A Top-Notch Tool For Market Timing

by Tom Aspray

The debate over whether it is possible to time the stock market has been going on for years and will likely continue into the foreseeable future. One of the difficulties in assessing the merits of market timing is that some of the analysis that goes into the determination is subjective rather than objective. This can make the testing of a methodology quite difficult.

Another key factor is the time frame that one is trying to predict. In other words, are you looking three months out? Six months? Years? Of course, the most difficult are the short-term forecasts as to whether the stock market is going to be up or down the next week.

Occasionally, you can make these with some degree of confidence but often only just after significant turning points when a top or bottom has been determined technically.

One of the key tools that I use to determine the intermediate- or long-term outlook is the weekly, as well as the daily, Advance/Decline lines. I have written about their application extensively in the past (One Indicator Stock Traders Must Follow), and they play an important role in my daily and weekly analysis.

Tracking whether the NYSE Advance/Decline is moving with prices or diverging from them has been a valuable tool in determining bull and bear markets. Trying to determine whether a correction will last several weeks or several months is more difficult.

One indicator that I have found often to be very useful in identifying the end of market corrections is the McClellan oscillator developed by Sherman and Marian McClellan in 1969. Their son Tom McCellan has continued their analysis of the markets and is an excellent technician, who covers a wide range of markets. I have had the pleasure of knowing this “pure technical family” for many years  and they provide a wealth of data, including daily readings of the market internals on their site.

In today’s Trading Lesson, I am going to share some examples of how I use the McClellan oscillator. My methods are likely to differ from Tom’s or that of other analysts. As I have repeatedly pointed out, a technical tool is only really valuable to another trader or investor if they study it enough to become convinced that it works. Only then will you be able to use it in real time.

The McClellan oscillator can be thought of as a momentum indicator of the A/D line as it looks at the difference between a 19-period and 39-period moving average of the net advances. Since the number of stocks traded has expanded so much in the past 20 years, percentage values are now used instead of the raw number of advancing or declining stocks.

I have been following the McClellan Oscillator since the 1980s and want to share with you some of the formations that I have found the most valuable, as well as instances where I rely on other measures of the market internals.

The signals discussed below can be directly translated into signals for those trading the Spyder Trust (SPY),   SPDR Diamond Trust (DIA) and the iShares Russell 2000 Index (IWM).

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This chart of the NYSE Composite covers the period from January 2003 through June 2003. The McClellan oscillator (OSC) is plotted below the bar chart, and the dashed black line notes the zero line, while the dashed red line is drawn at -150.

Multiple positive or negative divergences often provide the strongest signals, and this is a classic example. The McClellan oscillator (OSC) had an initial low at -234 on January 27 (point 1) as the NYSE Composite closed below its daily starc- band.

The OSC rebounded to -67 over the following seven days before it again turned lower. At the February 13 market lows, the OSC was at -175 (point 2) so the first positive divergence was formed.

As the NYSE Composite made another new low on March 12 and dropped below its starc- band (point 3), the OSC only dropped to -93. Therefore, a second bullish divergence was formed.

The OSC later moved above the zero line two days later, which confirmed that the low was in place. Seven days after the low, the NYSE tested the starc+ band with the OSC at +167. The market pulled back over the next few days as the 20-day EMA was briefly broken at point 4, but the OSC stayed well above zero. This was a good buying opportunity.

The NYSE rose over 8% in the next six weeks. The 20-day EMA was again tested in the middle of May as the OSC dropped below the zero line for three days before it again flipped to positive. The NYSE surged from 5200 in May to 5700 on June 17 when the OSC formed a negative divergence, line 6, before the zero line was convincingly broken.

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As Figure 1 indicates, the OSC dropped below the zero line on June 18 and stayed below it for the next seven weeks. Ten days after the high the NYSE came close to the starc- band and the OSC spiked to a low of -226. The rebound in the OSC failed below the zero line indicating that the correction was not yet over.

The chart shows that the NYSE then formed a nice triangle or flag formation, lines and b over the next month. In July the OSC dropped to -244 while at the early August low it was a bit higher at -240 (see arrow) so a slight positive divergence was formed. The downtrend in the OSC, line c, was broken on August 7, the day after the low.

