Tuesday, July 31, 2012

For the Second Straight Day Stock Pull Back Ahead of FOMC Announcement

The day kicked off with decent economic numbers as well as consumer confidence figures. The Chicago PMI was better than expected and after a bout of disappointing economic releases last month. This was a bit of good news albeit not great. However, stocks weren’t able to hang onto to gains as sellers took hold of the day. Volume ran higher throughout the session, but end-of-month rebalancing kicked it up quite a bit at the close. Finishing near the lows of the session, but unlike previous sessions the losses weren’t that bad. Heading into tomorrow’s Federal Reserve rate announcement the market is clearly expecting another round of quantitative easing and will be certainly looking for the central bank to deliver. For our trading it does not matter much whether or not the Federal Reserve decides to monetize our debt further. We only care about trends and if we get one we go with it. Sure, a policy debate can be made the Federal Reserve is simply kicking the proverbial can down the road. In reality, our trading relies on price action rather than opinion. Even if the Federal Reserve does announce a new money printing scheme does it guarantee the stock market goes higher? It will certainly help out precious metals and commodities, but there are no guarantees. Follow the price action and know your exits as you can possibly figure out how prices will react to any news. Yesterday’s commentary I briefly mentioned sentiment. Bill Gross the self-proclaimed (unconfirmed) Bond King penned an article claiming stock returns are essentially a Ponzi Scheme. He may be right or wrong, but aren’t Treasury Yields essentially the same thing? Social Security, while not illegal by the government standards relies on the same fundamentals. You need more investors to pay off current ones. A big reason Social Security will run out of money (other than Congress stealing from its coffers) is there will be more retirees than those paying into the system. Social Security does not pay out on the profits it makes from investments, but from the new ones who are paying into the system. Regardless of the topic at the end of the day, a bond guy writing an article about stock returns (mind you, PIMCO just recently opened an equity arm) is quite interesting here. Hidden agenda? There has been research regarding bond yields and stock returns. Interestingly enough a rising bond yield correlates well with a rising stock market. Why? As bond prices fall (people selling) the capital flows from bonds to equities. It doesn’t take a rocket scientist to see the correlation there. Since 2008 we have seen an unprecedented amount of cash flow into bonds and outflows in equities. When will this trend break? If and when the trend does break will capital flow to stocks? The answer lies in trend following and with Big Wave Trading. Tomorrow’s Federal Reserve meeting will bring on an exciting afternoon. Have a game plan and trade it. We’ll be enjoying the fireworks as others scramble to get into positions.

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