DNA Decoder's  Instablog

As bond yields approached and played around the 7% mark on Italy and Spain respectively, once again politicians began to yield. At the end, it was basically Angela vs the world. The rules on how the ECB will keep injecting liquidity into the banking system of troubled countries have been loosen up a bit. The market has received with open arms the ECB meeting output and it's cheering for now. It has been proved once again that the bond market is the boss. Everybody starts to yield near 7 MPa of pressure (just above 1,000 psi). As a matter of curiosity, that's around half the yield strength of human skin.

"I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody."

- James Carville, political advisor to president Clinton

Almost all market conditions and technicals were ready and set to run hard to the sub-1280 levels right before the meeting. Many of them are still present. But, even though this was not a bazooka shot, I think it is a game changer. Is it the end for the bears on the short term? It's difficult to say, but my hypothesis about going back to 1,266 or 1,250 seems farther to reach today than yesterday. It's possible that we will not be able to buy again at those levels for a while. We will see about that.

The important thing here is not to loose focus on the long term horizon. The printing virus will slowly proliferate around the world. As I pointed in my previous articles, I've been buying undervalued stocks on panic dips, and I sustain that strategy is better than trying to trade on short-term speculation, specially when the stress is so high, as shown by the bond market. No matter the conditions, you don't fight the central banks. It's no time to be a perma-bear, even if the economic data doesn't look right.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

According to technicals, the output of this European meeting will be...

(drums...)

nothing spectacular for the bulls.

An image with a thousand lines speaks a million bears...

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Quick bearish observations:

1. The market is playing a short-term symmetric triangle, which may mean downward continuation.
2. The FED speculation rally (which began fiercely with a candlestick pattern that has a close enough resemblance of a morning doji star) did not surpass the 62% Fibonacci resistance.
3. The 38% Fibonacci support could not hold the disappointment slide.
4. It is highly probable that the market is just starting the third impulsive fractal inside a third ugly downward wave.
5. The last candlestick is a "hanging man". What a way to scare the bull army eh?

Ross: [cutting the rope on the tree] Why did they hang him so high?
Cogburn: I do not know. Possibly in the belief it'd make him more dead

- True Grit (movie)

In short, technicals are confirming what we already know:

If the meeting output is not good enough, we are going down (which goes in accordance with the hypothesis I discussed in previous articles). If that turns out to be the case, the bond market will let us know in the coming days/weeks how much stress is needed for the politicians to yield and for the central banks to stop saving their bullets for later.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Currently, the P/E ratio average for the S&P 500 stocks is approximately 15. That's around the historic average. Then why many stocks look so cheap?

It depends where we look at. The financial and basic material sectors have suffered a lot of pain, while that's not the case for other sectors...

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The stock market performance for the past 12 months shows an impressive symmetry when segregated by sectors, which shows that the "risk-on"/"risk-off" portfolio approach within the stock market is flowing in accordance with the main "stocks or bonds" theme. Defensive sectors have performed better. That can be seen on the Utilities Select Sector SPDR ETF (XLU), the Consumer Staples Select Sector SPDR ETF (XLP) and the Health Care Select Sector SPDR ETF(XLV), which are positive for the 12 trailing months.

The Financial Select Sector SPDR ETF (XLF) and the Materials Select Sector SPDR ETF (XLB) have been abandoned by investors.

From a contrarian standpoint, I'm confident that the bulls will start to take command in some industries inside the basic materials sector sometime within the next 6 to 12 months. The bleeding has been intense for some. The "poster child" for the oversold community is the mining industry. Rising capital expenditures mixed with an industrial downturn have left the mining stocks in ruins. Check the Dow Jones US Mining Index ($DJUSMG) compared to the Dow Jones Industrial Average Index ($INDU) as a ratio below...

(click to enlarge)

The mining industry has been going down faster than the downward velocity of the Dow Jones for a long time. The SPDR Dow Jones Industrial Average ETF (DIA) can be used for the ratio too.

The SPDR S&P Oil & Gas Exploration & Production ETF (XOP) shows that the oil industry has been punished too and is surely filled with good opportunities. The accelerated recovery that the oil barrel price experiences when the markets turn bullish, the contango and the OPEC supply control, they all make the oversold oil stocks an excellent choice in my opinion.

Good old giants like McDonald's (MCD), Apple (AAPL), Microsoft (MSFT) and Intel (INTC) will surely receive a lot of attention when the markets turn around, along with any quality company with a good balance sheet that offers a good dividend.

We should be close to the climax in this drama and the stock market should find its bottom this summer. I think we will be in better shape by the time Santa is cleaning the chimneys with his big belly. By then, the chupacabra should have disappeared like he always does, at least for a little while. I currently have a medium to long term investment horizon (6 months +) and I'm buying undervalued stocks on the dips.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.