The OSC overcame the zero level four days later on August 12, line 1. The OSC peaked in early September at +196 and then formed lower highs while the market continued higher. Those who have read my articles on Fibonacci targets know that I use the 127.2% retracement level of the flag formation to determine initial upside targets.

For the NYSE, this level was at 5835.76, which was exceeded on September 18, point 4, as the high was 5850. Two days after the highs, the OSC dropped back below zero (line 2) and the market declined for the next five days. Those with orders in the market were able to sell part of their position at the price target but trading the short-term pullback would have been more difficult.

The market closed strong on October 1 as the OSC moved back above the zero level (line 3). As the chart indicates, the NYSE was in a clear uptrend into the latter part of November but the OSC moved above and below the zero line several times.

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Over the next five months, the OSC moved through the zero line at least 15 times, and while a nimble trader might have been long only when it was rising and short or out when it was declining, the market’s trend was clearly positive.

Below the OSC, I have included the NYSE Advance/Decline, which by October was in a solid uptrend, line a. Though the 21-day WMA of the A/D line was briefly violated three times, the uptrend was not broken until February 23. When the OSC is choppy, I always defer to the A/D line analysis.

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From the March 2005 high to the May 2005 low (point 3), the NYSE Composite lost over 7.4%. On March 16, with prices testing the starc- band, the OSC hit a low of -331. It formed a very short-term divergence three days later (see circle ) before rallying to +79. This bounce just retraced a bit over 38.2% of the prior decline suggesting that the correction was probably not over yet.

On April 15, the OSC made a higher low at -181 as the NYSE closed below its starc- band. The NYSE tested its lows nine days later but the OSC was only at -37 (green circle). The ensuing rebound was sharp but failed seven days later as the NYSE dropped to new correction lows at point 3. The OSC broke its uptrend on this new price low as it dropped to -49 but was still acting stronger than prices.

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This could have been a tough one especially for position traders who were using a stop tight under the prior lows. It may have been tough to get back in the next day when the OSC moved back above the zero line.

This action was more typical of the stock index futures where you will sometimes see a sharp drop to clean out the stops before the market reverses. For short-term traders who bought after the divergence at point 2, taking partial profits would have mitigated the damage.

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The next four months were a period where, again, the OSC moved above and below the zero line many times while the A/D line gave a clearer indication of the market’s actual trend.

The A/D line did form two positive divergences at the April-May lows, line c. This divergence was confirmed on May 18 (line 1) when the A/D line moved through the resistance at line b. In late June, the A/D line dropped briefly below its WMA, but by early July, it was again making new highs.

The NYSE A/D line made a high on August 2 and then dropped below its WMA. As the NYSE Composite was making a new high on August 11 (line 2), the A/D line was only able to rally to its flat WMA, therefore not confirming the price action. This was an early warning sign.

The NYSE Composite made new rally highs on September 12 but the A/D line did not make a new high, line d. This longer-term bearish divergence was confirmed when the A/D line dropped below its support, line e, on September 20 (line 3).

The NYSE Composite rallied back towards the previous high in late September and the OSC just briefly moved above the zero line. The A/D line was just able to test its declining WMA, which was a sign of weakness as it then turned lower.

Click to Enlarge

Looking at more current data, I wanted to provide you with more examples of what type of formations you may see in the McClellan oscillator as rarely will you see two that are exactly the same, though they sometimes share some common characteristics.

The NYSE Composite chart on the left side is from the fall of 2005 where you can see that the market made a series of lower lows, line a. At the initial low, the OSC hit -184, and then in October, it made a lower low with prices (line b) as it reached -241 on October 13.

The most reliable signals I have found are the positive divergences that form over a three-four-week period so the lower lows in the OSC may have made one think that the market would not bottom for several more weeks.

Just five days later, the NYSE Composite made a new low but the OSC did not (line c) as it was at only -121. Two days later, it moved above the zero line, which was the start of a seven-month rally. The ability of the oscillator to move above the early October high supported the bottom scenario

The formation in the fall of 2010 was more typical as stocks had rallied sharply from early September when the A/D line had broken out to new highs. In early November, the NYSE Composite tested the daily starc+ band before turning lower. Just seven days later, the starc- band was being tested and the OSC had dropped  to -245.

