One of the most important questions that an investor should consider is; at what level or at what interest rate will bonds threaten the rally in equities. At some point in this cycle, the interest rates on the 5 or 10 year bond will begin to catch the investor’s eye. At that point, the investor is likely to cash out some of the investments in the stock market and return those investments to the boring yet safe bond market. Most investors haven’t learned about convertible bonds, which, offers the investor a bond type security with an equity kicker, these bonds are a hybrid security (part bond and part stock). Don’t forget that dividends continue to enjoy a special tax status while bond income, does not. Therefore the yield on the bonds has to be a bit higher than the dividend paid by the equity for the bond to compete with the equity for investment dollars. Many tax free bonds have no tax consequence unless your state has an income tax and the bond you purchased is from a different state. Naturally, the yield starved investor has been pouring money into the equity markets looking for yields rather than accepting the paltry yields seen in money markets. With the Fed in total control of short rates, it seems unlikely that these rates will move far from the almost zero interest that they now offer. These zero rates, or 0.45% or even 1%, do not keep up with inflation and because you must pay tax on the interest earned you have a negative return on your money. Where the Fed does not seem to have any control is the long end of the bond market. We have been writing about the increase in yield of bonds at the outer edge of maturity. That yield curve continues to remain steep. Even the ten year yields are steep when compared to the short-term yields.
Last week we wrote about municipal securities which are tax exempt and that continue to yield more than taxable securities. This is the result of investor panic rather than problems with the municipal bonds. Yes, there will always be a few muni’s that fail, but those bonds are generally not rated and are extremely risky. Each bond issued has its own risk and that risk is disclosed by the ratings authorities. It takes just a tiny bit of research to uncover that analysis. Not all bonds are created equal and the bond rating agencies have done a good job researching and rating muni bonds. The purchaser needs to review the trust indenture of the bond to review the legal opinion on that bond.
Although many analysts don’t worry about inflation and concentrate their concern on deflation, we smell a change in the wind. Chinese cost of production is on the rise, actually about 18% higher wage costs which, will be reflected in the increased cost of goods. Naturally those goods needing more labor will cost more. We have seen an increased cost of raw materials needed to make the goods which will no doubt be passed on to the consumer. Many consumers to not see the cost increases because for example the cereal box looks the same as it always has but look at the weight on the contents and you will soon see that there have been price increases, you just haven’t noticed them. As to other goods, the prices are creeping higher. Consumers are tapped out. They are having trouble paying their bills and this will just ice the already baked cake. We hope that we are wrong.
Tuesday: January consumer confidence is released at 10:00, Bank of Japan releases its interest rate decision and the annual State of the Union address is delivered.
Wednesday: December new home sales are released at 10:00, and FOMC announces its decisions at 2:15.
Thursday: December durable goods are released at 8:30.
Friday: 4th quarter GDP is released at 8:30 and January Michigan Sentiment is released at 9:45 to 10:00.
The US Dollar index fell 8.64 in the Friday session leaving a very large red candle on the chart. The low for the session was 78.01 which is a level we identified in our last market letter. Actually we identified 78.06, missing the actually number by 0.05. The next support level will be found at 77.585 then 76.83, 75.93 and 75.235. If none of these levels hold, look for a test of 74.21. Even though we are deeply oversold, three of the four indicators that we look at continue to issue a sell-signal. Only the Thomas DeMark Expert indicator is issuing a buy-signal. The 5-day moving average is at 78.967. The top of the Bollinger band is at 81.63 and the lower edge is seen at 78.22. We are below the Ichimoku clouds for the weekly and monthly time-frames we closed just below the clouds for the daily time-frame. The short-term channel lines are: upper at 79.215 and lower 77.997. The US Dollar index has clearly broken out of its trading range and has broken to the downside. There are several things that can happen here; we rally back into the trading range, we expand the trading range or we trade to the downside testing the levels seen on November of 2010.
The S&P 500 issued a mechanical sell-signal in the Thursday session. That said, the stochastic indicator and the RSI are both hooking to the upside but have not issued a buy-signal. The downtrend line is at 1285.31 and the uptrend line is at 1276.21. Clearly these lines are going to intersect so long as they stay on this path. That intersection will occur mid Tuesday. These points are to be respected so, don’t fight the trend. We are above the Ichimoku clouds for all time-frames. The 5-day moving average is at 1282.90. The top of the Bollinger band is at 1295.52 and the lower edge is seen at 1245.97. The upper channel line is at 1300.52 and the lower channel line is found at 1272.87. We advise caution in this market. There are far too many bulls and too few bears to keep us happy. Further, we did receive a mechanical sell-signal which usually is a fairly reliable signal.
The NASDAQ 100 futures contract retreated in the Friday session. We are now at three days and counting. The NASDAQ 100 broke below the uptrend line and has remained below that line for two days. This is more than a poke below the uptrend line this is a serious breach of the uptrend line. The good news here is that it is a short-term uptrend line. We did see this index close below the longer-term trend line, but not for two consecutive days. All the indicators that we follow are pointing to lower levels with plenty of room to the downside. The 5-day moving average is at 2299.15. The top of the Bollinger band is at 2333.81 and the lower edge is seen at 2200.28. We are above the Ichimoku clouds for all the time-frames. Our concern is that although the S&P 500 rallied in the Friday session this index and the Russell 2000 failed to rally. Both the NASDAQ and the Russell 2000 have led the troops higher so when we see them in retreat and the generals pushing forward, we become concerned.
The Russell 2000 retreated 0.59% in the Friday session more than the NASDAQ 100 that retreated 0.55%. We are in the last week of January and in the midst of earnings season so things are bound to be a bit rocky. The 5-day moving average is at 789.52. The top of the Bollinger band is at 809.68 and the lower edge is seen at 772.39. The retreat in the Russell 2000 is more serious than the retreat seen in the NASDAQ. We have seen this index close below the longer uptrend line for three consecutive days. All the indicators that we follow herein are pointing to lower levels however; the stochastic indicator and our own indicator are bending a bit and could issue a buy-signal within a few days. We are oversold as measured by all the indicators that we follow. We are above the Ichimoku clouds for all the time-frames. There should be support at 765.10. If you feel like swing trading you could take a chance on a bounce but be very careful, this index takes no prisoners.
Crude oil action in the Friday session was an inside day. We are getting a buy-signal and would expect to see a bounce in this product. The 5-day moving average is at 90.24. The top of the Bollinger band is at 92.77 and the lower edge is seen at 88.10. So long as we stay above 87.25, the bulls will remain in control. Remember crude oil is priced in US Dollars and should the dollar weaken further, it will have an upside push on crude oil as well as other dollar based commodities. We are above the Ichimoku clouds for the daily and the weekly time-frames. We continue to like crude oil and believe that it will trade higher.
Gold has been having a really difficult time lately. There should be good support found at the 1329.90 level. Yes, we are oversold but no, there is not buy-signal at this time. The top of the trend line is at 1370.87. We are below the Ichimoku clouds for the daily time-frame but are above the clouds for both the weekly and the monthly time-frames. We are not only oversold on the daily chart but also on the weekly chart. The 5-day moving average is at 1357.80. The top of the Bollinger band is at 1425.56 and the lower edge is seen at 1336.79. We like gold but will not step in front of a moving locomotive and will wait to see some positive action in this product before purchasing the product.