Institutional investors use volume weighted average price (VWAP) as a gauge for position entry efficiency.  Accordingly, the prior day’s closing VWAP level is an important reference point throughout the next day, much like a pivot.  We have drawn arrows on the ES chart below to illustrate how closing VWAP (cyan) can serve as powerful support and resistance throughout the day, oftentimes marking the absolute high or the low.  Nearly all of today’s day-session price action was contained by the prior day’s VWAP.

We have updated the free TradeStation Anchored VWAP Bands indicator on our website to include this new feature.

Because institutional investors, such as mutual funds, are measured against their previous monthly and quarterly and yearly performance, and VWAP measures average price paid over a period, these other closing VWAP time frames may prove valuable as well.

9:56 am EDT:  Chicago Purchasing Mgr Index disappointed strongly and the ES is descending as quickly as it rose Monday.  There may not be many good entry opportunities as price does not want to retrace much.  As we write, daily S2 has provided support.  Aggressive shorts can enter at 1048.25 or, more conservatively, 1052.50 to 1054.00.   The ES needs to get back above 1060.00 for us to look for longs again (unlikely).   We are not bottom pickers here until all the way down to 1033 to 1037, which is the ideal swing long area into Friday’s Employment report.

The Precise Take – ES maintaining strength as quarter ends

Leaders Analysis:   The USD finally broke again overnight and gold is up proportionately, back over 1000.  30 Year T-Bond futures are still hanging around highs, which equity longs will want to see rejected to allow an easy pass to new highs.  If 122 is materially broken to the upside in T-Bonds, there will likely be significant short covering that will draw money into Treasuries and compete more seriously with stocks. 

Medium Term Analysis:  Tomorrow (Thursday) is a monster news day, with a good potential for disappointment in one or more of the four major market moving reports.  It may take a fancifully rosy Employment Situation report on Friday to boost equities to new highs.  If the current value area is rejected and the ES returns to the lower value area centered around 1042.50, we would expect it to be supported at least into Friday’s Employment report.

Trading Today:  As we write, yesterday’s market profile point of control of 1056.00 served as support after a slightly negative ADP Employment Report and Q2 GDP was subsequently revised to be less negative, which has given the ES a boost.  However, the 1063.00 market profile point of control is still being rejected.  Longs need to…

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10:20 am EDT:  Per our morning report, we are now a bit cautious with longs because of the negative reaction to the Consumer Confidence Report, however, the ES bounced to recover about half the initial loss after taking out the overnight low by two ticks (low 1055.50).  Accordingly, longs can enter in the 1058 to 1059 area, but we would not stick around if the 1055.50 low is taken out by more than one point, wanting to see the ES trade above 1062.00 by 11:00 am.  Otherwise, chances of a rally to test highs or exceed them is less likely.

The Precise Take – ES and T-Bonds attempting to break through critical resistance

Leaders Analysis:   Many have noted the break in correlation between the USD and equities, both up yesterday.  The divergence between equities and the EuroYen that we noted intraday yesterday has mostly righted itself overnight.  More importantly, though, 30 Year T-Bond futures were able advance and are suspended at critical resistance.  It would be very unlikely for both T-Bonds and equities to make new highs this week, so one should give soon. 

Trading Today:  Yesterday, though the rally was impressive in the ES, it was not able to reach or trade above the highest volume point of control at 1062.75, the point at which today we become outright intraday bullish.  Overnight, the ES oscillated around yesterday’s point of control at 1058.25.  We will look to be buyers in from the…

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The Financial Times recently reported on the Fed’s latest exit strategy to eventually contain the inflation zombie:

During the crisis, the Fed created roughly $800bn of additional bank reserves to finance asset purchases and loans. This total is likely to rise in the coming months as the central bank completes its asset purchases and the Treasury unwinds financing it provided to the Fed. Fed officials think they could raise interest rates even with this excess supply of reserves by offering to pay banks to deposit their surplus funds with it rather than lend them out. However, they also want to use reverse repos in tandem to soak up some of the excess reserves. Policymakers call this a “belt and braces approach”. [The latter, clearly a nod to the great Gekko.] 

