Traders Worry That April 27 Could Derail the Bull Market

Traders are saying the scariest moment of the second quarter will be on April 27, when Federal Reserve Chairman Ben Bernanke will hold the first ever press briefing following a monetary policy decision by the central bank.

This change in the Fed’s communication with the markets alone is enough to give investors the jitters, but the nervousness is compounded by the anticipation of a signal by the Fed chief as to whether the quantitative easing that has fueled this bull market will continue past its stated end date in June.

“I think Bernanke wants to continue to ‘QE3,’ but the rest of the Fed does not, and if he has to admit that on the air, it could be the turn,” said Steve Cortes, founder of research firm Veracruz LLC.

Stocks flirted with a new bull market high on Thursday as the first quarter came to a close. Two weeks ago U.S. stocks looked like they were headed for a correction as turmoil in the Middle East, the earthquake in Japan and weak consumer and employment data in the U.S. combined to bring the bears out in force.

But just like every time during this teflon two-year bull market, the bearishness could not even result in a normal 10-percent correction. After a seven-percent pullback in the S&P 500 , the market is back near its highs.

The momentum and durability of this bull market can be traced back to a single event that took place at the end of last August, investors said, when Bernanke first signaled that a second round of quantitative easing was likely coming.

“I believe that additional purchases of longer-term securities, should the FOMC choose to undertake them, would be effective in further easing financial conditions,” said Bernanke, in a speech at the Fed’s Economic Symposium in Jackson Hole, Wyoming on Aug. 27. In November, the central bank would formally announce plans to purchase $600 billion in long-term Treasury securities by the end of June 2011.

The S&P 500 is up more than 25 percent since that Jackson Hole speech as the second round of easy money inflated asset prices and pushed investors to take more risk. The fate of this program, and the possibility of a third such asset-purchase plan, could be signaled at the April 27 briefing.

“I would anticipate a giant ramp up in volatility ahead of this press conference,” said Jon Najarian, co-founder of TradeMonster.com. “Traders react to one word removed from a paragraph in the policy statement and now he’s going to hold a press conference?”

To be sure, while just about every trader will acknowledge the added liquidity has played a hand in the bull market, many still see it continuing on when it ends. They cite the improvement in company earnings and the money still on the sidelines following the credit crisis, among other things.

“The negative concern d’jour is that when ‘QE2’ ends in June, the market will trade sharply lower and the bears will be proven correct,” said Laszlo Birinyi of Birinyi Associates, in his monthly newsletter to clients. “Perhaps, we don’t know and quite frankly do not think that they do either. Bears, however, attribute the entire rally to the Fed’s buying, but we think that is an overstatement.”

One fact that points to this rally being primarily Bernanke-based is the amazing breadth of the gains. In the last 12 months, just 50 stocks in the S&P 500 are down more than 5 percent. It is a bull that is essentially lifting all boats, on low volume to boot.

“The end of ‘QE2’ could induce a 10 to 15 percent correction,” said Peter Boockvar, equity strategist at Miller Tabak. Since the second leg of this bull market began so closely to Bernanke’s Jackson Hole speech, “to think that the program will end and the market won’t anticipate and respond lower, I believe, is wishful thinking.”

Updating the Strong Correlation in 10 Year Yield and SP500

When we think of inter-market positive relationships, most of us think of Stocks, Crude Oil, and Gold (among other commodities) as highly positively corrlated and that’s true.

What doesn’t come to mind immediately is the very strong positive correlation in the 10-year Treasury Note Yield and the S&P 500.

It’s an important relationship that traders take for granted, so let’s take a look at the current update:

The Black line is our old friend the S&P 500 index and the red line is our lesser known friend the 10-year Treasury Note Yield.

The right side of the chart is scaled in terms of Yield, wherein 30 equals 3.0% and 35 equals 3.5% in yield (this can be confusing at first).

As you can see, stocks and yield move strongly together – rising and falling at almost the exact same time.

While each little wiggle and sqiggle doesn’t line up perfectly, the general swings and trend do align positively.

We’ll see the actual price chart of 10-year yields in a moment, but the main idea is to get an update on the relationship over the last 6 or so months – namely from the September stock market bottom when Chairman Bernanke announced rumors of impending QE2, which changed the intermarket structure until the present, namely in favor of inflation.

