The Precise Take – Bulls continue the press into options expiration today

The markets had another day of solid gains into the close yesterday after consolidating during the morning and early afternoon.  The ES has made a trip from the lowest point of control (for Sep 09 contract) to the highest.  However, overnight, the ES has rejected the highest point of control at 936.75, finding value at the lower 928.50.  With options expiration today (some expiring on open, some on the close), we would expect settlement somewhere close to 925.

Much talk abounds as to whether the rally this week is real, that is–are we seeing true strength and leadership that will carry the markets to higher levels?  We do, but will not be lured into the end-of-the-bear-market case unless and until we see continued strength into the close next week after an expected correction in the early part.  With a relatively light news week, earnings will continue to guide the markets.  However, with the bullish hysteria of the large banks behind, a new sector will need to ignite the markets.  Non-seasonally adjusted (NSA) M2 ticked up yesterday for the as of July 6 2009, and we need to see this trend continue over the next two weeks to avert a serious correction into the fall.

As we write, housing starts came out better than expected but has little moved the ES.  As with yesterday’s better than expected weekly unemployment claims report that saw a spike high and rejection, we are seeing sellers winning over buyers on bullish news, which itself is bearish.  Accordingly, we want to see the 936.75 point of control become support rather than resistance for the ES to break higher.  We are bullish above that area and bearish below 928.50, watching 913.00 to 917.75 as a possible reversal area where we would look to fade long.  Above 936.75, we see 945.25 as the likeliest possible high as it is weekly R3, which has not been…

Continue reading here.

First, a caveat that this data is over two months old and as of May 9, 2009.  Foreign purchases of long term US Treasuries went from $17.1 B in April to -$21.8 in May–absolutely abysmal.  What appears to be weighing on long term yields (which should have shot up immediately on this data point alone) is the huge increase in China’s holdings of US Treasuries (short and long term), going from 763.5 in April to 801.5 in May (+$38.0 B).  How is this possible if they were only net buyers of $4.0 B in long term Treasuries during the month?  One, they could have stepped up purchases of short term Treasuries, which in the long term is meaningless as to their confidence in the US Dollar.  Two (more likely), the massive net purchases by the UK of long term Treasuries in April of $16.4 B could have been conducted by China using UK domiciled vehicles, as China has done at times in the past. Notably, purchases of long term Treasuries by the UK were again very high for May at $14.2 B. Combined with the record support for the recent Treasury Auctions, this is bullish for long bonds and 10 year notes and bearish for equities over the coming months.

In line with what we wrote in this morning’s report, if long term Treasuries were to make new lows (and yields new highs), the US greatly jeopardizes its ability to finance its upcoming debt needs and the risk of inflation actually increases again as a halt in appetite for and mass repatriation of US debt would require the Fed to buy everything in sight, financed only by the printing of money.  Again, this scenario is too risky to chance, but anything more than a nominal new high in the S&P will indicate this nightmare scenario could occur and the Fed must be aware of the possibility.

Ideally for the Fed, equities and Treasury yields go sideways until we complete the refinancings, defaults and deleveraging that are necessary before the actual recovery can take place.  Clearly, though, the S&P 500 cannot stay in a 100 point range for the next year, so something will give.  Given the mid-term election cycle that will begin next spring in the US, another leg down in the stock market (even a new low) does not truly hurt the current administration if recovery appears to be underway next spring, which would mean a rally off current or new lows has been in place for a few months.

Another scenario (less likely) that we must consider is that the S&P breaks 1,000 and yields make new highs, but does not become unmanageable.  The stock market then begins a very choppy ascent, making only marginal new gains with frequent corrections.  This is ultimately inflationary too (with more risk to the Fed), but could be more palatable to the administration as it will find more public support for its agenda

Tomorrow, we’ll look at today’s 4:30 pm M2 report for additional long term market directional clues.

The Precise Take – Shorts forced to cover yesterday with bulls sights on retesting highs

Though we were on the road yesterday, we posted to the website a few lines in the morning regarding the gap up to the 913.00 point of control.  Once there, the ES never looked back and spring boarded higher forcing shorts to cover early.  At the beginning of the week, we placed a 915-920 target on the ES and considered it very unlikely to see a move above critical resistance at 922.75.  Obviously, the unlikely happened yesterday, especially considering the tendency of markets to reverse the day after permanent open market operations (POMO) are conducted by the New York Fed.  Speaking of which, today is another POMO day, which statistically is an up day with a large rally in the final 45 minutes (3:30 pm to 4:15 pm EDT) of trading.  However, considering yesterday’s deviation from the typical post-POMO profile, the nearly vertical rise this week in the ES and options expiration tomorrow, we would not bet the farm on another monster rally.  Having said that, we could see some short covering in the first hour from margin calls, but would be surprised to see the resistance are of 934.25 (daily R1) to 937.25 (top range of professional unfilled gap area) exceeded.  If it is, the bulls can have a field day and could see weekly R3 at 945.25 tested.

Two critical reports are released today, though neither is usually a big market mover.  Money Supply (released after the close) will provide evidence of the sustainability of this rally.  The three month window between the third Friday of April and the third Friday of July is a historically important time for non-seasonally adjusted (NSA) M2 to give evidence of whether the typical summer correction will be reversed and lead to further gains in the fall and winter.  This year it will be all the more important as the current volatility of NSA M2 is historically unprecedented (going back to the beginning of data from 1980).  Also Treasury International Capital released at 9:00 am will reveal foreign appetite for US investments and more importantly US Treasuries.  With the large gap up in yields yesterday, any weakness in demand will likely lead to a perpetuation of this trend and, accordingly, we have placed it on today’s list of potential major market movers.  If yields break to new highs, the ability of the US government to muddle through the coming refi and default disasters in commercial real estate, Alt-A , credit card debt, etc., will be seriously imperiled and will, instead likely lead to another crisis even as equities make new highs.  That is why we still believe that the Fed’s priority is still low yields and not a higher stock market.  The M2 reports today and over the next two weeks will confirm if this is the case.

JPM came out with a great earnings report this morning and, as we write the weekly jobless report came out better than expected.  After a spike up in the ES to 932.75, the ES has retreated.  If this high holds early, we are willing to…

Continue reading here.