As is typical when prices are at the starc- band, the NYSE rebounded for a few days before again turning lower. After just eight days, the market was again making new lows, line d, but the OSC was forming a bullish divergence (line f) as it only dropped to -141. One day after the low, the OSC broke through its downtrend (line e) and the following day was in positive territory completing the bottom formation.

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Bill Gross Explains How To Escape A Sinking Ship

by Tyler Durden

It is unclear if the florid analogy in Bill Gross' latest monthly letter, namely a "sinking ship" or at least a seaborne vessel on the verge of being one, is suppoed to represent the US economy, the bond market, or the Fed, but whatever it is, Bill, who is in the business of making money when bonds go up and vice versa and who nearly sank a ship while a naval officer, appears confident no ship is sinking. Yet. "The U.S. economy is not sinking, nor are the majority of global economies. Their markets just had too much risk, and in PIMCO’s opinion, too much hope for a constant QE and for the growth that it would produce. In effect, the ship was top heavy with too little ballast."

Sure it is, but while it inspired many a monthly letter bashing the Fed's ruinous policies not for Gross but for the 99%, it led to a record Total Return Fund AUM and record fees. What Bill is more confused, and even angry by, by is the dramatic bear flattening in the bond curve which was the most dramatic move in the past few weeks: not so much the move in equities, not the shift in credit spreads, not the vol in FX. Why is he surprised: because not even he had any idea to what extent everyone else was also frontrunning the Fed on a very levered basis. Which is why the TSY curve belly exploded as it did, wiping out billions in P&L form Gross and many comparable bond managers. Next comes the raging into the void by PMs who did not foresee precisely what they were warning about...

As for the economy, or bond market, or whatever, maybe not sinking, but certainly taking on water as Bill admits when he tell Bernanke's "cyclically oriented Fed" that "structural headwinds – demographic, globalization, and technology influences – that have had and will continue to have dampening effects on domestic and global growth."

However, what is lost on Bill is that as we explained yesterday, the Fed is far more concerned with collateral extraction as per the TBAC. Which means the upcoming Tapering episode will come, but following yet another very violent market reaction (has anyone seen what is going on in MBS?), it will immediatley unleash the UNtaper, and even more QE, and with it wipe out any pretense that eligible "quality" collateral (or lack thereof) matters when the S&P goes back into triple digit territory.

Because if the merest hint of just a slowdown in monetization leads to this... "Without the presence of a “Bernanke Put” or the promise of a continuing program of QE check writing, investors found the lifeboats dysfunctional. They could only sell to themselves and almost all of them had too much risk. A band somewhere on the upper deck began to play “Nearer, My God, to Thee.”... Imagine what would happen in 2014 or 2015 when the market suddenly finds itself facing a grim cravasse in which some 1000 S&P Fed-injected points are about to be "priced-out."

That said, whle Gross' piece brings up many questions, it certainly answers one: on whose side the Newport Beach bond manager is: "PIMCO, and the bond market have sailed some rough seas over the past few years. So has Chairman Bernanke. We’re all in thisi one together it seems."

Well, if one excludes some 99% of America's, and the world's, population Gross is absolutely correct...

* * *

From PIMCO's Bill Gross:

July Outlook: The Tipping Point

I’ve spun a few yarns in recent years about my days as a naval officer; not, thank goodness, tales told by dead men, but certainly echoes from the depths of Davy Jones’ Locker. A few years ago I wrote about the time that our ship (on my watch) was almost cut in half by an auto-piloted tanker at midnight, but never have I divulged the day that the USS Diachenko came within one degree of heeling over during a typhoon in the South China Sea. “Engage emergency ballast,” the Captain roared at yours truly – the one and only chief engineer. Little did he know that Ensign Gross had slept through his classes at Philadelphia’s damage control school and had no idea what he was talking about. I could hardly find the oil dipstick on my car back in San Diego, let alone conceive of emergency ballast procedures in 50 foot seas. And so…the ship rolled to starboard, the ship rolled to port, the ship heeled at the extreme to 36 degrees (within 1 degree, as I later read in the ship’s manual, of the ultimate tipping point). One hundred sailors at risk, because of one twenty-three-year-old mechanically challenged officer, and a Captain who should have known better than to trust him.

