The financial markets continued to trade in a choppy manner on Monday. As I had anticipated, the price action on Friday, with the SPX opening at a new high but closing below prior highs (Trader Vic’s 2B pattern), resulted in more selling yesterday. Equity markets gapped down open and were under negative pressure most of the day. However, the volume in the sell-off was low and the markets did not lose any key technical levels. Later in the day, the markets had a wild swing up with SPX erasing all its losses and going positive before selling off into the close. After the zig-zag action, the equities finished closed to unchanged but with a negative bias.
The market is still digesting the implication of Friday’s jobs report. In spite of comments by the government that the recession is far from over, the market is pricing in a greater possibility of an end to the monetary easing policy of the Fed. The yield curve continues to flatten with many traders taking off the curve-steepening trade which has worked very well. The rise in short term rates is forcing a re-evaluation of many assumption underlying the current equity rally, which is primarily a result of excess liquidity in the system (cash on the sidelines, with low borrowing costs).
In my view this flattening is a pure technical reaction as traders exit the curve steepening trades (long short term, short long term treasuries), and does not reflect any sustainable shift in expectations. Regardless of how the non-farm payroll numbers are spun, the economy is still far away from a strong recovery, and higher long term yields are going to put an even greater pressure in keeping growth down.
As anticipated, the dollar continued to strengthen. However after reaching an early morning peak, it weakened through the day, with the Euro finishing almost 1c higher from its lows against the dollar.
Oil is showing remarkable resilience in spite of the strong dollar. Oil was supported by a bullish call by Morgan Stanley, following on the bullish statements by Goldman Sachs last week. Both GS and MS are major participants in the physical delivery oil market, and such calls which help sustain the speculative bias, are helping to strengthen their bottom-lines.
Market Outlook: Choppy Action Will Likely Continue
Late day spikes where the broad market rips up 1-2% in a matter of minutes are becoming very common. Many of these spikes are triggered by short-covering when the market gets over some key technical levels. This shows that though the bearish sentiment has not gone, it lacks conviction. The bears rush to cover at the slightest hint of a rally.
Some bears will take heart from the fact that the market sold off into the close after the spike. Though the inability of the market to hold higher price levels is not strongly bullish, what is the key here is the ability of the market to hold key support levels on the downside. In spite of the sell-off today at the open (and the close), the trend continues to remain bullish. The market did not violate any key technical levels and the sell-off was at a low volume.
I expect the market to continue to display the sideways choppy action as the gains of last week are consolidated and some participants reduce their risk exposure. We are likely to see more intra-day swings, and a retest of the 200 Day Moving average. However, unless the key technical levels of 903 and 880 on the SPX are violated, the trend remains up.