Is the Market Really All Good?

Includes: DIA, QQQ, SPY
by: Gary Tanashian
It's All Good

I was surfing through radio stations Friday night while on a short drive to pick up a pizza. Hoping for a good rock song, I instead landed upon an economic expert speaking ever so authoritatively on National Public Radio. I am pleased to report to you that [paraphrasing him]:

As far as the ongoing financial crisis is concerned, the worst is behind us. We are not completely out of the woods, but the Fed has done an amazing job of providing liquidity to the banks. We have had a massive commodity bubble that has been responsible for the US Dollar's decline, and now that bubble is bursting. Again, the worst is behind us and it is time to restore confidence in the financial system.

There you have it, the old "inflation is caused by rising prices" canard. I am not going to waste virtual ink dispelling this foolishness. If you are reading this on or on the websites that regularly publish my work, it would be an exercise in preaching to the converted anyway. So the question at hand is do we believe all the happy talk that has suddenly overrun the major media or not? Here is another example of it: The US financial crisis is over.

All this and more came just days after Bear Stearns' (NYSE:BSC) bleeding was stemmed by desperate measures designed to limit the damage a domino effect would have inflicted on all parties doing business with the company and, by extension, all parties doing business with those parties and those doing business with them and so on and so forth. When you have leveraged derivatives in play that have no market and that nobody can really quantify, you do not want dominoes to start falling.

My friend Otto Rock had a look at what may be going on concurrently where hedge funds - heavy players in the commodities markets - may have seen their margin terms cut drastically during the same week that the insolvent likes of Fannie (FNM) and Freddie (FRE) have had their capital requirements eased by the OFHEO. Da Boyz is certainly pullin' out all da stops and you just gotta hand it 'em - pure genius!

Where's the Herd's Psyche At?

I have long since known something was way messed up in the financial system, as likely you did. But as a trader I want to be right, regardless of whether or not I agree with the talking heads. Market sentiment has been front and center both to the downside and now, apparently, as the market bottoms and turns up. The important question is whether this is the deal of the century or simply a collective group hug and endorphin release as bi-polar players swing to the other side, from despair/panic to hope/euphoria. Let's look at the VIX:

The current would-be market bottom - whether short term or something more lasting - was telegraphed well by sentiment extremes. I used the 20 day ema of the put/call ratio, but really all you had to do was turn on a TV, radio, access the internet or have a conversation with your neighbor or co-worker to know that sentiment was getting mighty bearish out there. And, an acutely bearish public is a recipe for reversal.

I actually like many of the charts I see out there including the much maligned, post-crash Philadelphia Housing Index. I like the daily charts of the Dow and Nasdaq. I like Microsoft (NASDAQ:MSFT), which I own along with a few other bull positions, and frankly I am ready for a nice, extended rally and a break from the media's constant harping on declining markets and economic meltdown. But first Da Boyz needs ta break the VIX out of this ascending triangle - and the break had better be down. Because if it breaks up, the target is VIX 56, and that level would be a record for the current VIX formula and would threaten the highs last seen in 2002 on the original VXO formula.

Precious Metals & Commodities

Here is where the most danger is for investors, with the bursting commodity bubble and all. Then, there is the gold bubble, populated by a bunch of crazies who never came out of the 70's. Do you sense the sarcasm in my tone? See the March 14 HUI chart and analysis at the COW for the technical reasons for my cautious stance heading into last week's gore fest. Regardless of any manipulative reasons for lighting the match, any spark was likely to bring a reaction of some sort. As it turns out, we got a biggie.

Note that while HUI did not hit the no brainer buy opp of 400-415, it came close and positions were added to on Thursday. The gold stocks have certainly gone contrary to the market, as they should do. But that sword cuts both ways on a short term basis. I would not necessarily hold my breath for a strong rebound as the margin clerk is likely to come a callin' soon. New lows and our 400-415 level are certainly possible.

What we actually have here is either a short term bottom in the markets and another leg down to be signaled by the VIX or something more lasting, upon which paper myths may be revived. What we do not have here is a financial system that is being repaired. Either policy makers' efforts will be successful and we will proceed to the next round of heightened inflation effects or they will fail and it's "last one out, turn out the lights".

I have worked up one of those crazy "everything but the kitchen sink" charts for you to ponder. I will leave you with this chart so that you may think about it in conjunction with the above analysis. Draw your own conclusions.