Equity Market is in Trouble

In Week #9 (the WIR dated March 3), the yield on the US 10-year Treasury Note had fallen to just 4.48 pct and bondholders were a very happy lot.

Stockholders that week, however, were dispirited because the US broad equity market had been crunched ($DJX -4.2 pct, $SPX -4.4 pct, $COMP -5.9 pct and $RUT -6.2 pct, all W/W). Ten of ten sectors were down (Utilities XLU -1.34 pct was the week’s best performer; Telecom IYZ -2.90 pct was second best; most were down over -4.8 pct that week. Of the Dow 30 stocks, only Merck MRK +2.9 pct and AIG +1.1 pct were gainers W/W.

That was the week that the China equity market came unglued as monetary policy tightened. The FXI index dropped -9.8 pct on the week. International currencies were so volatile, I wrote in my journal, “Turmoil!”

I also wrote in my notes, “Massive switch from stocks to bonds. Huge inversion in the yield curve is pointing to R”, which meant recession.

The Dow was 12114 and $GOLD was 644.10. $XAU at 132.35 had plunged -9.24 pct and the GDX ETF crashed along with it -9,92 pct. $COPPER dropped -5.12 pct that week. The Yen ($XJY) was up a startling +3.73 pct W/W and traders were thinking maybe the Japanese Carry Trade was over at the end of that month/quarter.

What happened next was remarkable. The Fed, HB&B and Humungous Private Equity Corp (HPEC) stepped up to the plate and begun a series of humungous corporate take-overs and bids based on huge credit expansion in the US financial system. The first was HPEC’s bid for Texas Utilities. My notes read, “TXU big story; insiders $42 billion”.

The following week, the DJIA rallied to a gain of +1.34 pct; 22 of 30 Dow stocks had gained; bonds dropped sharply (as yields lifted from +7 to +12 basis points); and there was more talk of humungous deals in the works.

The week after that (#11, March 17), however, was another test of the bond cycle peak as yields dropped again, stocks fell back, only XLU of my 10 equity sectors had gained, and 22 Dow stocks dropped, as the DJIA closed at 12110. I wrote in my notes, “US broad market not likely to recover past 50D MA >>> lower lows and highs (expected)”

In Week #12, March 24, I wrote, “$ out of Long-term bonds.” The yield on the 30-year T-Bond jumped +11 bp. The four major US equity indexes that week lifted between +3.1 pct and +4.0 pct; ten of ten sectors were up; 29 Dow stocks were up and one was flat, zero down. The $XAU jumped +3.4 pct to 137.78. $GOLD was up to 657.30. More deals from HPEC, and more deal talk, rumors, etc.

Week #13 (March 31) was another downer as, in my ETF sector watchlist, only Energy (XLE) was up, barely +0.10 pct W/W as Industrials (XLI) and Semiconductors (SMH) got hammered. Only four Dow stocks were up. But $GOLD was now up to 669.00 and I wrote in my notes, “Long end bond market is selling off >>> inflation worry.”

April, however, did not bring showers, unless you want to count the proliferation of HPEC deals, and the run-up in credit expansion the Fed permitted to help these deals happen.

So on April 7, 10 of 10 ETFs and 24 of 30 Dow stocks were up. $GOLD jumped to 679.40. The yield on the US 10-year Treasury Note jumped +10bp to 4.73 pct.

Now I happen to be using the rate table at Yahoo Finance, which is produced by ValuBond. I have not been using Bloomberg, which has substantially different numbers. Not being a bond trader, I am not into Bloomberg. The data at Yahoo Finance is the same data used for the charts at BillCara2.com.

On April 14 (Week #15), only the Financials (XLF) dropped, as I noted, “$$ out of the 2-year Treasury and into cash”. $GOLD lifted again to 689.90. The yield on the 10-year was now up to 4.74 pct, up from 4.48 pct in six weeks, and I started to opine that once that yield crossed the +5.0 pct level the equity market would get shaken up (as equity yields could not compete). I also said that I believed a 5.25 pct yield on the US 10-year would be probably the tipping point.

I might have called it the Cassandra Crossing, which refers to a movie classic from the 1970’s, where a European train moves forward to an unstable bridge, and the passengers fearing they will die in a crash start trying to unhook rail cars to lessen the weight. I don’t recall how that movie ended, but often when capital markets seem to get moving toward some possible crisis point, I wait for the usual media references to the Cassandra Crossing, so I’ll mention it here first.

On April 21 (Week #16), 10 of 10 ETFs and 24 Dow stocks were up, but the goldminers ($XAU) started selling off – Tuesday through Thursday that week – as I noted, “Govt is saying they will remove risk today and pass it along to future generations… scare tactic to cause profit taking in the golds.”

The next four weeks saw humungous selling of gold by central banks in Europe – the Bank of Spain sold material amounts of their remaining holdings – and the gold price dropped, but interestingly the bond yield curve was lifting and traders were talking more inflation, so the falling gold price was incongruous. The humungous deals continued though as credit expansion from the Fed and HB&B helped. Equities were thriving as the ETF’s went +7, +9, +7 and +9 out of 10 up those four weeks. The DJIA had moved to record highs of 13556 and by May 19 the talk about town was how quickly we’d see Dow 14,000.

But the past three and a half weeks have been a teeter-totter as prices have see-sawed to a current DJIA reading of 13295, and the yield on the 10-year US Treasury is listed by ValuBond at 4.95 pct (5.32 pct by Bloomberg). Cassandra Crossing dead ahead.

As I first looked at Asia-Pacific and European equity markets this morning, there was a definite red sky. Sailors know this as a bad sign: “Red sky at night, sailors delight; in the morning take warning”.

I continue to say that if, as and when interest rates/yields rise here, the equity market and gold is in trouble. We are now awaiting word from the Fed and other central bankers as to their game plan. If they intend to continue to tighten monetary policy here, then equity yields cannot compete with bonds and the stocks will fall.

Nobody knows how strong the underpinnings are to the bridge ahead. Unfortunately.

Yesterday was a tough day as bond yields popped and earnings yields cannot cope with the new discount rate, so stocks sold off. All ten of the equity sectors dropped, the Utilities of course being the biggest loser (XLU -1.63 pct) and the DJIA fell -130 points (-0.97 pct), while the NASDAQ Composite dropped -0.87 pct.

For the US industry groups, the biggest losers were Airlines ($XAL -2.1 pct), REITs ($DJR -1.73 pct), Paper ($DJUSPP -1.71 pct), Broker-Dealers ($XBD -1.69 pct) and Transports ($TRANQ -1.67 pct).

Wednesday, June 13, 2007