Derivatives Risk Growing - Are You Listening?
The Wall Street Journal published an article on Thursday September 15 titled "Credit Derivatives And Their Risks Are On The Table" by Henny Sender. In the article Sender advised that the Fed was gathering the big Wall Street players to discuss the rising concerns about risk in what is known as the credit-derivatives markets. Sender goes on to make the case that the clearing structure of the dealers and hedge funds is not keeping pace with the exploding growth in these complex financial instruments. Confirmations of these trades are falling behind the growth of the trades and the paper is stacking up both at the dealers and the hedge funds. Quoting Sender, "The spotty record of confirmations can become a risk management issue in times of turbulence."
Bernie Schaeffer has another excellent article on his website www.schaeffersresearch.com entitled "The Aftermath of Katrina: What's Behind the Market's 'Resiliency'?" In that article Schaeffer points out what he believes to be the underlying support for the stock markets in the face of the July London bombings and hurricane Katrina. That "put support" involves the tenuous stability between naked put options sellers and stock-hedged put buyers. I recommend that you go to his site and read the details for yourself, but suffice it to say that there is a substantial and growing dynamic between the put sellers and buyers. This interaction can be mutually beneficial as long as the markets remain calm and oscillate only slightly above the major put support levels, those being 120 on the SPY (1200 on SPX) and 38 on the QQQQ. I believe that the "oscillation dampening effect" of that ever increasing put support volume can be seen in the chart below.
Mr. Schaeffer goes on to correctly advise that a market crash would be a low probability situation, but that low probability event is made more risky by the inevitable reactions by both the put sellers and put buyers which would result following a dramatic market break below put support. In effect, much follow-on selling of stocks would occur to attempt to stem the waterfall losses. The stability of the markets would be at risk once the selling starts. Mr. Schaeffer also points out that a lot of complacency has been built into the markets due to the limited market reactions to the London bombings and hurricane Katrina. Options trading, credit and other derivatives must grow in scope because of the decreasing market volatility as observed in the chart below. The derivative spring gets wound even tighter as the options participants seek more profit in a market whose trends get "flatter".
But what event would it take to shatter the fragile market support? It may not be any single event, but the sudden break in the levee resulting from the slow motion effect of rising energy prices and the coming recession. The forensic evidence for the Market Listener may be this week's dramatic plunges in the Philadelphia Fed and the Michigan Consumer Sentiment indexes.
The complacency will not last forever.
8 Year Weekly Chart of Nasdaq Composite
TECHNICALS: All major indices are sitting on top of their 50 day moving averages (DMA's). And these indices are also just above their rising 200 DMA's. The simple technical picture is that the indexes are holding just above these widely respected moving averages. The Dow Industrials is having the most difficulty in holding above both 50 and 200 DMA's. Volume has been above average for the last 2 weeks, but we must throw out Friday's peculiar upside volume which was the result of the S&P 500 re-weighting.
TREND FOLLOWING COMPLIANCE: The NDX was down a mere -0.52% on the week, but this downward momentum has strengthened the possibility that the next ZigZag leg will be a down leg.
The NDX continues in its relative underperformance as evidenced by the NDX/SPX ratio chart on the next page. The chart appears to be telling us that technology will lead the next trend leg lower.
A Cash signal was issued to subscribers on Wednesday and a Sell signal was confirmed on Thursday of this week. The following charts tend to support the fact that the next trend leg will be down. The Sell signal was weak on Thursday and was further weakened by the upside performance of the markets on Friday. The Sell signal remains in place until we get stopped out.
12 Month Chart, Daily Prices - NDX ZigZag
1 Year NDX/SPX Ratio
Our Fault Tolerant Cash Safety Stop is calculated to be 30 points above the NDX close at 1599 or 1629. However, since the week's highs were in the 1616 range, I would use that level as my exit since any close above that level would likely lead to higher highs and would negate the down trend channel. Our Early Exit line and stop loss level will be 1616. Limit your losses at all costs! And let your profits run.
Subscribers will receive an email with revised trailing stop levels if the market sells off next week. Subscriptions are free. Send an email to; subscribe@MarketListener.com with "subscribe" in the subject line.
30 Day Chart NDX - Trend Following Channel
RISK ASSESSMENT: The downside market risk (probability of a sell-off) is dominated by geo-politics, oil transport/refining and the very vulnerable consumer. The University of Michigan Consumer Sentiment index (Sept. Prelim) fell dramatically this week from August's 89.1 to 76.9. The upside/downside risk next week will be in how the markets interpret the FOMC announcement on Tuesday Sep. 20.
Our Trading System - What The Numbers Are Telling Us
On Wednesday, subscribers were notified to go to cash. On Thursday the Sell signal was put into effect before the close. We have had several signal changes in the last two weeks. This volatility in the markets is likely indicative of a market top. We will continue to use our faster chart model until the topping pattern resolves itself one way or another. Our optimized fast MACD parameters will lengthen if this rally extends into late September.
