ReVEnGe! (TLT,SPY)

There’s not a whole lot in this world that gives you the yummy-tum as watching an enemy go down.

 

Slowly.

 

When the come-uppance is cold and unexpected, when it comes after a significant wait, and is delivered gently, it’s as tasty as it comes.

 

So we read and always believed to be true, but it wasn’t until we tasted the sweet sauce of the swallows returning to Capistrano that we understood the bone rattling truth of the vengeance concept.

We’re referring, of course, to the weekend story of the swindler from Boston who tried one trick too many, was too clever by half, and fell into a trap laid for him by a rival group of hucksters.  Not only did he lose everything he owned (including a fair chunk that he stole from yours truly!), he also lost both his hands and family in the bargain.

 

Apparently, the Mrs. and his twin sons were in on the sting.

 

And he goes to jail, too.

 

Lash by bloody lash…

 

As to the market, it now looks like both gravity and the bond market are about to take their revenge on the investment world: the former as payback for equities doing nothing but rise for the last five months, and the latter for being scorned by equity investors over that same period.

 

Let’s start with the bonds.

 

This is six months’ worth of the iShares 20+ Year Treasury Bond ETF (NYSE:TLT), and it clearly shows a security that has broken out of its range –

As of the close last Friday, TLT had cracked above two separate lines of resistance (in red) and risen above its 137 day moving average (blue circle).  Moreover, it also possesses powerful momentum indications.

 

To wit, both RSI and MACD (in green) are now above their respective waterlines (the latter confirming just some 10 days ago) after five months of positive divergence against price (long green lines).

 

All told, it’s a bullish picture for the bond market over the short- and perhaps medium-term, with upside resistance emerging at the long term moving average at TLT 127 (in yellow).

 

But there’s further reason to be excited about fixed income’s revenge.

 

Squeeze the Bond Fruit!

 

The chart below shows a woozy of a redirect over the last couple of weeks, with cash flows into bonds – particularly the 10 year – climbing dramatically.

Over 500,000 short futures contracts have been closed since peak negativity back in January, making this the weightiest short squeeze in bond market history – and a signal to us that traders are now getting scared.

 

The rise in bonds has much to do with a growing distaste for equities over the last month.  According to data from Bank of America, last week saw the largest outflow from equity markets in better than 40 weeks, a net total of $7.4 billion.  But U.S. stocks were hardest hit, registering $14.5 billion in net outflows, the worst week since the fall of 2015.

 

As the chart below shows, the S&P 500 has now drifted below its short term moving average, which has begun folding over as the index sinks.

 

Have a look –

Both RSI and MACD are sinking (in green), the former submerging below its all-important waterline early last week, the latter on the very verge of doing so today, as we write.

 

This is an ominous sign, and one which portends further losses to the SPX 2265-2285 level (upper blue square), the point at which a rising 137 DMA and a first Fibonacci retracement level step in to stymie the drop.

 

And it could happen as early as the open today.

 

Why?

 

The key is found at the current line of support at SPX 2322 (in red, above).  Should that line fail to hold, MACD will also go sub-waterline, confirming RSI’s dump last week and sending an armada of androids and alien body snatchers into sell mode all over the planet.

 

The following enlargement shows precisely how sharp the knife’s edge is.  Have a gander –

When MACD takes on water – which could be as early as today – a flood of sell orders from market technicians just like us could wash over the market like a Fukushima tide, sending cash flows from equities to bonds into Nietzschean turbo-spittle mode.

 

And that’s precisely what we’re expecting.

 

Trade of the Week

 

Much of the rationale for this week’s trade comes from the ex-market geopolitical reality that hits this week.

 

And that includes:

 

  • French Elections, in which outsiders are expected to carry a plurality of the vote,
  • the American Armada now streaming towards North Korea to take part in war games with South Korea’s military,
  • A massive drop in the price of Chinese iron ore, that many believe will trigger a commodities selloff,
  • The fallout of a snap election called by Britain’s Conservative Party, a move that surprised everyone and may have unintended consequences,
  • Martial law in Venezuela, as that oil rich noation continues to circle the drain, and
  • Increasing uncertainty regarding tax reform in the U.S. of A. Will it come later this year? Next year? Any time at all?

 

Of course there’s earnings and some economic numbers expected, too, but the market may just trade off the technicals we’ve discussed above if none of the above listed outside factors proves disruptive.

 

In other words, it’s all probably negative.

 

So the trade we’re offering is quite simple, based as it is on more expected upside from the bond market – a safe haven trade – and continued weakness in stocks.

 

We’re playing it long/short, with Treasuries expected to outperform over the next 60-90 days.

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You win on any outperformance of TLT over SPY until July, whether she climbs faster or falls slower.

 

With kind regards,

 

Hugh L. O’Haynew

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