Thursday Afternoon Update and Realization

Afternoon Update

The Realization

In yesterday's letter I think I adequately animated my mental anguish over Tuesday morning's unanticipated buying spree. This was the morning the market exploded higher across the board despite the lack of any significant Bullish fundamental or technical signals. It is in fact a re-examination of this buying, coupled with today's action, that has me coming to a more thorough conclusion this afternoon. The reason we are seeing this buying enter has little to do with the news or technicals of the day (regardless of what you hear on TV or read in a newsletter...these guys need to come up with some sort of explanation to get a paycheck), but rather with the over-riding story that free money is still available.

Although the macro market continues to sit in a sideways range there appears to be a shift in the environment that was evident after this morning's open. The trade has acted impulsively in either direction with contrary reactions to both Bullish and Bearish fundamental and technical signals. However, it is pretty clear after the buying that continued this morning that there is now an overwhelming amount of allocation into the supportive markets. While the market broke heavily in preparation to Bernacke's report yesterday afternoon, it appears that the big money is now banking on the assumption that the extended period of 0% rates will continue much longer. This means the borrow cheap and bet big on risky assets trade looks like it is back on for the time being.

How the Allocation Works, the Indicators, and How to Trade it

Allocation
As we have seen over the last 18 months in the market it is indeed now money flow that is the largest fundamental in the market. While it can be seen in the technicals and can correlate to fundamentals it is in itself the driving force for price. Right now it appears that the money is coming in beginning around 7:30 am (CT) and specifically within the first hour of the stock market open at 8:30 am (CT), but in the past we have also seen another round at 2 pm (CT) during the last hour of Equity trade. During the morning though it is strong...and stronger than normal...due to the low volume over the summer months. You also now have more computer trading programs than ever before and many attempt to front run buying when it gets a hint that it is coming to sell it back higher. This means that the spurts are bigger and easily run over higher volume and technical resistance levels in the market. Moreover, I speculate that the institutional money is attempting "purposeful buying", meaning they are not necessarily looking for the best entry, but rather to in fact push the market higher.

Right now the buying is coming into the Equity, Energy (minus Nat. Gas), Metal, the Australian Dollar, and the Canadian Dollar markets as the most correlated group. Both the Soft and Grain markets have had their own rounds of allocation during June and the beginning of July, but they appear to be following their individual fundamentals...or lack thereof for right now. Also, the European Currencies seem to still be trading the European story rather than the correlation to U.S. Equities. Although this Currency group can move with the macro market, as it did today, it is not necessarily the same move as I will describe in the Beyond section.

Indicators
As you may have noticed from some of my late notes I have a few indicators that I look for to see if an allocation is coming for the day. First, I look for buying on the European open beginning between 1 - 3 am (CT). Oftentimes this is followed by a continuation on the trend higher overnight and into the morning. Next, there is often buying that enters the market during the Metal open (namely in Gold and Silver) at 7:20 am. This is not a necessary signal, as it did not occur this morning, but if it does then you have another red flag. Finally, there is usually a flood into Crude Oil on the 8 am open like this morning. We usually see very little break on the rallies leading up to the big buying that enters at 8:30 across all of the market because (and this is partially speculation) you have a large group of prop traders working for these institutions that know the buying is coming and front run the trade themselves (I wish I got peak orders). If you get 2 out of 3 of these signals you can bet that the inflow is coming.

Trade
To take advantage of the trade it is usually best to jump in around 7:30 am, but if the opportunity is not ripe yet then waiting until the 8:30 stock market open is second best. Due to the current volatility and skittishness of the market I still recommend executing this more as a day trade than a position entry as well. There are still likely to be violent breaks in the market and the release of poor fundamental news can always sidetrack a rally. Putting this all together means that I recommend buying dips as the best strategy to carry forward over the next couple months.


Where the Technicals Point

As I look at the market right now the technical leaders among the market are Nasdaq, Crude Oil, Copper, and the Australian Dollar, so I will go through and highlight what the rally possibilities are for each market:

Nasdaq- Short term the market is on the verge of a smaller Bullish breakout that projects a move above 1866.25 to nearly exactly 1950. However, this smaller move would indicate a rally above the previous swing high that would project a larger objective for the market. Because the Nasdaq is downward sloping with a lower previous low I will use the Dow with a higher low as an indicator for Equities. Above 10,536 the Dow projects a move based on the left low to 11,462 or to just above its highs for the year.

Crude Oil- Short term Crude Oil has set off a Bullish pattern above $78.55 that projects a move to $81.48. This move in turn will set off a much larger projection above $80.82 that then has an objective of $91.17.

Copper- Copper has set off a pattern today above $3.1230 that now has a projection of $3.3210. Although the market also came very close to the apex of the triangle consolidation pattern we should also keep in mind the 46 cent projection that has an objective of around $3.52 for the larger move.

Australian Dollar- The Aussie Dollar is stronger technically than the Canadian and with a close above .8772 that provides an objective of .9297 or just above the highs for the year.

In Summary
Most of these correlated markets have shorter term projections, but will likely eventually provide larger objectives through a series of domino moves. These objectives all point towards a macro rally back near the previous highs for the year. Although this is not an exact science and there are a lot of causal what ifs I view this move as a strong rally that will likely unfold over the rest of this month and August.


What to Keep an Eye On and Beyond

Fixed Income
I have repeatedly pointed out that the Fixed Income markets continue to maintain their uptrending rally, so this should be an interesting sidenote to gauge the future action. Money can flow into both risk and risk aversion assets as a hedge, but I still believe that the market is in a mode where only one will dominate. This means that if the macro rally holds true that both the Japanese Yen and Fixed Income should suffer a break in prices over the next month and a half. However, as the Fixed Income markets tend to front run the Equity moves it is highly possible that after a macro rally we could see another subsequent break, as a move that lags behind but follows this drop in interest rates.

European Currencies
The European Currencies should also be an interesting note as their correlation to the broader market is suspect at best right now. We saw during the first half of the year how these Currencies can fall off the table while the rest of the market can simultaneously continue to rally. The Currencies tend to move in a cyclical fashion over a longer series of time and according to a 3 leg wave I still see the Euro at least travelling to par with the U.S. Dollar over a series of time. The duration of this move is still up in the air though and we shall see if the next move is sooner rather than later or swifter rather than slower.

Fundamental Concerns and Cyclical Patterns
I still do not believe that we are out of the proverbial woods on the global concerns that are now front and center in the markets. The European debt and unrest story, Chinese market bubble, U.S. debt and overspending, and unwinding of stimulus plans should continue to develop over time. While the break in the market since late April was rather nasty I believe that this is still more of a precursor to a further market decline either later this year or next. The swings in the market over the last half decade have followed a similar pattern with Currency moves leading roughly six months ahead of Equities and Commodities and Fixed Income moves leading these same markets by roughly 5 months. While this rally looks probable I would still keep a potential larger move lower on your radar going forward. Double top anybody?

Finally

In the Gartman Letter on Wednesday he referred to Tuesday's action as a tectonic shift to begin buying Equity dips off of. Although he did not presume much this was the first place that spoke something about Tuesday's action and led me to my essay today. Nothing in the markets is for sure, but if this picture does unwind just remember that you heard it here 2nd (and with much more detail).

Have a good weekend and I will be back Monday.