We survived, and a year later I exited – the Diachenko and the Navy for good – theirs and mine. I think I heard a sigh of relief as I saluted the Captain for the last time, but in memory of those nearly tragic moments, let me reprint an article posted on wikiHow, outlining exactly how to go about abandoning ship should you ever venture into the South China Sea or anywhere close to Davy’s infamous locker. The article is a bona fide and serious attempt to instruct would be passengers in a Titanic-like disaster. I found it, however, as comical as yours truly pretending to be a chief engineer in 1969. Judge for yourself…

wikiHow: the how to manual you can edit

How to Escape a Sinking Ship

The Basics: Before Setting Sail

1. Understand the mechanics of a sinking ship. Water usually enters the lowest point of a ship first, the bilge area.

2. As more and more water enters the ship, it will start to heel significantly. From this point on, sinking will occur quickly. Abandon ship.

If Sinking is Imminent

1. Think about your sense of etiquette. What will you do if push comes to shove?

2. If you’re in charge of the sinking ship learn how to send a Mayday. Read “How to call Mayday from a marine vessel” on the attached internet link.

3. Stay calm and don’t panic.

4. If you see someone with fear, yell at them.

5. While still on deck, watch for catapulting objects coming your way. Large items can kill you.

Abandoning Ship

6. Find a lifeboat. The best scenario is to enter a lifeboat without getting wet.

7. If jumping off the ship, always look first.

8. If you survive, be ready for the reality that others may have perished. Seek counseling.

Counseling indeed! If only I knew then what I know now: wikiHow, not experience or damage control school, is the best teacher. So, should bond investors abandon ship? And who to believe? The captain of the Fed, the co-captains of the USS PIMCO, or just trust your instincts? Well there is no wikiHow moment to guide you in this case, although it’s true that yours truly, PIMCO, and the bond market have sailed some rough seas over the past few years. So has Chairman Bernanke. We’re all in this one together it seems.

Immediate analysis of the past 6 weeks’ market action would argue that in late April, both the Fed and PIMCO observed that bond markets were approaching a tipping point. Yields were too low, prices too high, both for investors’ and the economy’s own good. The Fed’s Jeremy Stein had written a research paper outlining the risk. I, in fact, had written a March Investment Outlook outlining Governor Stein’s paper, and to be fair, PIMCO had been warning of high seas for what seems like an eternity. “Never,” I tweeted, “have investors reached so high for so little return. Never have investors stooped so low for so much risk.” True enough, history will likely record.

It will also record however, that the risk was not only in narrow credit spreads and emerging market debt/equity markets but at the heart of the credit system itself: U.S. Treasuries. What supposedly old salts like yours truly didn’t suspect was that all bonds, and yes, equities too were at risk of heeling over based upon a rather perfect storm, one that forecasters everywhere found difficult to fathom.

The forecast for bad weather as I’ve mentioned was becoming more rational with every increase in asset prices. If all markets were being artificially supported as PIMCO claimed and the Fed confirmed, then someday, someday that support via quantitative easing would have to be withdrawn. But the dark clouds seemed to be far off on the horizon. Investors worldwide piled on the leverage – not just in high yield or equity space – but in Treasuries as well. If the Fed (and BOJ) were going to keep writing checks at one trillion per year, then these two central banks alone might be buying 70-80% of all developed market future supply. The fear was that there might not be enough for others, not that there was too much leverage.

Well, that started to change with the May 22^nd taper talk and, of course, with the Fed’s June 19^th statement and Chairman Bernanke’s press conference. In trying to be specific about which conditions would prompt a tapering of QE, the Fed tilted overrisked investors to one side of an overloaded and overlevered boat. Everyone was looking for lifeboats on the starboard side of the ship, and selling begat more selling, even in Treasuries. While the Fed’s move may ultimately be better understood or even praised, it no doubt induced market panic. Without the presence of a “Bernanke Put” or the promise of a continuing program of QE check writing, investors found the lifeboats dysfunctional. They could only sell to themselves and almost all of them had too much risk. A band somewhere on the upper deck began to play “Nearer, My God, to Thee.”

