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Despite several very ominous signs last week that the stock market rally was about to be hit on its head, stocks recovered yesterday from Thursday’s plunge.  All week, risk was being taken off the table with a massive increase in junk bond yields.  If there was one market that could legitimately be called a bubble, it is the junk bond sector.  It is my  main bubbleometer.

In recent months, the bonds of the most shaky companies were being gobbled up by yield-hungry ‘investors’ (or should I call them gamblers?).  Many were ‘covenant-lite’, meaning that if the company was unable to pay interest (default), they could not be taken over by the lending party.

Others have been PIK (payment in kind), where the interest payments are not in hard cash, but in more bonds!  So far, the US Treasury has resisted the idea of issuing their own PIKs, but if this mania continues much longer, I wouldn’t be surprised if they do.

The recent record low yield on junk bonds reached a staggering 5% with the spread over  ‘risk-free’ Treasuries now wafer-thin.  This was the result of an historic reach for yield – and a pure manifestation of insane levels of confidence/bullishness.  Yield was all that mattered – credit quality came a very poor second  These buyers will live to regret their blindness.

But last week, junk bond yields hit a very hard brick wall:

The break of the 50-day MA is the first sign that mood is changing out there.  Remember, junk bonds trade very much like equities and both are propelled by the same swings in confidence – and liquidity.

Are there other signs we are near a top?

But that’s’ not all – here are some more writings on the wall…

US  housing remains in a very weak recovery.  Last Wednesday, mortgage applications made another bad miss to the downside with first timers staying away from new home viewings in droves.  With incomes struggling to keep pace with prices, is that a surprise?  If housing can’t get off the ground with all of the subsidies thrown at it by governments, what is the outlook for the economy?

The eye-watering valuation of $6 Billion placed on a company that has no assets, only one employee, and has debt and is losing $2 million a year.  Oh – and the stock was promoted through spamming.  Is this an epic sign of manic bullishness?  Can it get even more extreme?

Companies are not able to grow organically, so are buying growth by snapping up others.  Invariably, this ends with destruction of value. They are also buying their own shares in an effort to increase P/Es – and boost executive bonuses.  This behaviour invariably occurs at the end of bull markets.

Time Warner is in play again

Another important straw in the wind is Murdoch’s desire to purchase Time Warner for $75 Billion.  Is history repeating/rhyming here?  If you are of a certain generation, you will remember the dotcom bubble years when AOL made the biggest bid in corporate history by buying Time Warner for $156 Billion in 2000.

That event marked the top of the market because the Dow peaked a few days later and in three years, declined by 40%.  In later years, this takeover was called the biggest mistake in corporate history.  Will history repeat that judgment this time around?

The basic rule is that CEOs get excited about making outsize bids for other companies at market tops.  History is littered with examples.

With all of these signs, I had expected the Dow to make a serious top last week, but the strong recovery yesterday has put that in jeopardy.

Since 2009 at the depths of bullish sentiment, confidence in the world of finance has ratcheted higher to the current manic levels.  But the mood among the general population remains muted.  This large divergence marks a fractured market.

DOW

My target range has been 17,100 – 17,500 and it hit the lower reaches last week:

But with momentum weakening, further upside will be much harder to achieve.  My upper tramline is very reliable with a great PPP and multiple well-spaced touch points.  Breaking above that will require massive buying but with the Fed’s QE unwinding on track, will there be a new supply of liquidity to keep the ball in the air?

US Corporate profits appear maxed out at around 9% of GDP – historically, a very high margin – so a reversion to the mean appears much more likely.

The economic data (unemployment, consumer prices) that the Fed watch appear on track, so a resumption of QE appears highly unlikely (although some pundits are calling for it, though).  So, a fresh stimulus to stocks from this source can be discounted.  With the dollar in bull mood, US corporate profits from abroad will produce fewer dollars – and an increase in P/E – can the market (P) stand such giddy valuations?

Now the Dow has reached my target range, it could top out at any time.  Stay tuned.

BARCLAYS

The bellwether for the stock market is the financial sector – remember, that started turning down well before the 2008 crash.  In the QE era, they have been major beneficiaries of the funny money hand-outs. With liquidity drying up, the banks will be gasping for air as they sink to t he depths.

But Barclays topped out months ago:

It is trading within my trading channel and hit the lower tramline last week.  The outlook appears grim.  I remain short.

EUR/USD

I had a Trader email on the euro yesterday.  Here is the hourly:

Yesterday, it fell to the 1.35 support level and is now trapped between the resistance and support.

It is only a matter of time before support gives way in a third of a third  move.  I remain short EUR/USD.

USD/JY

This is one of my favourite setups for a huge move.

The market is currently testing major support at the 101 level and when it does break, the move down will be very sharp.  I remain short.

EUR/JPY

This is another of my favourite setups this year:

My wedge has now been broken and market is heading for my tramline target in the 132 area.  This one should be fun!  I remain short.

GOLD

Is following my road map, so far:

My E wave could have topped out at $1340 already.  But my tramlines have another possibility:  $1340 is my a wave, last week’s low is my b wave and the c wave is to come.

I shall soon discover which path gold will follow next week and I remain light long with a tight stop.

T-BONDS

Could have topped out last week on a splendid five motive wave pattern:

My wave 3 also sports a complete five sub-wave pattern, so all is correct with my labels.

My tramlines likewise are excellent.  If the market breaks the lower line, that will be my signal that yields are starting up again and to trade short the bonds.  Of course, this five-waver could be part of a larger pattern that preserves the uptrend.

I remain on the sidelines awaiting developments.

Have a great weekend!

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