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Front Running the Fed—Mike Swanson
Quote of the month:
“A collapse in U.S. stock
prices certainly would
cause a lot of white knuck-
les on Wall Street. But
what effect would it have
on the broader U.S. econ-
omy? If Wall Street
crashes, does Main Street
follow? Not necessarily.” -
Ben Bernanke, 2007
Inside this issue:
Front Running the Fed 1
Stock Market Traders 5
Feedback on Book 7
How Important was the Rally? 8
Sectors and Stocks 9
To subscribe to this newsletter go to WallStreetWindowMonthly.com—rate $250 per year. OCTOBER 4, 2010
Last month I turned the
stock market barometer
graphic you see on the top
left of the front page of
this newsletter to red.
Now I'm turning it back to
yellow. I moved it to red
because at the end of Au-
gust the S&P 500 was ap-
proaching its critical
1040 support level. If it
had broken that level it
would have entered a full
blown stage four bear mar-
ket and it is still in
danger of doing that going
forward if it breaks that
number.
However, at the beginning
of September it regained
its footing and rallied.
So the market is not in
danger of entering a stage
four bear market for now.
In fact the overall bias
is up for the short-term
in the context of the
long-sideways trading
range that the market has
been locked in since the
start of the year and in
my book sideways means
yellow. Don't get too
scared, but don't get too
excited about buying ei-
ther. The fact that I
moved this graphic from
one thing to another in
the space of a month is a
testament to the overall
sideways trend of the mar-
ket.
Friday night I went to the
movie theater and sat down
with some popcorn to watch
the new sequel to the
Oliver Stone Wall Street
movie. The first movie is
a classic for which Mi-
chael Douglas won an Oscar
for best actor. The se-
quel isn't so good and
suffers from a poor story
and unbelievable final
scene. As a movie it
really is pretty medio-
cre.
It had some neat depic-
tions of the stock market
collapse and financial
crisis of 2008. In it
they dramatized the deci-
sion not to bailout Lehman
brothers and then the
whole collapse of the
banking system and the
bailout a few weeks
later. They changed the
names of course, but it
was neat to see some
Stock Market Barometer
2
scenes depicting it.
In the first movie Douglas's Gordon
Gecko character makes a speech in
which he proclaims greed is good.
In this movie he comes out of jail
and gives a book tour in which he
is shown giving a speech predicting
the financial collapse and explain-
ing accurately exactly why it is
going to happen - and why the sys-
tem had gotten so messed up. If
you haven't seen the first one
though don't go see this one. Just
watch that one it is just so much
better.
Seeing it made me think back to
2008. It is still amazing that all
of the banks got caught up holding
these garbage mortgage securities.
It was obvious it was going to hap-
pen. In 2007 anyone who read a
newspaper and paid attention knew
that the housing market had topped
out and was in a bear market. Go-
ing into 2008 the stock prices of
mortgage companies had been in a
free fall for over a year and half.
I knew all that then. I didn't
know though to what extend banks
were exposed to the mortgage market
until the first quarter of 2008
when I read some articles that
showed the amount of toxic debt on
bank balance sheets that the gov-
ernment was allowing them to mark
up with fictional valuations. Then
in the summer it was public knowl-
edge that Fannie and Freddie Mae
were going to go bankrupt by Octo-
ber.
So that summer there were all of
the classic signs that the stock
market itself was in a bear market
and clear events that you could
point to that would drive the mar-
ket lower.
On one hand it still amazes me how
Wall Street proved itself to be run
by incompetents. Michael Lewis's
book The Big Short explains why it
happened and should be required
reading for anyone investing in
this market. However, when I look
back on then it is also clear to me
how it was crystal clear what was
going to happen, and when you look
at today things are not so clear.
Membership help?
To renew or cancel contact:
3
The market has been going sideways
all year so there has been no real
clear overall trend to the market.
Or to put it another way there have
been no trends that have been sus-
tainable. Sideways markets are
about the most difficult markets to
try to make money in as a trader,
because they tend to confound both
bears and bulls and just cause you
to churn your account.
This sideways trend won't last for-
ever. It will end either with the
broad market averages falling
through their long-term support
levels - which for the S&P 500 is
1040 - or by going sideways for
even longer and then breaking out
into a new big rally by the end of
the year or next year.
Last year in the summer I did a lot
of buying in individual stocks and
made some good money, but I sold
those positions at the end of that
year and in January, because I
thought the huge upward momentum
would come to an end and the market
would enter a sideways phase for
most of 2010 - which in fact is ex-
actly what happened.
