Wrap up for Monday

First let me say thank you for all the emails, prayers and thoughts regarding my wife. Unfortunately I got so many I don't have time to respond to all of them tonight. I'll just say that basically she's had what has seemed like Bronchitis for a while and while her mother is a doctor in Budapest, she is scared to death of doctors. This has been getting progressively worse and the main symptom is she can't breath, last night it was so bad I had to put my foot down. It's really scary to see some one you love gasping for air, even in her sleep and you can imagine that feeling of not being able to take a breath, it's scary. All the tests, X-rays, EKGs came back normal and the gave her some antibiotics and some other stuff. I think it was a self perpetuating thing to some degree, the harder it became to breath, the more panicked she would be making it that much harder. We still aren't 100% sure, but it seems like Bronchitis and I can already see she is better which I think is because the test came back normal and she's not as anxious. As many of you know I have 4 herniate discs and the mind body connection is very real, stress doubles my pain in minutes so I think she experienced some of that, but she saw some of the emails from all of you and was really touched as was I, this group never ceases to amaze me.

OK, so the market today, in one word, "Europe". Europe was quiet for too long in the beginning of the year. Most of you probably remember me saying a month or so ago, "Europe will once again be the market focus very soon", today was a great example of that. We had literally nothing on the US economic calendar today. That will change tomorrow, we also have AAPL after the bell and the F_O_M_C Wednesday, volatility in US macro data will pick up this week starting tomorrow.

I added another link to the "Useful Links" section, the Global Economic reports. Just take a look at today's, it's hard not to think Europe, but as you see, important US data is building this week.

Since we have moved out of the seasonal adjustment period, the US economic indicators have been falling off. Some say it's a deterioration, I believe it's been bad the entire time, it was only the often arbitrary seasonal adjustments that hid the extent of the trouble in the US, but even sticking with the official line, you can see the US economic trend is turning for the worse, you can see that under the same heading with another link, CitiGroups's Economic Surprise Index, again, check out the link and the changes since February when seasonal adjustments were just starting to wind down.

I can't even start to do all the EU event justice, but one that I said to watch was the Spanish 10 year yield which is back above 6% today, this is the unsustainable level in which Greece first sought their bailout and a direct effect of the ECB creating a senior and subordinated bond market (I just recently touched on that topic again a few days ago). Comparatively German yields are at record 10 year lows as the flight to safety take on a whole new meaning, even though today's economic releases clearly show the German manufacturing dynamo just hit  brick wall. I don't want to get too political, but the EU exists for one reason only, a free trade zone for German exports and the math hasn't added up for a while, but it is now striking the German populace at new extremes, we may be a whole lot closer to the end of the EU as we know it as the cost to keep it together far outweighs the benefit of German exports.

Over the weekend the politicians all took victory laps on IMF funding commitments, the supposed firewall; just keep in mind they already agreed to raise the financial commitments years ago and thus far I believe only 19 IMF countries have ratified those commitments from well over a year ago. This "new" firewall is a joke, don't fall for the hype surrounding it.

From a common sense point of view, s goes the EU, so goes China as the EU is their largest trading partner. If indeed the Chinese are shorting the dollar and trying to maintain a bid under EUR $1.30, today must certainly have the Chinese wondering how much money they should continue to throw down that hole. Step back and take a look at the Euro...

 Euro Weekly trend...

$USD triangle, my money is on a quick head fake break down below support and then the $USD breaking out to the upside in a big way (assuming no intervention). This would be a Euro negative and a market negative, it also makes sense with our near term expectations of volatility shakeouts although some recent strong shakeouts are over and have revealed their true trend such as WMT today, a trade we have been following for a while.

There are a few lessons to be learned here, the most recent was my call last week that large caps were about to take it on the chin, hedgies are moving out of everything. WMT broke down with a breakaway gap, then a big bear flag, the area we started shorting WMT is in red, after it broke below the bear flag, I warned there would be a volatility snap back-Market Trend 1) All important support that is broken will cause a huge volatility shakeout. Trend 2) Nearly all gaps are filled, this wouldn't have been the case 3 years ago, but since the advent of High Frequency trading, even this breakaway gap that even I didn't think would be filled was filled. Remember the non-stop daily calls for increased market volatility, there you have it. Many shorts who chased the break of the bear flag were likely shaken out, this is why I'm transitioning from shorter term trades using leverage to longer term trades without leverage and as always, wide stops are crucial, but for our WMT shorts, the draw down was only about $1.00, easily survivable if you are not leveraged. So the obvious question is , does this gap get filled?  We'll take a closer look at WMT tomorrow, but as we reach that point of no return, the breakaway gaps will hold and that will be a signal that the market character has changed significantly and not for the better.

