So far, an expected quiet morning with the overnight low of 1000.50 sucessfully defended.  The ES should be able to break a bit higher into the afternoon, especially if it can clear Friday’s market profile point of control at 1010.50, though it will likely back and fill up to that point.  If the low is taken out, we become bearish and will look for shorts, but only after support at 998.50 is taken out.  As we wrote in the morning report, there are a lot of support levels immediately to the downside, so gains will be difficult to hold on to.  To the upside, above 1010.50, and we should be able to reach the 1015.00 day session only R1 resistance point.  New highs are unlikely with gold and the EuroYen in retreat, but possible into tomorrow morning with the POMO effect.

The Precise Take – Quiet news day ahead of jam packed (potentially) watershed week

Friday:  After a strong bullish premarket push up to the 1007 area resistance, the ES retreated a bit , but was able to break through a few minutes after the first hour.  As we updated intraday:

The R1’s were exceeded premarket, but the double top of the last two day’s in the 1,007 to 1,008 area have proved to be the stumbling block.  If the ES cannot exceed by 10:30 am, we would move stops up on any longs and resist taking new longs unless and until the resistance is cleared.  We now become bearish below 1,000 and would look for shorts below that area.

The close was not as strong as the bulls would have liked, but overhead resistance was cleared and we have a clear break of the 1000 level on the long term charts.

Looking ahead this week:  With the 10 Year auction that needs to show strong foreign interest and the FOMC Announcement on Wednesday, and 30 Year auction on Thursday, the markets will be looking to tomorrow’s 3 year auction at 1:00 pm for clues.  However, as we have seen recently, the smaller auctions can go poorly as long as the last longer dated auction of the week goes well.  Therefore, it has more bullish potential for Treasuries (bearish for equities) than vice versa because weakness will be downplayed.  This week is the last holdout for Treasury longs and we expect much volatility into Wednesday and Thursday, though today will likely be quiet.

POMO:  Today and tomorrow are days on which the Federal Reserve Bank of New York conducts permanent open market operations (POMO), for which we have developed trading edges with the help of others.  See our overnight post that updates the time profiles for today and tomorrow.  In short, the paint the tape tendency is diminishing as we’re seeing many of the day’s gains finished by 3:30 pm on POMO days in this July rally.  Also, the first hour today could prove tricky as we have some conflicting information.  We would look for a break of 1007.75 to the upside or 999.50 to the downside in the first 15 minutes to see if there will be a directional edge for the morning.  If we go down initially, longs may want to hold out, looking for a low into the hour that closes at 1:30 pm.  For the July rally only (n=5), there is a very strong tendency on the second day of a back to back POMO set to see a strong open and continued gains until about mid-day, after which we have been getting very weak closes.

Big Picture:  In the ongoing saga of Treasuries vs. equities, we feel this week is the last holdout for the Treasury longs and that it’s do or die for the Fed.  As we’ve been writing, the potential disaster that awaits with long term yields breaking to new highs is much greater than a stock market correction.  However, institutional sentiment seems to be that the Fed will simply let QE expire when it runs out of money or time (six months from announcement on March 18 09) in September.  The FOMC could wait until the next meeting in about six weeks to renew, but yields will likely have gotten away from Bernanke by then, and a hinting of a rate increase (which could correct yields) is too politically dangerous for Bernanke, who would not want to be seen as having single handedly put in the last stock market top.  Accordingly, while we still find it likely that QE will be renewed on Wednesday, we must prepare for a Fed that stands idly by as the Treasury market disintegrates and for the monster rally in equities that could accompany.  Until Wednesday, we will tread carefully, but we expect to have an answer by Thursday on where we are headed over the next few months.

The leaders are not yet pricing in further equity gains this morning.  The EuroYen cross, an important barometer of risk taking is testing its June highs.  A break through resistance would signal expected further gains.  Gold is off its Thursday highs and curiously did not advance on Friday’s gains in equities.  Also, the 30 Year T-Bond is holding support at its July low, but just barely.

The Big Rally:  We hinted at a massive equities rally that could continue from this week’s news.  There was very little transacted volume in the markets from the area of 1000 to 1200 on the S&P 500, which takes one form of resistance off the table.  Also, as our friend Billy O’Nair has researched, the S&P is now 15% above its 200 day moving average, which has historically led to further gains in the following three months.  In this environment, overbought and oversold are largely irrelevant and mean reversion strategies are indeed getting hammered.  A note of caution, however.  The only time the S&P 500 has been 15% over its 200 day MA in the late summer or fall was the second week of August, 1987.  Go to your charts if you don’t recall what happened a few months later.  The time of year is critical, because, as we have studied, M2 volatility (at historic highs now) can exacerbate corrections in equities that become self-feeding.  If we get a reversal this week, we are very skeptical about the ability of equities to break to meaningful new highs in the subsequent weeks and will be on alert for crash signals into October.  We’ll also throw out that the NFP Friday was a spike high and NFP have been reversal days this year, while FOMC days tend to be trend continuation days.  Again, we need to wait until Thursday for confirmation of everything.

Trading Today:    As we write, the ES is entering our intraday bearish area at 1001.50.  However, we would like to see a break of 998.50 early before entering shorts and indeed may fade long this area if buying comes into the ES.  We would also expect longs to come in at the 994.00 to 996.00 area.  If it turns out to be a range day (likely), the downside will be trickier …

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