Sage Weekly Letter – 3/18/2012

Ten days ago I published a simple blog post entitled “The Chart of the Day” which highlighted the tightening coil in the 30-year US Treasury bond chart – I wrote:  “Federal Reserve ($FED) monetary policy has greatly influenced this market’s movements over the last several years, however, once this market breaks free (rest assured that it will eventually) the move will be explosive.”

Interestingly enough this post was one of my top five most viewed posts ever, I also received over a dozen questions and comments asking for advice on how to play this market once it “broke free”. Last week this happened:

 

Last Tuesday’s action across markets was quite significant as price behavior indicated that the market now clearly holds a view that the worst of the financial crisis/sovereign debt crisis is over. Perhaps most importantly the overall positive results from the Federal Reserve’s bank “stress tests” means that US banks may be ready to lend more aggressively once again which will likely serve to expand monetary velocity which has been sorely lacking during the last few years:

 

The steep rally in equities combined with the sharp sell-off in US Treasury bonds (breakout in yields) and gold ($GC_F $GLD) is the markets way of expressing a view that the “fear trade” is over and the economic recovery is firmly intact while dis-inflationary pressures are much less likely to pose a threat to economic growth. The following chart illustrates the current trends across five key markets (S&P 500 – US Dollar Index – Gold – 30-year US Treasure Bond Price – Japanese Yen):

 

The sharp declines in precious metals ($GLD $SLV) over the last three weeks can be largely attributed to the idea that the Federal Reserve will not be embarking on additional policy easing measures due to the strengthening economic recovery and increasing signs that inflation is at, or even slightly above, the Fed’s target area of roughly 2%. While the dominant fundamental which has driven the gold bull to nearly $2,000/ounce has been Federal Reserve monetary policy, the next leg higher for gold will likely be attributed to loosening monetary policy from other important global central banks such as the $ECB and the PBOC (People’s Bank of China) – the market is likely to be reminded of this shortly.

Meanwhile, equities have continued to launch higher even in the face of rising yields and a strong dollar. The decline of the Japanese yen may be the most important and least mentioned story thus far in 2012 – the decline in the yen is virtually the mirror image of the US equity market ($QQQ $SPY) rally. While it would be foolish not to acknowledge the strength of the uptrend in equities, there continues to be some key warning signs which should serve to curb bullish enthusiasm:

 

Small caps ($IWM $RUT) have not confirmed the breakout across many of the senior equity indices.

 

The Citigroup Economic Surprise Index for the United States continues to trend lower in very similar fashion to declines of the index which preceded equity market corrections in 2010 and 2011. Equity investors should not act or live in daily fear (as we did during the fourth quarter of 2011) of the next shoe to drop in the eurozone debt crisis, however, we should remember to not become too complacent and allow ourselves to be lulled “into a false sense of security”.

The large rising wedge combined with four consecutive daily closes outside its upper Bollinger Band should serve to cool off short term bullish enthusiasm on the $SPY, however, you can rest assured that dips will continue to be bought:

 

While financials ($XLF) served to ignite Tuesday’s monster rally, make no mistake, large cap tech ($QQQ) is the market leader – can the Qs make it 12 consecutive weeks of gains this week?

 

Best Ideas for the Week Ahead:

  • Sell rallies in the Australian dollar and the euro ($AUDUSD $EURUSD)
  • Buy gold near major long term support 1600-1610
  • April/May bear call spreads on QQQ
  • Long gold miners ($GDX below $50/share targeting a move back up to the 50-day simple moving average)
  • Look for a rally back to 113-114 in $TLT – this rally should be faded.

 

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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