I made a little money buying in
February, but when April came I be-
came very cautious on the market,
because we saw the investor senti-
ment numbers reach manic levels of
bullishness while all sorts of
negative technical divergences oc-
curred all in context of the side-
ways trend. I said there wasn't a
sign of a top in the market yet in
April, but didn't think it was a
good time to buy and was mostly in
cash myself.
Then of course we saw the flash
crash day. Much of the TV blamed
that day on a "fat finger" and this
week there have been news stories
claiming that it was caused by a
big order from a financial advisory
company, but whoever placed the or-
ders I took that day as a warning
sign that the overall trend of the
market had changed.
In the weeks that followed the
flash crash I became convinced that
we would not see the market trade
to new highs unless the market man-
aged to stabilize and go sideways
for months. This meant that the
overall risk to the market was now
to the downside and the market con-
ditions worsened once the market
averages went through their long-
term 150 and 200-day moving aver-
ages and stayed below them for sev-
eral weeks, which made me turn
bearish on the market.
I had no interest in going long
stocks so in order to try to make
money the only other option was to
try to trade on the short side. So
I did that, but didn't have any
success, because each of the market
drops that did occur came to an end
at support. Moves to the upside
were no longer sustainable, but so
were moves to the downside. It is
best to do nothing in a sideways
market, but I don't always feel
like I have that luxury.
That is a big problem for hedge
fund mangers who are under constant
pressure to try to beat the market
every month. So that can force
them to try to make trades when
there really aren't any to be had.
So in a sideways market you have
less overall investor interest
since few people are making money.
Volume has faded as a result and
what we are left with are hedge
fund robots and trading algorithms
competing with each other over
short-term gyrations.
4
Individual investors don't have to
face the wrath of angry or impa-
tient investors so they can be pa-
tient and wait for better condi-
tions, but they often succumb to
similar psychological pressures
anyway. When the market goes up
they feel like they cannot miss out
and as the market goes higher and
higher this pressure on them in-
creases. They can't stand the idea
of others making money without them
so they end up buying at tops and
if they succeed at doing that the
market suddenly turns down on them.
In a sideways market that can hap-
pen over and over again to someone.
The best way to make money in a
sideways market is through options
strategies. This is something Ike
Iossif has been doing the past few
months and you can get his options
alerts for free for the next few
months by going to optionsadvi-
soryreport.com. Once you go there
scroll down the page to the opt-in
box. We put together some educa-
tional audio reports on trading op-
tions you can listen to after you
sign up.
Although every single major market
has a similar chart as the US aver-
ages, there are some markets out
there in strong bullish trends.
Gold is trading near an all-time
high. Emerging markets recently
broke out and are in powerful up-
trends as you can see from the
emerging markets ETF EEM. Chile
and Thailand are currently the
strongest stock markets in the
world. There is no sideways pat-
tern to them. While Brazil appears
to be just breaking out too.
If you want to invest in a bull
market those markets are the place
to look. I'll highlight a few of
the best stocks in these markets in
the Power Investor Service this
week.
5
Stock Market Traders Front Run the
Fed — Mike Swanson
Last month marked one of the best
Septembers in years as the DOW ral-
lied 7.7%, which made for the best
September for the DOW since 1939.
Bulls are excited about the rally
and market while bears are wonder-
ing what is behind it. There are
no signs of a big economic boom
around the corner to justify the
stock market going higher. In fact
economic data continues to be weak
and all of the talk is that the
government needs to do more stimu-
lus to boost the economy and the
Fed may engage in more money print-
ing.
In fact I do not think we'll see a
real recovery in the economy until
real estate prices put in a final
bottom. Historically economic
troughs come when real estate bot-
toms and this should be more true
now than ever before, because it is
the real estate bust that destroyed
bank balance sheets and has caused
them to be cautious about lending
out money.
Real estate futures contracts on
the Case-Shiller real estate index
are not projecting a bottom in real
estate prices until later next year
and a recovery in them in 2012.
A few months ago the real estate
futures market was forecasting a
bottom for real estate in the sec-
ond quarter of 2010 so now they are
downgrading their forecast for real
estate.
To me that means that the overall
economic picture for the next 6-12
months is actually worsening in-
stead of getting better.
But the stock market has been going
up the past few weeks.
Why?
A lot of people think its because
of the upcoming Congressional elec-
tions. If you listen to FOX News
that is all you'll hear about. But
I think there is something more im-
portant that traders are looking
at.
