9/23/2010 9:16:19 AM

Long-term bonds moved higher in price for the fourth day in a row with heavier than average volume seen in four of the last five sessions. Is the Fed the cause or is it investor angst?

Recommendation:
If DIA price is higher at the close than at the open, sell shares of DIA to close the long position.
If QQQQ price is higher at the close than at the open, sell shares of QQQQ to close the long position.

Daily Trend Indications:

- Positions indicated as Green are Long positions and those indicated as Red are short positions.

- The State of the Market is used to determine how you should trade. A trending market can ignore support and resistance levels and maintain its direction longer than most traders think it will.

- The BIAS is used to determine how aggressive or defensive you should be with a position. If the BIAS is Bullish but the market is in a Trading state, you might enter a short trade to take advantage of a reversal off of resistance. The BIAS tells you to exit that trade on "weaker" signals than you might otherwise trade on as the market is predisposed to move in the direction of BIAS.

- At Risk is generally neutral represented by "-". When it is "Bullish" or "Bearish" it warns of a potential change in the BIAS.

- The Moving Averages are noted as they are important signposts used by the Chartists community in determining the relative health of the markets.

Current ETF positions are:
Long at DIA $102.80
Long QQQQ at $44.76
We are long Oct $106 DIA puts at $185 per contract ($1.85 per share) on Friday, Sept 17th.
We are long Oct $48 QQQQ puts at $94 per contract ($0.94 per share) on Friday, Sept 17th.
We are long Oct $113 SPY puts at $231 per contract ($2.31 per share) on Friday, Sept 17th.

Daily Trading Action

The major index ETFs opened lower and immediately bounced higher in a move that would last just over fifteen minutes. That would market the high of the day as the next four hours were spent in a choppy decline. The afternoon rally wasn't particularly strong and faded in the final hour as the Dow tried to break into positive territory. All the major indexes posted losses. The Russell-2000 (IWM 65.84 -0.79) lost 1.2% and the Semiconductor Index (SOX 330.45 -4.84) was off two percent at its worst levels of the day and finished down nearly more than 1.4%. The Bank Index (KBE 23.04 -0.41) fell most of two percent while the Regional Bank Index (KRE 22.19 -0.64) fell nearly three percent. The 20+ Yr Bonds (TLT 104.61 +0.93) gained most of one percent as investors continue to bid up prices of long-term bonds on above average volume. NYSE volume was average with 952B shares traded. NASDAQ volume was still average with 2.166B shares traded.

In addition to the weekly crude oil inventory report, there was a single economic report of interest released:

• FAHB House Price Index (Jul) fell -0.5%

The report was released a half hour into the session. The prior months number was adjusted from a -0.3% fall to a -1.2% which caused more concern that housing prices are continuing to move lower.

We have been expecting a double dip in housing and found it laughable when pundits were calling a bottom for the housing market. In fact, we believe that the housing market is probably the major factor in impeding growth in the economy. We realize that the unemployment rate affects the overall economy but is acute in its effect on the housing market and continues to influence the double did scenario as well as cause concern for the general economy.

Long-term bonds moved higher in price for the fourth day in a row with heavier than average volume seen in four of the last five sessions. Is the Fed the cause of the move higher in price or is it investor angst? I think it is a little of both, since the Fed is conducting open market operations and has suggested they will continue that course. In fact, the Fed mad it pretty clear that were prepared to do more quantitative easing, which means that they would be buying U.S. treasuries, presumably on the long end of the curve. This creates an environment where investors feel safe in buying fixed income since the Fed will end up buying bonds from them so they don't have to worry about capital losses. This, by the way, is something of a fallacy when the trade is so crowded that the smart money begins to sell even as the Fed begins buying. Still, with the fixed income market about ten times the size of the equity market, when investors pursue fixed income over equities, it has a pronounced effect on stock prices.

Utilities (+0.6%), Materials (+0,4%), Health Care (+0.1%), and Consumer Staples (+0.1%) moved higher on the day with the other six sectors in the S&P-500 moving lower, led by Financials (-1.6%), Consumer Discretionary (-0.7%), and Tech (-0.6%). You might note that three of the four sectors that achieved gains are the classic defensive sectors which amplifies a message. "The risk trade is off, long live the safe trade!" Well, it may or may not be long lived, but preference is for safety now.

Implied volatility for the S&P-500 (VIX 22.51 +0.16) rose modestly as did implied volatility for the NASDAQ-100 (VXN 23.63 +0.37).

The yield for the 10-year note fell four basis points to close at 2.55. The price of the near term futures contract for a barrel of crude oil fell twenty-six cents to close at $74.71. The U.S. government's weekly report showed crude inventory supplies rose by 970K barrels.

Market internals were negative with decliners leading advancers 9:5 on the NYSE and by 5:3 on the NASDAQ. Down volume led up volume better than 2:1 on both the NYSE and the NASDAQ. The index put/call ratio fell 0.33 to close at 1.29. The equity put/call ratio rose 0.10 to close at 0.72. We believe the fall in the index put/call ratio was a serious miscalculation on the part of market participants and that complacency is now high enough that the market will roll over within days, if not on Thursday.

Commentary:

Wednesday's trading saw average volume and only a minor move higher in implied volatility but the negative market internals are worth paying attention to. U.S. equity markets are poised on a knife's edge and are ready to move lower on the slightest provocation. Only the major indexes are in uptrend states with the Russell-2000 moving into a trading state, joining the continually weakening semiconductor index and the bank indexes. In particular, financials continue to lead the way lower and semiconductors never bought into this rally.

I will state this here, and probably will have to restate it in the future. It is not normal for a rally to be led by the major indexes. A solid rally is lead by the leading indexes and followed by the major indexes. The era we live in now has so many HFT (High Frequency Traders), hedge funds, and day traders using the major index ETFs as trading vehicles that the individual securities are being moved by the indexes rather than the other way around. This means that behavioral economics finds that using leading indexes to predict moves of the major indexes is more difficult. Fortunately, there are other ways to determine directional biases.

We saw enough on Wednesday that we are now calling a market top. We don't mean that the market can't move higher before moving lower but we don't believe it will break its current highs. It is enough to signal us to take profits on our long positions. We are going to take the gamble of closing our long positions at the close on Thursday, rather than at the open, since futures markets are significantly lower this AM. Our conditional order will be if the major index ETFs are higher at the close than at the open, we will exit our long positions. Otherwise, we will wait for the open on Friday to take action.

We hope you have enjoyed this edition of the McMillan portfolio. You may send comments to mark@stockbarometer.com.