That being said, let’s now look at the 6-month chart of 10-year T-Yield:

While stocks bottomed at the start of September, yields bottomed a month later in October and have rallied (along with stocks) non-stop except for the start of 2011 when the yield flatlined at the 3.5% region (an important number).

There was a lot of talk of yields at the 3.0% resistance but once that broke in December, it was a “no lookback” policy as the yield – and stocks – traveled higher.

February saw a big spike-up to the 3.7% area – shy of the major psychological 4.0% area – and then the yield declined in the same “ABC” format as stocks did – falling sharply during the Japan crisis situation.

Similarly, yields broke back above their key resistance levels – like stocks – at the 3.3% and 3.4% levels in a 45-degree angle move up to where we are now, back at the 3.5% region.

What levels are important to watch?

It’s going to be the dual EMA crossover at 3.4% and move important than that will be the 3.3% horizontal pivot then the 3.2% “2011 low” that was made similarly in stocks.

It goes without saying that, unless something major thwarts the strong positive relationship temporarily – stocks and yields will trend up or down together, so you can look at both markets in terms of key levels and chart expectations and IF/THEN statements (trades).

When calculating your Intermarket Analysis picture, be sure to include Treasuries/Bonds – (prices and yield) – into your work.

The bond market competes with the stock market for investor capital and serves as a “Risk Off” market (stocks are “Risk On”) – thus bond prices are inverse stocks and bond yields are correlated to stock movement – but that’s a whole other story.

Corey Rosenbloom, CMT

Harry Dent: “Major Crash” Coming for Stocks, Commodities Already…

America's No. 4 Auto Maker? Tesla Leaps on Bullish Call

After being upgraded and declared “America’s Fourth Automaker” by Morgan Stanley, shares of electric auto

maker Tesla Motor soared more than 13% Thursday morning.

Morgan Stanley upgraded Tesla to “overweight” from “equal weight” and predicted the company can hold 3.6% of the global auto market within ten years, Dow Jones Newswires reported.

Analysts at Morgan also reportedly slapped a $70 price target on Tesla, implying the stock could more than double by the end of the year.

Wall Street cheered the bullish note, bidding Tesla’s stock up 12.02% to $23.61 Thursday morning. The rally trimmed Tesla's 2011 loss to 10.9%.

Palo Alto, Calif.-based Tesla says it is the only U.S. auto maker that builds and sells highway-capable electric vehicles in serial production.

Tesla badly trails America’s largest auto makers: Ford (F: 14.91, +0.05, +0.34%), General Motors (GM: 31.03, -0.52, -1.65%) and Chrysler. Toyota (TM: 80.25, -0.71, -0.88%) is the world’s largest auto maker.

However, Morgan Stanley predicted 5.5% electric car penetration globally by 2020 and 15% in 2025, Dow Jones reported.

The 30-Year Fixed-Rate Mortgage Inches Higher

The Freddie Mac weekly update on mortgage rates is out today. The 4.86% rate is the second weekly rise following the five-week decline from the 5.05% interim high reported on February 10th. The first chart features an overlay of the 30-year fixed rate (excluding points) with core and headline inflation based on the Consumer Price Index since 2007. In light of the ongoing crisis in residential real estate, this data series is one I've been following closely.

Click for a larger image

Here is a long-term view of the complete data series from Freddie Mac, which dates from 1971.

Click for a larger image

Fed Official Sees Higher Rates by Year End

WASHINGTON—The president of the Minneapolis Federal Reserve Bank said Thursday the Fed may need to increase short-term interest rates by year end if underlying inflation rises as he anticipates.

Narayana Kocherlakota, in an interview with Dow Jones Newswires and The Wall Street Journal, said that if the U.S. economy grows at about 3% this year, as he expects, and underlying inflation ticks higher, as he expects, then the Fed will end its $600 billion bond-buying program as planned in June.

He expects core inflation (inflation excluding volatile food and energy prices) will rise from about 0.8% late last year, when the Fed launched its bond-buying to about 1.3% by year end, he said. As a result, lifting the Fed's target for short-term interest rates by more than half a percentage point late this year is "certainly possible." He noted that the often-cited Taylor Rule, named for the Stanford University professor who devised it, would in that circumstance call for a ¾-percentage-point increase in rates.