You can sum it up in two words -
quantitative easing.
Quantitative easing is when a cen-
tral bank prints money out of thin
air and uses that money to buy gov-
ernment bonds, mortgages, and junk
bonds from banks and other finan-
cial institutions, in the process
they expand their balance sheet and
give banks excess reserves which
they hope they will lend out and
stimulate the economy as a result.
The problem is that QE is a very
difficult policy to implement. The
risk is that a central bank engag-
ing in QE buys too many securities
and then creates inflation - even
hyperinflation is a danger. The
other risk is that nothing happens
and instead of lending money out
the banks just sit on it. When
that happens investors and busi-
6
nesses lose even more confidence in
the economy and lose any hope that
the government can force it to
grow. In my view the latter is a
much greater danger than the former
in the current situation.
We already saw the Fed engage in QE
in 2008 and it had no impact on the
economy. It helped banks, but no
one else. Japan's central bank
used QE in the early 2000's to no
effect.
I first talked about QE in the Au-
gust issue of this newsletter and
said that it would begin to be an
important story to focus on. In
the long-run I didn't - and still
don't - think it will have much of
an impact on the economy, but it
has captured the minds of traders
more than I ever thought it would.
It has helped the market more than
I had originally expected.
Bradley Willet of Fallstreet.com
points out that the current rally
in the market began once Federal
Reserve Ben Bernanke gave a speech
in which he suggested that he would
use quantitative easing if the
economy continues to weaken.
In my view traders and hedge funds
have been buying up junk bonds,
treasuries, stocks, and gold ahead
of expectations that the Fed will
announce QE at their next Fed meet-
ing in November.
This is why treasury bonds appear
to be trading at crazy levels that
make no sense. Why buy a long-term
bond with almost zero yield? The
hedge funds buying these bonds are
doing so in anticipation that the
Fed is going to buy treasury
bonds.
Bulls are arguing that it doesn't
matter what happens with the econ-
omy. If economic data is weak the
Fed will print money. If the stock
market drops the Fed will print
money. Bernanke has in effect cre-
ated a "Bernanke put" on the stock
market similar to the ""Greenspan
put" that led to the moral hazard
that created the housing bulls and
the implosion of Wall Street banks.
James Vale of Beacon Equity writes,
"official statements from the Fed
serve to lower the ultimate cost of
its upcoming massive buying spree
by allowing the PIMCO-led herd to
feed at the trough first, other
less-connected fund managers to
feed second, and the public to pick
up the remaining feed last in order
to reduce the appetite needed from
the Fed to reach its objectives re-
garding interest rates."
"Whether QE II becomes official at
the FOMC meeting on November 3, De-
cember 14, or as far out as January
25, PIMCO’s Bill Gross and his ri-
vals have already scaled into as-
sets expected to benefit from the
coming tsunami of printed cash by
the Fed—and in amounts equivalent
to QE I, at least."
A month ago rumors were that the
Fed would do one big one trillion
plus QE buying program, but now the
Fed has been leaking stories to the
Wall Street Journal that they are
7
thinking of buying smaller amounts
of bonds multiple times spread out
over several meetings. One goal is
to bring long-term bond rates down
to below 2% in order to help the
mortgage refinancing market in
2011.
Bank of America projects that the
Fed will push 10-year treasury
rates down to 1.75% in the first
quarter of 2011.
Traders are positioning themselves
in front of QE. The big question
is what happens when QE comes?
The market still has heavy resis-
tance at its April highs and is
unlikely to be able to create a
sustainable rally through those
levels without first reaching them,
having a big pullback off of them,
and then going through them again.
That is a process that would take
the rest of the year to play out
and part of it would be a move to
those highs that would simply trap
a lot of people who buy into them.
It is just as possible that the
market rallies near those highs as
we reach the November Congressional
elections and a Fed QE announcement
and then it peaks on the news and
falls all of the way back down to
the 1040 level on the S&P 500.
What will be important to watch are
investor sentiment readings. If
sentiment gets as frothy as it did
last January and April in a few
months then we'll have be on guard
for another nasty sell-off like we
saw in May - in fact it would
probably be worse. But until sen-
timent gets all bulled up like that
for now the momentum for the this
month should be sideways to up with
a likely dip to start the month due
to the market's current overbought
condition on a daily chart.
Some Feedback on My New Book Stra-
tegic Stock Trading
A reader asked: "I have a QUESTION.
