Asset prices went up across all asset classes on Friday, as stocks, bonds and commodities rallied with the US Dollar Index closing at the lowest level of the year. The equity markets had a spectacular finish after chopping in a tight range till the last half an hour. The energy sector outperformed most of the day with crude oil closing above the $66 level. The closing rally also lifted the materials, industrials, transportation and the banking index, while the Nasdaq closed at a new high for the year.
Yields fall as Bond Buyers Remerge
After the massive sell-off in long dated treasury bonds earlier this week, bond yields have pulled back substantially. It seems bond buyers were waiting for this round of treasury auction to be done before they stepped back. Since yesterday’s highs, the yield on the 10 year bond have fallen from 3.758% to 3.465%, while they fell from 4.628% to 4.338%. The drop in yields provided a much needed relief to the equity markets which were a bit disappointed by the less than expected rise in the first quarter GDP estimates.
Dollar Sells Off
The US Dollar continued the sell-off with the DX closing at its lowest level of the year. The Euro-USD futures (6E) too closed at the highest level of the year at 1.4164, which happens to be close to the 50% retracement (1.4156) of the Euro’s fall from last April’s high (1.5985) to November’s lows (1.2326). Some market commentators are calling for the Euro to continue to rise against the dollar till the 61.8% retracement at 1.4587.
I feel that central bankers outside the US are likely to make noises to stop the rise of the USD. Most of the developed economies are dependent on the US as their primary export market and continuing fall of the dollar will hinder their exports. As a result we are likely to see efforts at competitive devaluation by other nations to stall the fall of the dollar. Some of their actions may be pure jaw-boning to stop speculative traders; others may take specific market measures to help their cause.
The Spectacular Close: Futures Spike 2% in a Few Seconds
What a lot of traders are talking about is the spike in the equity markets at the close. The SPX was trading in the opening range (903-912) for most of the day before it broke through the upper resistance about 15 minutes before close. This seems to have triggered a large number of buy stop orders as the SPX surged into the close.
The move was violent and the SPX futures market, the most liquid market in the world, too got overwhelmed. Though the closing print on the SPX (cash) was 919.14, the ES futures traded all the way up to 927.75 at 4:00PM. The chatter is that there was an order to purchase 2500 contracts of the SPX futures at close entered by a single dealer (JP Morgan according to some). This corresponds to a notional value of $575 Million dollars. This resulted in all the offers to sell between 914 and 927 to be hit. This also triggered a lot of stop orders to buy, adding to the stampede.
Unnatural Market Action: Window Dressing or Something More?
It is common for stocks, especially those which have performed well in the prior month to trade up on the last trading day of the month. This is because of what is called window dressing where fund managers want to own stocks which have performed well to look good to their customers. However the spike at the end was not window-dressing.
There is some speculation that there was an effort to prop up the market into the close to ensure a finish close to the high levels of the month. It is very odd for a major dealer to wait till the close to enter such a large order especially on a Friday which happened to be the last trading day of the month. Liquidity tends to be less near the close on Friday as many traders and desk square out their positions before the weekend.
We are living in an era of significant government intervention in the financial markets. What some call market intervention for the greater good, others call market manipulation. It is not clear what happened today, but it was certainly not normal.
My Portfolio: Trading
I booked some profits on the TLT I has purchased earlier this week when it reached my 3% profit target. I continue to hold the bearish TBT Put spread. My USO put spread is not doing too well as crude oil continues to rise thanks to a falling dollar. Though USO is now at the upper end of the channel it is trading in, I will have to re-evaluate this position soon.
Altered Trading Mindset: Contra-Trend versus Trend Following
As readers may have observed, over the past few months my style of trading has become contra-trend. This is primarily a result of the market behavior over the past year where no trend sustains itself long enough to allow position trading. With sector rotations occurring every day, very few equity sectors are able to sustain their gains.
Over the past month, the macro themed trades like commodities and currencies are finally showing a sustainable trend. However, I have missed out on these trends because I could not reset my trading thought-process to follow the trend. This afraid to hold fear seems to be common theme across many traders. This perhaps is the biggest indicator that though the equity markets have risen in value, the bullishness which should accompany it is missing.
Market Outlook: 200 Day SMA Beckons but Short Interest Missing
The SPX is creeping ever closer to its 200 Day SMA which now stands at 928.60, about 1% away from the close today. This average is coming down about 2 points every day, and it is very likely that we will touch the average next week, especially after the bullish close this Friday.
Many market participants are expecting a big round of short covering once the SPX reaches this level and fresh money pours into the market to chase the rally. One caveat though is the large drop in short interest in the market. According to Bespoke Investment Group, the short interest on S&P 500 stocks is at the lowest level since February 2007, with the average stock having 7% of its float short.The largest decline in short interest was in the Real Estate Group.
The past few months have decimated the bears, who seem to have thrown in the towel. Though this can be bullish in the short term, it also means that any correction may be more severe since there are not that many shorts who will buy to cover during a decline. One can argue that there are so much money on the sidelines belonging to the people who missed the rally that they lack of short interest will not matter.
In any case, we are living in very interesting times with the financial make-up of the world changing dramatically. For an investor it poses significant challenges. At these times, I like to remember that cash too is a position.