S&P vs Treasuries relative performance
Will the market continue to defy gravity and keep moving up at this incredible pace or is the day of reckoning close?
It has been well over a year since my last post. I have taken the time to perfect an automatic trading system that is now responsible for my long term assets and the majority of my returns in 2014. It is very satisfying to know all the math behind it and be aware of the risk profile. Maybe I will post about this system later on, but today I want to have a quick look at the markets again, that seem to have defied logic due to massive government interventions.
Looking at the chart above, we can see that the SPY/TLT ratio, a proxy for risk-on vs risk-off has just back-tested the 2011 top and bounced successfully. The correction (down move = outperforming treasuries) looks corrective, the up move looks impulsive. In EW terms we could have just completed wave 4 and may be turning up here. This chart seems to predict an outperformance of the stock market, not a correction that everyone expects.
Treasury futures Elliott wave count (contract adjusted for roll)
In truth though, treasuries and stocks both did extremely well in 2014. In fact I owe a major percentage of my returns this year to Bond futures. The chart above shows the classic bond contract (ZB). The flash crash in yields we saw in October lines up perfectly with a potential wave 3 of this move and the pullback since then has maintained within the channel without dipping too far. This seems to suggest yet another move up, which would be incredible when combined with the first chart (outperforming stocks). Currently we appear to be in wave b of wave 4, which I expect will break the channel eventually.
Putting these two charts together, I think another quick move lower in the market is not out of the question, to fake people out before the next run up. This view is also supported by the indicator chart below.
Indicator chart
Looking at a couple of my indicators, I can see that the move up had good breath, the support of volume (wave volume). The low had a high volume (shakeout) and that we have successfully corrected sideways. None of these indicators predict something bad is about to happen, despite the divergence they show. A short term pullback may be in the cards, which could be another buying opportunity.
% of S&P500 stocks above their 50 DMA
The breath measured by the percentage of stocks above their 50 day moving average also shows remarkable strength of this market, erasing an almost 2 year long divergence. Looks like we are due for another larger wave up?
30Y – 10Y treasury yield spread
Treasury yield spreads are still showing a flattening. With projections of the spread between 30y and 10y yields to .36% I am still loving the long end of the yield curve better.
US vs World
US still outperforming the world. No sign of letting up yet.
Utilities turning up or down?
Utilities are at a critical juncture here. We made a higher low vs the broad market but failed to take out the downtrend line. Outperformance here could be another tell of an impending shorter term correction.
Technology still outperforming
The technology sector is still leading the charge up. No signs of weakness yet.
Junk vs Quality still down
Junk is still in a downtrend. Many people point to the poor performance of high yield debt as a sign of bad things to come.
Industrials pullback over?
Industrials look good though, so we have room to grow.
Europe vs World coming into support
Europe looks bad, but coming into support here. We should at least see a bounce.
Germany impulsive looking down
Germany looks corrective on the way up and impulsive on the last two declines. Will the European powerhouse economy lead us down again? The cyclical nature of the German market surely seem to foretell something bad.
Conclusion
During most of 2014, we saw negative signs and positive signs. The US market has ignored them all and rode the liquidity wave to the stratosphere, and even though the FED has now tapered, the market simply marched on on the back of massive stimulus from the Bank of Japan (BOJ) and asset purchase plans of the European Central Bank (ECB).
This level of coordination between different central banks is unprecedented. It will continue to make technical analysis challenging and frustrate people, but it is also a great source of wealth generation for those who can participate.
Participants are obviously only those with significant investment assets, whereas everyone who pays taxes foots the bill. Quantitative Easing (QE) is thus the means by which wealth is redistributed to the upper classes. Piketty caused a stir recently with his book observing the growing inequality and the massive redistribution of wealth.
With our overleveraged economies and massive debt bubbles, it will be difficult to accept growing interest rates. A significant rise in interest rates will result in a slow-down of the economy, due to the interest servicing burden. Simultaneously, Central Banks are telling us that we need inflation (another tool to transfer wealth from paycheck earners to asset holders) to promote economic growth. Price stability is not 0% inflation, but rather a continuous inflation.
To resolve this obvious contradiction, Central Bankers will continue to print money (inflation) to buy Government Bonds, thus putting a bid under the bonds and keeping debt interest low in the process. Creating inflation without raising bond yields will also continue to encourage “yield seeking” and keep pressure on pension funds, continuing the wealth re-distribution theme, in the name of prosperity for all.
The music is still playing, the fat lady still sings and nobody can tell when the music will stop. Eventually the music will stop, but at the end of QE3 the BOJ simply grabbed the fiddle and Draghi sung a sweet tune to the delight of all asset markets.