Well I go too far in my sinking ship metaphor, but you get the point, I hope. The U.S. economy is not sinking, nor are the majority of global economies. Their markets just had too much risk, and in PIMCO’s opinion, too much hope for a constant QE and for the growth that it would produce. In effect, the ship was top heavy with too little ballast. Guess I should have known, huh?

Well where does the ship go from here? Should you as a bond investor jump overboard and risk the cold money market Atlantic Ocean at near zero degrees? We don’t think so – and not because we want to keep you on board – we just don’t think so. Why not?

1) The Fed’s forecast of the economy which prompted tapering panic is far too optimistic. If 7% unemployment is tapering’s final port of call, we simply think that we’re much further away than the Fed’s compass would suggest. We argue for structural headwinds – demographic, globalization, and technology influences – that have had and will continue to have dampening effects on domestic and global growth. The Fed, we would argue, is too cyclically oriented, focusing substantially on housing prices and car sales. And speaking of housing, since mortgage rates have risen by 1½% in the last six months and the average monthly check for a new home buyer is up by 20–25% as well, then as I tweeted several weeks ago, “Mr. Chairman are you serious?” Growth will be negatively influenced.

2) Inflation, according to the Fed’s own statistics is running close to a 1% pace. The Fed has told us that they “target,” “ target” 2% and for the next 1–2 years are willing to accept even 2½% until they reverse engines. Fed Governor Bullard of the St. Louis Fed was in our opinion correct where he dissented from the majority decision several weeks ago, citing the distant shores of 2%+ inflation and the seeming inability to even move in that direction.

3) Yields have adjusted by too much. While T.V. and the press focus on 10-year Treasuries at 2.55% as their guiding star, subjective stabs by yours truly or anyone else are difficult day to day. The technicals, as Mohamed has written, can dominate while the fundamentals are flushed to second page priorities. When analyzing the fundamentals though, I like to point to a “North Star” that is as permanent as possible within the context of current market instability. Tapering aside, if the Fed has consistently informed the market that its policy rate – Fed Funds at 25 basis points – will stay there for a substantial period of time even after the end of QE, then to my eye, Fed Funds will not increase until at least mid-2015 and even then subject to a consistently strong economy that produces 2%+ inflation. I wonder if we can get there in this decade to tell you the truth. But the beauty of this North Star Fed Funds sextant is that it can be rather directly observed in futures markets, either for Fed Funds or for Eurodollars, which are a close companion. Right now, Fed Funds futures markets are predicting a 75 basis point yield in 2015, and Eurodollars validating a similar conclusion. That would suggest a mispricing, despite the obvious caveat of professional observers that some of the 75 is a surcharge for potential volatility. In any case, if frontend curves are up to 50 basis points cheap, then intermediate curves – the 10-year Treasury – may be as much as 35 basis points too cheap. They belong in our opinion at 2.20% instead of 2.55%.

So there you have it, fellow passengers and paying clients. Don’t jump ship now. We may have reached an inflection point of low Treasury, mortgage and corporate yields in late April, but this is overdone. Will there be smooth sailing tomorrow? “Red sky at night, sailors delight?” Hardly. Will you be able to replicate annualized returns in bonds and stocks for the past 20–30 years? Hardly. Expect 3–5% for both. But sailors, don’t panic. And like wikiHow suggests, if you see someone that’s afraid, “yell at them!” Yell, “This ship’s going to make it to port,” Fed, PIMCO, and PIMCO co-captains willing. Those icy Atlantic money market waters are likely to be with us for a long, long time. Have a cocktail, tell the band to stop playing dirges, because you’re gonna be just fine with PIMCO at the helm.