A lot of your examples cover the
2000-2003 period when you illus-
trate actual techniques. We all
know there are lots of techniques
which have their day, like OBV. My
question is whether you back-tested
these techniques on more recent
data, and whether they still have
the same power. I think you could
do it on Telechart.
In fact, I'm going to write up some
Telechart screens devoted to these
techniques. You stated them more
succinctly and specifically in the
book than you do here or in the
videos.”
Thanks for the comments! Awesome!
Actually the section of the book
about picking charts and stocks I
wrote a few years ago so that is
why the charts are from that time
frame. You can find charts that
are exactly the same last year.
Many of them in fact. One reason I
turned bullish on the market last
summer and started buying is be-
cause I was finding dozens of them
in June and July. This year there
aren't so many of them, because the
broad market has gone sideways so
much.
You might want to check out stock-
finder. This is another screening
product put out by the same people
who make telechart. It is a simi-
lar program, except it allows you
to make much more complicated
scans.
8
How Important was the move
we saw this past month? by
Andy Emerson & Kevin Amos
It couldn’t get any better for the
bulls. At the beginning of the
month the markets were oversold
short term and near the lows of
their yearly trading range. The
market was as close to entering a
stage four decline as possible.
What happened next was one the best
rallies the markets have seen in
years over the course of a month.
Where we’ll spend the rest of our
attention is when and where is this
market going to decide if it’s go-
ing to be bullish in the months to
come or is the bears just lying in
wait.
The most important part of this
whole rally was that the averages
were able to make higher highs.
This completely changes the charac-
teristics of the markets and one
has to take notice.
Now moving forward then we feel
it’s time to start looking at the
markets for places to start buying.
As for now the averages are con-
solidating and the SP 500 is trad-
ing sideways under 1150.
Even though the index is overbought
we feel it’s a good chance that the
averages will make a run at the 52
week highs before making any size-
able pull back, therefore in these
condition one has to be very selec-
tive in his buying and only buy
stocks that are healthy techni-
cally.
Below is a chart of the SP–500 and
the short term move we see in the
averages. Clearly above the 150 day
moving average in red ( bullish )
and for the short term the 50 day
moving average in blue is about to
cross up and through the 150 day
moving avg. ( bullish ).
Now for the longer term chart and
the one where we feel it’s a safer
bet to let the market show us be-
fore jumping in with both feet. If
the markets test the highs great,
that would be bullish but then it’s
super overbought and a pull back
will occur. It’s this pull back
where we really get excited about
buying. This could take months (
first of next year stuff) and that
takes patience, but then we’ll be
sure it’s truly bullish. Below is
what the chart would look like on
the pull back.
9
Sectors & Stocks There was an improvement across the
board in the indices, sectors and
stocks. Looking at the S&P 500
there fifty-four percent of the
stocks that make up the index are
now trading in a stage two advance
or consolidation range above their
long term trading ranges. Looking
at the industry groups it is even
more positive with sixty-one per-
cent trading above their long term
moving averages. These are some of
the most interesting sectors for
buying:
INTERNET
TRANSPORTS
INTERNET
10
CHEMICALS
AIRLINES
Below is a list of the under per-
forming sectors.
FININCIALS
BANKS
HOSPITALS CONSUMER STAPLES
11
PAPER
SEMIS
Now lets take a look at some of the
better performing stocks that could
be accumulated on pullbacks or some
that could be bought on breakouts.
In looking thru the sectors these
stocks were either the leaders of
their sectors or ones which have
the potential for a breakout to the
upside.
MOSY
HSTM
BROKER DEALER
12
ANAD
CVLT
BVN
ACV
RHT PRGO
13
PEP
AGN
CCE
SNMX
CCK
GSS
14
HRL
ECL
DUSA
Here is a list of stocks that we
are tracking also.
OREX PFE FIRE UTHR CERS SA SLXP
ILMN ENR SLGN CMP ORCL CLX SMG RGLD
GG ABV SGEN CVLT AKRX BMC INTU OPNT
BLL TQNT SATC QUIK OPLK INCY LXK
SLM IPAR CHKP ENLN PRX KMP GPK PCYC
KOF PRGS SAM AEM ABUT AEZS YGE BLPC
STV BPL OFO APL AZK VHC EGO KGN SOL
WES EXAS SXL RIC AMRN ONCY.
Again the stocks listed and the
stocks that are charted out here
are stocks that are either perform-
ing well within their sectors and
could be bought on pullbacks or
stocks that have the potential for
a break out to the upside and could
be bought accordingly.
15
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