The daily stochastic has turned down from overbought territory flashing a sell sign. The Ultimate Oscillator never reached the overbought 70 level before turning down. The down trend has barely started and was somewhat corrected by the S&P re-weighting activity on Friday. All indices participated in the abnormal flurry of buying and selling of the S&P components in the last two hours of the day. The trend picture will be given more clarity next week after we get the FOMC announcement behind us.
NDX - Revised 6 Month Daily Chart Model - Friday Sep 16, 2005
What About Bonds? - The 30 Year T-Bond yield chart is shown below. If you look at the big 2-year picture, how could you infer that the ten-year yield is saying anything about "rising inflation worries"? It just doesn't show up in this chart yet.
2 Year Weekly - 30 Year T-Bond Yield
What About Gold? - The big inflation monger this week was gold. Newmont Mining and $HUI Gold Bugs index were up nearly 9% on the week. Where is it going and how far can this rally take us? The $HUI/GLD ratio chart suggests that we could get some more relative strength from the Gold Bugs before we get into uncharted territory.
3 Year Weekly $HUI / Gold Ratio
M3 Money - As expected the Fed was pumping a lot of money into the system post-Katrina. The numbers were huge and may have contributed to some market support this week. How long can the Fed pour gasoline on the smoldering inflation coals without causing a flame that gets out of control?
What Is The Current Market Sentiment?
The VIX continued its downward trend this week to 11.22. The CBOE Total P/C ratio was flat on the week. There seems to be a lot of negative sentiment on the street and in households, but the falling VIX indicates that put sellers are up to their old tricks again. They are likely selling the October puts with a vengeance. Complacency is reigning supreme even as the market is in a very vulnerable technical position.
Where Do We Go From Here and How To Listen For the Next Signal?
We have set our stop loss level at 1616. Our Sell signal is weak and vulnerable. With a bit of luck we might not get stopped out on Monday. On Tuesday afternoon we will get the FOMC announcement on the Fed Funds target rate. There is no use trying to surmise which way the markets would move either with a pause in the rate hikes or another 25 BP increase. Only time will tell us. By Tuesday at the close, the trend for the week, and possibly for several weeks, should be confirmed.
Market Listener Trend Timing Signal Summary
Current Signal: 100% SELL (Bought RYVNX Rydex Venture
Fault Tolerant Cash Safety Stop - For the Week of September 19, admit failure and exit to cash (RYMXX) on a daily close of NDX above 1616.
We will issue an email to subscribers next week if we get an exit signal or have a mid-week update necessary to adjust the FTCSS level.
The Market Listener Trend Indicators
|ZigZag Trend||ZigZag Pref %1||Approx One-Way
|Down (weak 1.12%)||5%||1 Month||5|
|Up (8%)||5%||1 Month||5|
|Up (2%)||5%||1 Month||5|
|Up (5%)||5%||2 Months||10|
|Up (16%)||5%||4 Months||20|
Signals & Results
(YTD Gain/Loss with RYVYX & RYVNX approx. + 24.1 % as of Sep. 16 Close)
|ML Signal 3|
|Sep 15, 2005||Sell||Sell||-||Buy||Sell|
|Sep 14, 2005||Sell||Sell||-||Buy||Cash|
|Sep 07, 2005||Buy||Buy||Sell||Buy (mod.)||Buy|
|Sep 06, 2005||Buy||Buy||Sell||Neutral||Cash|
|Aug 08, 2005||Buy-||Buy||Buy||Buy||Sell|
|Aug 04, 2005||Buy||Buy||Buy||Buy||Cash|
|July 08, 2005||Sell||Buy||Buy||Buy||Buy|
|June 24, 2005||Sell||Sell||Sell||Buy-||Cash|
|May 13, 2005||Buy||Buy||Buy||Sell++||Buy|
|May 06, 2005||Buy||Buy||Buy||Sell+||CASH|
|Feb 11, 2005||Sell||Sell||Sell||Sell||Sell|
|Feb 04, 2005||Sell||Cash||Sell||Sell||Cash|
|Jan 14, 2005||Sell||Sell||Sell||Buy||Sell|
|Dec 31, 2004||Buy||Buy||Buy||Sell||Cash|
|Aug 27, 2004||Buy||Buy||Sell||Sell||Buy|
|Aug 20, 2004||Sell||Buy||Sell+||Sell||Cash|
|Aug 06, 2004||Sell||Sell||Sell||Sell||Sell|
With Rydex Dynamic funds, we can trade in the morning and 5 minutes prior to the close during the trading day/week when we see that one or more of the fast signal indicators have changed signals. This is particularly important if we need to go to a CASH position in order to preserve capital. The above table shows the results of the Adaptive System Model Signals.
Listen To What He Says
NAB Mark 8:34-38 And He summoned the crowd with His disciples, and said to them, "If anyone wishes to come after Me, he must deny himself, and take up his cross and follow Me. "For whoever wishes to save his life will lose it, but whoever loses his life for My sake and the gospel's will save it. "For what does it profit a man to gain the whole world, and forfeit his soul? "For what will a man give in exchange for his soul?
"For whoever is ashamed of Me and My words in this adulterous and sinful generation, the Son of Man will also be ashamed of him when He comes in the glory of His Father with the holy angels."
I am working on the art of listening and hope that you are also.