Tyler Durdan touched on this last Thursday, and we will expand upon it here as it is particularly relevant to our ongoing theory that it is the proceeds from permanent open market operations (POMOs) and their close cousins that are driving equities.  Though this may be received wisdom to ZH readers, the Fed has done us the favor of providing additional evidence through the FT story.  A bit of background, as we are new contributors to this forum:

Money Supply:  Based on our previous research on the effects of swings in M2 non-seasonally adjusted money supply (M2) on the stock market, we were a bit surprised in July 09 by the resiliency of the rally, which continued in the face of such a dramatic contraction in M2.  The dismal Durable Goods report from last Friday confirms that the capital goods sector is still under significant pressure as a result of a lack of money in the general economy.  With banks not lending to normal businesses and consumer credit contracting equally as violently, what is the basis for this rally and from where does the never-ending flow of equities juice flow? 

Bank Non-Borrowed Excess Reserves:  The Fed statistic that most closely correlates with the 2009 equities run-up appears to be bank non-borrowed excess reserves (bank NBER), which is a component of the monetary base (M0).  As explained by the Fed, bank NBER is simply total bank excess reserves minus bank borrowed excess reserves (bank BER).  This resulted in bank NBER going negative throughout much of 2008 because banks acquired most of their excess reserves through participation in Fed lending programs.  As the Fed has wound down these programs in 2009, bank BER has steadily declined and has been a drag on M0.  Concurrently, though, bank NBER has advanced since late March 09 with only one brief material pause in June, and reflects those excess reserves that need not be repaid as part of any Fed lending program.  The Fed purchases of MBS, Agency and Treasury securities netted $990 billion trillion since March 09.  The distinction between borrowed and non-borrowed excess reserves is critical because the latter would be ideally suited for leveraging and lending out to hedge funds and the like to “invest” in the high beta stocks that have led the rally.

The primary conclusion is simple—the stock juice flows from steadily increasing Bank NBER, which is hidden to even astute observers that focus on only M0 or M2.  Though we previously found no historical correlation between M0 (or its constituent components) and the stock market, we have witnessed an historically unprecedented set of circumstances.  Now that the Fed has become the world’s largest hedge fund, we are prepared to accept unorthodox conclusions.

So why not inflate both equities and the general economy simultaneously?  It was most likely a race against time.  The administration and Fed needed to replace the incredible evaporation of wealth that occurred in late 2008/early 2009 to quell the voting and investing masses.  They could not reflate the entire economy this quickly without jeopardizing their ability to borrow cheaply and restart the housing bubble.  To keep long term yields low, they reflated the stock market only, with the hope that the general economy would eventually catch up in 2010 and be able to sustain the stock market gains.  The problem with rising yields has not been solved, but was postponed. 

As we noted in previous research, we are toward the end of a seasonal drain on M2.  Once over the October hump, it should be easier for the holiday season to carry the market into March 2010, especially with the help of another $634834 billion in MBS and Agency POMO into next March (not to mention the possible Treasury SFP wind-down effect to the tune of $114 to 185 billion).  The Fed must be perfect, however, as any new panic will quickly feed on itself and likely lead to another mass exodus from equities.  This is quite simply because currently, there is absolutely nothing else to back up this rally in the general economy if the Fed funny money cannot do its trick.

Back to Money Market Funds:  If bank NBER is materially tied up in equities, then the Fed cannot drain from this source to mitigate inflation, or it risks the resulting cascade of sell orders that accompany the typical panic.  According to the FT article:

The obvious counterparties for reverse repo deals are the Wall Street primary dealers. However, the Fed thinks they would only have balance sheet capacity to refinance about $100bn of assets.  By contrast, the money-market funds have $2,500bn in assets, which means they could plausibly refinance as much as $500bn in Fed assets. Officials think there would be appetite on the part of the funds, which are under pressure [at gunpoint] from regulators and investors to stick to low-risk liquid investments. 

The Fed Helps Build Our Case:  As of September 17 09, bank NBER had increased by $563 billion since the March 09 rally began.  With M2 net flat during this period, the $563 billion has not made its way into the general economy by any stretch.  Perhaps it is sitting idle; however, the Fed says only $100 billion would be available from primary dealers in the future?  As the vast bulk of bank NBER is concentrated in primary dealers, this begs the obvious question of what will be tying up the remaining $463 billion (and we are not including the expected increases in bank NBER into next March, which could double this amount)?  Given a conservative lending leverage ratio of 10 to 1, there is potentially $4.63 trillion already sloshing around.  Even if we are much more conservative, given the roughly $2 trillion increase in the US stock market since Mar 09, it is not only easily conceivable, but probable, that a substantial portion was courtesy of the Fed ATM machine.

