Cliff Wachtel's  Instablog

Here’s a review of the key market movers and highlights for the prior week, and  the lessons they suggest.

The short version: For short term traders, forget the waves of bad news on the Mideast, EU, China tightening, US jobs and spending weakness. The S&P 500 daily chart below shows a strong long and short term trend higher that we don’t fight until we have evidence of a reversal, or at least a pullback.

S&P 500 DAILY CHART COURTESY OF ANYOPTION.COM    26feb 20 0633

Most major stock indexes, commodities, and risk currencies ended the week higher, closing at or near multi- month or year highs. For example:

• US stock indexes closed the weak about 1% higher

• Every major currency was up against the safe-haven USD, except for the even safer-haven Yen, which closed the week flat against the Dollar

The continued rally in risk assets is especially impressive considering the technical and fundamental reasons markets have to pull back

Bearish Technicals

It’s unusual to see risk assets rally this long (over 10 weeks) without at least a normal pullback of 5-10% to test support. It’s widely believed that a pullback should happen, though that’s been the case for a while now.

Multiple Sentiment Signals of Overvalued Equities: See here for just one example of a regular stream of reports that bullishness has reached levels typical of a market top.

Bearish Fundamentals

• Chinese Tightening: Yet another Chinese hike on reserve rates for its banks in order to slow the world’s leading engine of growth.

• Ongoing EU Tightening: Not only the PIIGS nations but most of the wealthier European nations are cutting government spending

• Persistent rising costs of living, personal and government debt, accompanied by shrinking incomes, as exemplified by this report.

• Mideast political turmoil: Violent demonstrations for reform have now spread to the oil-rich gulf state Bahrain, prompting one Saudi prince to note (here) that even the wealthiest Gulf States like his own are at risk of a similar fate, casting uncertainty over nearly half of the world’s oil production.

• Continued Deterioration In The EU Sovereign Debt & Banking Crisis: The latest events this week include:

• Soaring Portuguese bond yields prompting pressure to accept a bailout and accompanying additional austerity measures from Germany. Unclear whether Portugal will be politically able to sustain more cuts, especially if the new Irish government visits  its own ‘day of rage’ on its creditors

• Uncertainty ahead of the February 25^th Irish elections that could well seat a government determined to renege on a portion of Irish bank debt, which could in turn ignite a wave of similar actions among the other PIIGS. That risks destabilizing the EU banking system that owns most of these bonds

• The EU expands its  loan fund to help PIIGS but we all know that loading more debt on those that cannot repay their current debt load is at best a stopgap measure to buy time, and at worst a recipe for even bigger losses later.

• Continued Signs of Banking Instability Worldwide: In addition to ongoing concerns for banks worldwide, be it continued US real estate weakness and foreclosure fraud troubles, the threat of PIIGS bonds defaults for EU banks:

• Increased EU bank borrowing from the ECB reported late this past week, suggesting at least some EU banks are having trouble accessing normal lines of credit

• Ireland halting capital injections to banks until after the February 25^th elections

• A recent bailout for major German lender WestLB after failing to establish a restructuring

• South Korea’s JoongAng Daily reports on a crisis among savings banks, featuring small scale bank runs that threaten to engulf the entire industry. See here for details.

• EU, UK expected to begin tightening as early as spring 2011: That usually spells the end of a bull market in stocks, as we were reminded this past week in a Morgan Stanly (MS) report here.

• Market Leaders’ Pullback: While most stock indexes head higher, assorted sector leaders like Apple (AAPL),  Goldman Sachs (GS),  Netflix (NFLX), Molycorp (MCP), and Chipolte (CMG) have shown recent weakness.

The Bullish Forces That Have Prevented Even a Normal 5-10% Technical Correction

Continued low rates and stimulus favor riskier investments: its old news but bears repeating, and we see regular reminders in the press that stocks tend to stay aloft while rates remain low, as noted here in a report from Morgan Stanley (MS) that includes chart showing the strong correlation between Japanese stock market performance and interest rates. In addition, there are reasons to believe that both the Fed will continue with additional stimulus (QE 3) going forward as reported here. The same goes for the ECB regarding the PIIGS, it continues to do all that is needed to avoid any kind of default.

Desperate Boomers Take Risks: Per a Wall Street Journal report this past week, the majority of the Baby Boomer generation is tempted to try to quickly rebuild decimated retirement savings via the hot stock market and/or high yield fixed income investments. Equity funds continue to see large inflows of new money that goes directly into stocks.

Optimism That Much Of The Above Headwinds Will Be Overcome in 2011. As reported by Cullen Roach here.

Regardless of how many bearish warnings we’ve seen, or how irrational markets may appear, we don’t fight the trend or the bullish forces that have been triumphant for most of the time since March 2009. We have to respect the strong pro-risk asset trend and resist the temptation to try to fade it before it actually reverses.

That means bears either stand aside or take long positions at relative support areas for short term trades with appropriate stops.

Equities and ETF Traders: Long individual stocks, indexes,  or their related ETFs: SPY QQQQ  DAX, FRC, DB and STD.ETFs for some of the stronger trending commodities and risk currencies: AUD FXE, FXB,GLD, SLV, CORN, GRU.

Forex and Commodity Traders: Trade precious metals, oil, copper, grains and soft ags, as well as  risk currency pairs that are in solid trends directly.

Binary option traders follow the daily trends for hourly or daily call options on these risk assets, again ideally attempting to enter when these pull back to near term support or break through near term resistance.

For a review of coming week market drivers and how to play them see Part II on coming week market drivers.

Disclosure: Author is short the EUR for personal portfolio with no leverage as a multi-week trade awaiting a EUR breakdown as the reality of restructure dawns.

Disclaimer: The above is for informational purposes only and not to be construed as specific trading advice. Responsibility for trade decisions is solely with the reader

Related posts:

1. COMING WEEKS’ MARKET DRIVERS: EU DÉJÀ-VU, HOW TO PROFIT TOO
2. WEEKLY CALENDAR THEMES, HIGHLIGHTS, MARKET DRIVERS: BEWARE PACKED WEEK AHEAD
3. Key Market Movers for the Coming Week: Will Bullish Continue to Be Bearish?
4. KEY MARKET DRIVERS FEB 7-11: Continued Stimulus Hopes Keeping Markets Aloft
5. Key Market Drivers January 17-21, Trading Ramifications, EU Spring Meltdown?