"If you consider monetary policy was appropriate at the end of 2010...and then you see core inflation go up by 50 basis points over the course of 2011..the usual response that we know from 20 years of thinking about monetary policy (or even more) is to raise the target rate by even more than that increase in observed inflation," he said. "So that means you should be raising the target rate by more than 50 basis points."

The Fed dropped its short-term interest-rate target nearly to zero in December 2008 during the financial crisis, and promised to keep it there for "an extended period." Trading in futures suggests markets anticipate a Fed increase to 0.5% early in 2012.

Mr. Kocherlakota is one of the five regional Fed presidents with a vote on monetary policy this year, along with the Washington-based Fed governors. He is a swing voter on the Fed's policy committee, who isn't clearly aligned either with hawkish Fed officials who tend to favor tighter credit or dovish members who tend to favor looser credit

Two other regional Fed presidents with votes—Charles Plosser of Philadelphia and Richard Fisher of Dallas—have expressed concerns about inflation and suggested they would favor raising rates in the near future.

The Minneapolis Fed president, a former academic, said he expects a "pretty big upward movement" in core inflation—that is inflation excluding volatile food and energy—which he considers the best predictor of where overall inflation is.

Mr. Kocherlakota also said that the Fed's second-round of bond buying, known as QE2 for "quantitative easing," was more potent than he anticipated when he and other Fed officials launched it last year. It raised near-term inflation expectations, then dangerously low in his view, by more than he anticipated, measured by financial market indicators.

Mr. Kocherlakota said when the Fed decides to tighten monetary policy, he favors raising short-term interest rates over selling assets by the Fed's portfolio, primarily because the Fed has a firmer understanding of how interest rates affect the economy.

The goal would be to raise the federal-funds rate, at which banks lend to each other. The means would be novel for the Fed, namely raising the rate that banks earn on excess reserves kept at the Fed. Raising that rate would pull up the fed-funds rate and bring up other short-term interest rates.

The central banker shrugged off the effect of recent global shocks, such as the crises in Japan and the Middle East, on the U.S. economy as "relatively small."

"There's a more psychological channel of how these uncertainties impact financial markets," he said, citing the European debt worries last year, but didn't appear too concerned.

A number of private-sector forecasters have recently cut their expectations for growth in the U.S. economy. Mr. Kocherlakota said he has lowered his own forecast, but not by as much as private-sector economists.

Since November, he said he has expected 2011 growth in the range of 3% to 3.5%. Earlier in the year his forecast was closer to the top of the range, he said. Now, it's "closer to the lower end of that range."

Mr. Kocherlakota praised Chairman Ben Bernanke's decision to hold quarterly press briefings, saying it will give the Fed chief an opportunity to "forcefully" put forward the message about keeping inflation under control.

The Federal Open Market Committee consists of the Fed governors in Washington—seven when all the seats are filled—and 12 regional bank presidents. Five of the presidents get to vote at meetings, the New York Fed president and four others, who serve an annual rotation. All 12 participate in FOMC deliberations, though. The committee next meets April 26-27. After that meeting, Fed policymakers will disclose their latest forecasts for the economy, and Mr. Bernanke will hold the first of his quarterly press briefings.

Last week, Mr. Plosser, Philadelphia Fed president, said, "The economy has gained significant strength and momentum since last summer and seems to be on a much firmer foundation going forward," and added, "monetary policy will have to reverse course in the not-too-distant future and begin to remove the massive amount of accommodation it has supplied to the Economy."

And Dallas Fed President Fisher said in Brussels that current Fed policy is sowing the seeds of market imbalances. "We have abundant liquidity, now there's excess liquidity, which is working through the system," Fisher said. "There are, in my view, early signs of speculative activity that I don't consider constructive."

OIL PRICES STILL CONSISTENT WITH PAST RECESSIONARY LEVELS

Interesting factoid here from David Rosenberg’s latest. As he has been quick to note in recent months the high price of oil is an increasing burden on household’s and the current levels are highly unusual. Rosenberg notes:

Below we show the ratio of WTI to the core CPI, which recently crossed the 40x threshold for just the third time in history. As you can see, it only took a break of 20x to bring on the recessions of 1973-75, 1990-91, and 2001. A breach of the 40x level occurred in November 1979 and October 2007 (recession began two months later, both times).

Source: Gluskin Sheff