The market has made the rules clear, leverage can only be used on quick trades, you have to be nimble and don't expect to hold leveraged positions for more than a few days. How many leveraged options trades have I closed for a 7%-244% gain in a matter of a few days? If I held any longer I'd be toast. Longer term positions which in my opinion should be part of your accumulation (shorts), need wide stops and fewer shares, when the volatility dies down you can always add to them. If you can't play be these rules, it's better to sit this volatility out until the market starts to trend.

As you might know, the Dutch cabinet resigned en masse today after failing to reduce their budget to the EU mandates. PREDICTION: Get ready for more sovereign downgrades and then the government raiding the offices of S&P, Fitch and the other ratings agencies that downgraded them. Banks will start to see massive downgrades, the capital hole is too large, they don't have the assets to pledge to the ECB and they darn well don't want to issue more shares at these prices. As pointed out a few days ago, raising liquidity is not the same as raising capital, the example I used was for anyone who was owned a business, you know that cash flow is not the same as profits and while EU banks seek to raise liquidity, they are stuck when it comes to capital, even after 2 LTROs. Speaking of which, were did that money go? Sarkozy in his dream world told us all that the capital from the 3 year loans would go to finance sovereign debt carry trades (borrow for 3 years from the ECB at 1%, buy Italian debt at 5% and carry a 4% profit), did that happen? No, then banks made a reverse carry trade and stuck the money in the ECB's deposit facility for .75% interest, a negative -.25% carry just to shore up their capital base. This saw the ECB deposit facility soar to all time records. Even "IF" the ECB was willing to do LTRO 3, the banks have no pleadable assets left, that's why the ECB lowered the standards of assets from A rated to less than A rated, the banks are running out of assets. For the ECB, what is the point of putting all that liquidity out there and only seeing it return through the deposit facility?  The best argument that could be made at this point is simply to shore up the gaping hole in the capital base which is as high as 60% of some banks' market cap with the average around 20%, HUGE PROBLEM.

Reminiscent of the F_E_D's 2008 Discount Window Borrowing Stigma, EU banks that have taken LTRO money are being punished severely, remember when no US bans wanted to borrow from the Discount Window in the US because it was seen as a sign of weakness? The same trade is unfolding in Europe. Do you also remember how quickly funding dried up during the Lehman crisis? GE (not the financial division) was in huge trouble and US corporations on average depend on borrowing for 30% of their needs, in the EU, the average is 70%.

 Spain is the domino that will likely cause it all to fall and contagion will take on a whole new meaning for what's left of the core. In any case, Draghi has made it pretty clear he's not a Bernanke clone and isn't find of more printing. Draghi is probably right, more debt doesn't solve the problem of debt, but that piece of wisdom is too little too late.

The European Top 100 Index has now given back all 2012 gains.

Spain's IBEX is nearly back at 2009 lows, so take a look at the CitiGroup Economic Surprise Index (whether you buy the seasonal adjustments or not) and ask yourself the question that has consumed the financial pundits, "Is the U.S. decoupling bullishly away from the world economy or is it simply lagging?" I think you know where I come down on this one.

I pointed out this chart today in the Risk Asset Update,

Very near term the SPX (green) vs the Euro (red) would seem to show a bullish divergence in the near term only as the Euro has not hit the same lows as the SPX relative to where they both were on 4/16. This would appear to be somewhat supportive of the market in the near term, but as I addressed over the weekend, there is another round of Euro repatriation, meaning $USD denominated assets owned by EU banks are being sold (most likely equities are a large part of that); to repatriate the Euros, first the proceeds in $USD must be sold ($USD must be sold) and then Euros bought. We saw this same thing happen during the October rally, arbitrage algos interpreted the stronger Euro as cheap US stocks and they bought, even though it was a wholesale liquidation of assets to try to bolster EU banks' capital base. That is happening again, the question is whether the algos will be turned on and if they will take this divergence as a signal of cheap US stock prices and buy in the near term or whether they learned the lesson and the arbitrage algos will remain dormant. There's little way to say for sure, but this is one potential volatility catalyst that is well in the making.

For today, it seems Gold and commodities to a stronger degree did follow that legacy arbitrage. If Gold continues to follow the arbitrage model, this should be good for the GDXJ miners position as miners have a reasonably good correlation in short term moves with gold.

 Commodities seem more aware of the longer term (meaning since the 16th) arbitrage opportunity as they were running ahead of the Euro (which is just a proxy for the Dollar Index as the EUR/USD pair accounts for 50% of the Dollar Index).

