If the Trend is Your Friend, This Market Hates You

So that tug of war around 1,100 on the S&P 500 continued yet again today with this latest round ending in a draw once again.  Despite holding control for most of the day, the bears did their best Houston Oilers impression and snatched defeat from the jaws of victory and allowed the index to finish up a measly 1.31 point.  (For those unaware, the Houston Oilers have the dubious honor of giving up the largest lead in NFL playoff history.)  This is yet another sign that this market is struggling for direction.  S&P 500 volume was light at 3.4 billion shares, which, again, was likely composed primarily of HFT and ETF players.  This is clearly evident by the 10 point jump that occurred in the last 30 minutes of today’s session.  I have a hard time believing that a lot of retail investors are so precise in their buy orders.

Outside of equity, the positive momentum that was seen in the Treasury market yesterday continued in a nearly unabated fashion.  Yields again fell, with 10-year rates dropping back below the 3.00% level to around 2.98%.  Not to be out done, the 30-year also saw its rates fall below the 4.00% level yet again.  Much of the buying today likely stemmed from investors continued concerns about the prospects for deflation after the release of this morning’s Producer Price Index (Reuters:  Producers Prices Fall More Than Expected In June).  According to the Labor Department, prices fell 0.5% during the month of June, which constituted a greater decline than what analysts were expecting.  On a year-over-year basis, prices are up 2.8% in aggregate.  Core PPI, in contrast to the headline number, edged up a miniscule 0.1% compared to May and 1.1% compared to a year ago.  While readings like this certainly do not show that deflation is imminent, they do keep the prospects for it alive and well.  This also means that the Federal Reserve is likely to remain comfortable with its current interest rate policy, which takes some of the price risk associated with owning Treasuries off the table.

As I intimated yesterday, divergences in the price action seen in the equity and Treasury markets are, in my opinion, among the most significant indicators we have on where the values of each market are likely to go.  The fact that Treasuries have rallied fairly dramatically in the past two days while the equity markets have meandered around, tells me that equity’s rally is losing steam with each passing day.  Treasury market participants tend to be ‘smart money’ investors who have both the capital and insight to forecast the economy’s ultimate direction with much greater accuracy than their equity-focused counterparts.  Because of this, I’m much more apt to believe what the Treasury market is saying about the domestic economy.  And right now, the markets are telling me that we’re on shaky economic footing at best.

Even more importantly, investors of all stripes simply do not seem comfortable with the prospects for the U.S. economy in the 3rd and 4th quarters.  Double dip worries along with a great deal of tax and regulatory uncertainty makes predicting economic performance all the more difficult (it’s near impossible in a ‘predictable’ environment anyway).  That sort of environment does not breed broad based equity rallies.  Specific sectors can rally, but more often than not the fundamentals driving the sector’s performance are unique to that industry and not reflective of the larger business environment.  To an extent, we may already be seeing this with technology companies this quarter.  Intel, Google, and AMD have all reported strong quarters (Google’s quarter missed analyst expectations, but the numbers were still strong when viewed in a larger context) that appear to defy the economic indicators that have been released lately.  And with 1,100 widely seen as a key resistance point on the S&P 500, the longer the market holds at current levels without breaking through this barrier suggests that a pullback comparable in scale and speed to the recent rally could materialize.

Lastly, I would be remiss if I didn’t mention something about the dollar’s drop against nearly all major currencies over the past month.  Especially when viewed in terms of the Euro, investors have been trading out of their dollar positions with near reckless abandon.  Since hitting is low around 1.19 early June, the Euro is up about $0.10 versus the dollar, or about 8%.  While the scale of the rally may differ slightly, the Yen, Australian Dollar, and Canadian Dollar have also seen positive price action of late.  If the last year is any sort of guide, a strengthening Euro could be supportive of equity prices as foreign investors would find it less costly to purchase U.S. dollar denominated assets.  This relationship was never more obvious than during the ’09 rally when the Euro and S&P 500 moved in near lockstep (see chart below) until early December.  The fact that the recent rally has coincided with a reversal in the Euro is at least one technical point of concern that should not be overlooked by the bears.

As was the case yesterday, I’m still holding on to my short equity position and continuing to wait for some sort of catalyst to give this market a direction.  Patience will continue to be a virtue in here.  I hope I’ve still got some virtue left in me.