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The Most and Least Expensive Cities to Run a Household in America

By Ross Crooks

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Stock Market Looks To Head Lower

By: Michael_Noonan

What is the message of the market as the week, month, 2nd Qtr, and first half of the year just ended? The second half of the year is likely to prove more troubling for the Bulls. We do not make predictions for a future that has not yet happened, but an assessment on what may unfold for the remainder of the year is about to begin on a weaker tone, based on the developing market activity.

All of the available news, information, data, fundamentals, technicals, from any and all sources eventually gets translated into the market as the driving force[s] that create the trends and trading ranges. Everything gets distilled into a bar chart, showing a high, a low, and where the final closing price occurred. An important add-on to that critical information is volume, the energy, or lack of energy behind each and every market move, in all time frames.

Yes, yes, it seems so basic to state, but the information to be gleaned from reading bars and volume escapes the majority of participants. Ironically, the ultimate message of the market, the most reliable source of information receives the least amount of credibility. Fundamentalists treat charts as an amusement. Technical analysts try to harness the market’s energy of information into some formula, imposing past tense indicators onto present tense activity, and expecting accurate future direction.

This is not a review lecture of various forms of market analysis; rather, it is context for understanding that the markets have an incredible amount of logic in the messages that everyone gets to see, for those who so choose, that eliminates all the noise and perhaps the weakest link common to us all, emotion.

The high, low, close, and volume generated by the market is totally void of emotion. The market just is. Any emotion comes from the viewer/reader of that information. If one were to follow the market’s lead, instead of trying to predict what it may or should do, the results for success can improve dramatically.

To chart context we go.

The long-term trend remains up. Factually, there has not been a market turn in price on the monthly chart, as yet, from an objective look at where price is, still near the highs. What we want to do is read the logic of price and volume activity. Last month, price made a new all-time high and closed in the middle of the range. If you look at each bar, since the 2008 low, about 90% of them had a close near the high of the bar’s range.

A close at the high-end of a bar indicates who is winning the “battle of the bar,” between buyers and sellers. Buyers have been in control of this market since 2008. Why is the close for May mid-range the bar? The market is telling us sellers were meeting the effort of the buyers, a draw between the two forces. What is interesting to note is that the draw occurred at the highest level of the rally.

Aren’t buyers supposed to be in control at market highs? It has been that way for the past five years! The question it begs is, why is the market showing a change in behavior at this critical juncture? We do not need to know the fundamentals. We do not need to know the market is above a series of moving averages, [past tense, and lagging information]. We do not need to view RSI, MACD, Bollinger Bands, you name it. None of them addresses what is developing right now!

June just ended, and we see a similar bar that also closes mid-range. Do both bars mean the same thing? No. Why not? Look at the volume for June v May. The composition of the internal makeup between the two has to be different, based on that observable fact. Monthly bars are for context, not for timing. To get a better read of the June activity, we need to see the nest lower time frame, a weekly chart.

A line has been drawn to connect the swing highs and lows to get a view of the overall trend without the “noise” in between. We can now see the composition of the monthly June bar, and it shows the largest weekly bar was to the downside with a low-end close. That factual observation has a negative connotation. When you add to it the volume, the highest weekly volume in over a year, the market is telling us that the increased energy was to the downside. These are indisputable, objective facts.

The last bar, last bar of the month, was a rally. An objective comparison shows it is smaller in range than the previous down bar, [less ability to rally], and while the close is at the upper end of the bar, [buyers "win" the day], it did not close much higher than the weaker bar, and compare the close of the second bar to the close of its preceding close. There was a greater distance down than there was up, in the last bar.

Finally, note the sharp drop in volume on the last weekly bar. Demand lessened on the rally effort. What happened to the buyers? This is a red flag, a warning. The trend of the monthly and weekly charts remain up, but the internal character has weakened.

The clustering of closes from March and April acted as a support when last week’s low retested the 1550 area. There is still bullish spacing, where the current swing low remains above the last swing high. What we need to watch more closely, moving forward, is how future rallies develop. Will volume increase, or not? Will the closes be strong or weak?

We turn to the daily to see how its details reflect the content of the weekly.

Connecting the swing highs and lows, the daily time frame shows lower highs and lower lows, the essence of a downtrend. The smaller time frames show faster developing market activity than the higher time frames, and changes in the lower time frames occur before there is a change in the higher time frames.