GLD followed the correlation more closely intraday. This repatriation event is one key piece of data we will have to be aware of and see how the market choses to play this. If the market goes the way it did off the October rally, then there's breathing room on the upside which the hedge funds will appreciate as a SCSO (Second Chance Shorting Opportunity). If the algo masters are aware of the risk they take in  letting the legacy arbitrage loose, then the market may get a brief reprieve, it won't matter though as we have seen all strength in the market sold in to since at least the first week of March and probably a lot longer than that.

Here's but one brief example of ES tonight...

As ES moved higher after th close, 3C is leading negative, this can go on for days as we have seen in the last 3 bounce attempts, but clearly all strength is being old, whether distribution or short selling. This should give you an idea of what to do with market strength, but once again, it's either play by the rules the  market has set out or sit it out, I don't look down on anyone who chooses to sit this out, it's not my style though-so let the trade come to you, if you are setting up longer term shorts as I have been doing, the stops need to be wide and selling in to strength is a must, chasing the market is the quickest way to get knocked out of your position. I have been also using smaller position sizes, which allow me to add on additional strength.

We have a ton of wild cards, AAPL earnings being one tomorrow, the biggest is the nuance of the F_OM_C statement, every placement of every comma will be compared to the last statement to try to glean the F_E_D's position. Personally I think Bernie would love to hit CNTL P, but with gas and food inflation running high, it's a big risk and one that the seasonal adjustments may have come back to bite him in the butt. If we had 4 months of deteriorating economic reports, he'd be more justified, but with the seasonal adjustments masking weakness, to the main stream it looks like what could be spun as "Transitory" weakness.

My gut feeling is that the lateral-ish movement today looked to me like the are trying to get enough accumulation to bounce the market. From a volatility shakeout view since the SPX broke the 50-day on April 10th, the working theory has been they need to get the averages above resistance to shakeout shorts and get longs trapped. The huge amount of calls that came in to the SPY late last week spoiled what looked like a decent $140 SPY pin which would have accomplished that, there were simply too many calls between $138 and $140, thus the $137.93 close on op.ex. Friday.

This is what I think they would like to see happen and with volatility higher than ever, it could happen, especially if the F_O_M_C statement gives the market anything that is even remotely ambiguous enough to allow the market to interpret it as dovish.

See the yellow candle I drew in. This would accomplish what we expected to see since the SPX broke its 50 DMA. Today's hammer in the SPY, DIA, QQQ and IWM all would suggest the short term support may in fact be there, the gap is there and we know what the trend has been with gaps, that gap around the $140 area would be an ideal target in the near term.

This is exactly what the market looked like it wanted to do before the Calls in the SPY went from 8-10k open interest to over 200k open interest between $138-$140 within a matter of 2 days last week. This is also what the underlying action late Friday looked like it wanted to do before we saw the perfect storm in Europe today before the US open.

Looking at the closing charts, I can't say that I would argue that the market doesn't still have its sight set on such a move.

Most of these charts are a bit longer term to remove some of the noise from the shorter intraday charts, except the IWM which I'm showing a shorter version of just because of the EOD momentum.

 DIA 15 min, again large caps look to be the weakest.

 IWM 2 min just because the EOD momentum was so strong with a leading positive divergence

 QQQ 15 min, finally the tech rotation that sticks?

SPY 5 min just because it never confirmed today's downside move. Wall Street sells in to strength, with little strength today we saw few important negative divergences other than those that seemed to be in place just to keep the market at a reasonably low level to accumulate, they would need to buy extra cheap to make up for today's rout.

With the F_O_M_C and AAPL earning coming up (I will be selling in to any strength that may come in the form of AAPL earnings, we all know that they guide low so they almost always beat-the death kiss for AAPL may have been the dividend, it killed MSFT's growth) the Dominant P/V relationships almost seem meaningless, but nonetheless, across the board in all major averages, the dominant relationship was Price Down/ Volume Down among the component stocks. This relationship, other than being the most common during a bear market, has the least impact on 1 day implications.

The one place where we might find a 1 day oversold event was in the market internals


Decliners outpaced advancers (NYSE 790/2233 Nasdaq 611/1932), and new lows outpaced new highs (NYSE new highs/new lows 27/78 and NASDAQ new highs/new lows 28/72). 


A 3:1 ration in advancers/decliners has historically been enough to create a 1 day oversold/overbought event.


We'll just have to see if NFLX put a damper on Tech's apparent effort to rotate in.


See you soon and thanks again for all the well wishes.