As Gekko closed his famous speech in Wall Street, “Greed – you mark my words – will save Teldar, and that other malfunctioning corporation, the U.S.A.”  While we have focused here only on coercive greed, it will be interesting nonetheless to see how this works out.

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This article was originally posted here on zerohedge.com.

Update:  A reference to “trillion” above was revised to “billion” and is marked.

1:03 pm EDT:  The ES has found resistance at the 61.8% retracement of the recent down move at 1060.25.  We did not consider it material as the major 1062.75 point of control looms just above.  However, it has been respected to the tick, so the swing shorts are attempting to defend what they perceive as one of the last holdouts for another (foiled?) attempt to short this market.  We may either get (1) a non-follow through over the next couple of days as we did with the May 18 09 Monday rally, with an eventual subsequent retest of today’s lows, or (2) a follow through such as the Jul 13 09 Monday that rallied unabated for nearly a month.  Either way, we would not look for swing long entries at these levels, preferring to see acceptance just above the 1062.75 point of control before entering.  Otherwise, chances of rejection of the value area are much higher below the point of control.  Having seen only the mildest of pullbacks today, we are not excited about chasing this market on a daytrading basis either.  Aggressive longs can enter at 1055.25, with a slightly less aggressive entry at 1052.25.  A reversal of the day’s gain is unlikely, but longs don’t want to see price trade below 1047.00, which would be an indication that the higher value area is being rejected.  The EuroYen has broken correlation by making lower lows as the ES has made higher highs today.  Equity longs will want to see this corrected by early tomorrow.

Correction to morning report:  We incorrectly identified today as the penultimate day in the quarter, when in fact it is tomorrow.  The similarity to the two previous end of quarters is lessened by this fact.

10:17 am EDT:  The ES front ran our preferred long area of 1042.25 by a few points and blasted through expected resistance at the weekly pivot of 1051.00, which are both highly bullish.  Per our morning report, we will not pick tops now, though the ES is having a bit of difficulty at combined session daily R2 at 1055.50.  New longs can enter between 1051 and 1052, with the tighest stop we would use being 3 points.  There is no resistance we see above 1055.50 until the next upside target, which is the highest volume market profile point of control at 1062.75.  Only on a return to 1043.00 do we become bearish now.

The Precise Take – ES maintaining support into end of quarter

Leaders Analysis:   The EuroYen forex cross bounced off its 200 day moving average overnight with equities following as we would expect.  30 Year T-Bond futures (continuous futures contract) are at very strong resistance at the 121 to 122 area.  Accordingly, if we are to see a reversal in the markets, with equities ending the correction and resuming higher, and with T-Bonds reversing down from resistance, we expect it this week, possibly as late as Friday on the Employment Situation Report, which has generated great strength in the 2009 rally.  If T-Bonds were to close above 122 or the EuroYen below its 200 day moving average, we would expect this to weigh on equities and see a longer correction.

End of Quarter:  No major news items today, and we are closing the quarter as of tomorrow.  The previous two quarters also ended on Tuesday.  March 30 (Monday) was a large distribution day and June 29 (Monday) was a small range net up day.  March 31 was a net up day that closed in the middle of its range and June 30 was a small range net down day.  All in all, it looks like end of quarter paint taping is a bit less likely than end of quarter profit taking, so we will be cautious with longs until Wednesday.

Trading Today:  After slightly breaking Friday’s low, which was the bottom of the current market profile value area (see shaded gray box in chart below), the ES has recovered overnight.  The new long term point of control after Friday is the 1042.50 area, which we will watch closely today.  If the ES trades below 1033.00 (strong Fib support), we will likely see…

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10:42 am EDT:  We would protect any day trade shorts entered from the pivot area (see morning report) with a tight stop just above the 1049.75 level.  There have been more upside than downside surprises in this rally.  As this is shaping up to be a non-trending day, we would tighten stops if price reaches the 1040 to 1043 area (about to be hit as we write).  Still not looking for longs unless 1049.75 is taken out.  Will most likely not look to fade strength or weakness out of the current combined session range of 1039.75 to 1049.75.