The downtrend on the daily justifies the red flag warnings on the monthly and weekly charts. It is a read of the three different time frames that tells us the market looks to head lower. The strength of the higher time frames takes more effort to turn them, so we can expect more rally efforts, rather than an immediate decline underway.

What we can look for, based on developing market activity, is stronger declines and weaker rallies. Plan accordingly.

As an aside, last Thursday, we issued a potential short trade alert in the S&P to our blog subscribers, IF what we saw developing confirmed expectations, http://bit.ly/19KEwew. We did it as an exercise to demonstrate one does not need to predict the markets, but to be prepared for what follows developing market activity up to the point of making a decision to buy or sell in the market[s].

If a signal occurred, and the trade work, it was known in advance for specific reasons and not in hindsight. We were looking for a weak rally that failed. Our preparation worked, in that aspect, because it kept us out of a trade potential that then became questionable.

What developed was market weakness right from the start and not a rally. Price then vacillated the rest of the day, but there was no reason to sell, based on developing market activity. The emotional element that plagues us all was removed, based on preparation and the lack of a reason to execute.

Price did sell off at the end, unexpectedly, but that is a somewhat different story. Turns out, we had a similar set-up in 30 Year Bonds, a trade we did recommend making, and for the reasons similar to those in the S&P alert.

Those who remain long in the stock market are getting red flag messages. They should be heeded.

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The Fed Is Now Taking Over The Entire Treasury Market 20 bps Per Week

by Tyler Durden

Yesterday the Fed released its latest balance sheet data: at $3,478,672,000,000, the Fed's assets reached a new all time high of course, up $8 billion from the prior week and up $615 billion from last year - after all with 4 years almost in a row of debt monetization or maturity transformation, either the total holdings or the 10 Year equivalency of Bernanke's hedge fund rise to new record highs week after week.

But that's not the bad news: the bad news, at least for Bernanke, and why the Fed has no choice but to taper is monetizations (however briefly as following the next market crash Bernanke or his replacement Larry "Mr. Burns" Summers will be right back in) is that since the Treasury is about to print less paper (recall: lower budget deficit, if only briefly), and the Fed is monetizing the same relative amount of paper, the Treasurys in the private circulation book get less and less, as more high quality collateral is withdrawn by the Fed.

This is precisely what the Treasury Borrowing Advisory Committee warned against in May. This is also precisely why the Fed's "data-dependent" taper announcement is pure and total hogwash: the Fed knows it can't delay the delay (pardon the pun) of Treasury monetization as doing so only risks even further bond market volatility as less Treasury collateral remains in marketable circulation, and as liquidity evaporates with every incremental dollar purchased by the Fed instead of by the private sector.

So just how bad is the situation? Quite bad. As as of last night, courtesy of SMRA, we know that the amount of ten-year equivalents held by the Fed increased to $1.608 trillion from $1.606 trillion in the prior week, which reduces the amount available to the private sector to $3.603 trillion from $3.636 trillion in the prior week. There were $5.211 trillion ten-year equivalents outstanding, down from $5.242 trillion in the prior week.

After the Treasury issuance, maturing securities, rising interest rates, and Fed operations during the week, the Fed owned about 30.86% of the total outstanding ten year equivalents. This is above the 30.63% from the prior week, and the percentage of ten-year equivalents available to the private sector decreased to 69.14% from 69.37% in the prior week.

In other words, in 1 week the Fed's "take over" of the bond market continued at a brisk pace of 23 bps, which is its average weekly uptake. This is roughly equivalent to 10% of total private collateral moving from private to Fed hands every year!

So basically every year that the Fed does not taper its purchases, Treasury issuance being equal (and it is declining), the Fed removes 10% of high quality collateral from the world's biggest bond market.

And that, in a nutshell, is what Tapering is all about: the realization, and then the fear, of what happens if and when the Fed continues its monetizations of public debt to the point where there is so little left, that when a trade takes place the entire curve moves by 1%, 2%, 5%, 10% or more....

Everything else is smoke and mirrors.

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