Wow, what a day for the market. All the major indexes erased yesterday’s losses! It was a “red-letter day” for the Dow achieving it’s best one day advance of 2007.

But from a technical standpoint, the market continued to weaken. Over the past two days, more stocks have declined than advanced. About an equal number of stocks hit new lows today and yesterday then hit new highs even though the markets are only points off their 52-week highs. This suggests that while the “weighted averages” rebounded, more than half of all the stocks traded on our exchanges are still down after two days of relatively volatile action. Furthermore, increasing volatility typically signals a peak or trough in the market.

It’s still too early to tell if the bear market is starting, but today’s action reinforced the recent technical weaknesses in the market.

Bonds swooned today pushing the 10-Year Treasury note to its highest closing level since May 15, 2002. As expected, equities sold off in tandem with bonds (not even Greenspan’s jawboning could save the markets today). As I mentioned in my post June 7th, history suggests that equities could sell off even further given the recent sell-off in bonds.

One of my favorite analysts, Steve Saville , recently wrote an enlightening piece on the relationship between increasing bond yields and equity corrections. In his commentary he writes:

…a downward trend in the bond market will eventually take its toll on the stock market. It’s a question of when, not if, a downward trend in the bond market will drag equities lower. The “when” is typically 5-7 months, but is sometimes as long as 12 months from the start of the bond market’s decline….The current situation is that bonds are about 6 months into a downward trend, so we have entered the time-window when weakness in bonds should be starting to have an adverse effect on the stock market…If the bond market’s decline continues without significant interruption over the next few weeks then a knock-on effect will almost certainly be a sharp stock market correction. (emphasis mine)

He wrote this on June 10th, after the 10-Year Treasury note closed at 5.12% the previous Friday (6/8/10) – a full .23% lower than today’s close.

Mr. Saville goes on to speculate that rising bond yields could end in one of three ways:

1. Bond market rallies pushing rates lower and in line with equities.
2. The stock market corrects over the next couple of months thus keeping equities and bonds inline.
3. The bond market pushes equities into a cyclical bear market.

This is an update to a post I made on May 7th. I’ve copied most of the significant text so I took down the old post.

According to AAA, the average nationwide gasoline price hit another all-time high a couple of weeks ago at $3.22/gallon, besting its previous record of $3.06/gallon on August 11, 2006. Some are calling for energy prices to continue to move up calling for $4/gallon gas. Well, allow me to add some fuel to the speculation fire (pun intended).

Over the last eight months, we have seen an uncharacteristic draw in energy inventories which makes a solid case for higher energy prices this summer. Before I continue, let me provide a quick primer on the nature of energy inventories and shoulder seasons. Read the rest of this entry »

The equity and bond markets took a sizable hit today as bond yields soared. The Ten Year Treasury Note increase 13bps, its largest jump in 3 years (Since 5/7/2004). The equity markets followed suit by declining nearly 2%. Recent history suggests even further losses in the equity markets may be coming.

It was just twelve months ago that equity markets were in the midst of a 7% correction. The impetus for this correction was rising bond yields. Yields bottomed out in January of 2006 at 4.39% and gradually climbed until they reached 5.19% (0.80%) in mid-May. Coincidently, equities started their correction in early May and it lasted through early July.

Currently, Ten Year Treasuries have experienced an increase from 4.5% in March to close out today at 5.1% (0.60%). Including today’s nearly 2% drop, the S&P is just 3% off its YTD (and all-time) high.

It seems that the market is finally coming to the painful conclusion that the Fed is handcuffed and will not be able to lower rates this year due to increasing inflationary pressures. Rising energy and food prices are certainly not making the Fed’s job any easier. Energy and food prices are both up over 15% YTD according to the CRB Index.

I have maintained for some time that the next bear market will be defined by stagflation – a state of above average inflation and below average economic growth. The second cyclical correction of the last two secular bear markets (’37 & ’73) were both inflationary and it is looking like it will NOT be different this time .

In addition to the steep decline in bond prices (and corresponding increase in yields) the technical strength of the market is getting sloppy. Today, the number of declining stocks on the NYSE outnumbered the advancing stocks 11:1. Even with stocks less than 3% off their 52 week highs, more than twice as many issues on the NYSE hit 52 week lows as did 52 week highs (and at one point during the day, the S&P was less than 1.5% off its all time high). Market leadership has been neutral at best recently and today’s action should push the technical indicators that I track closer to being bearish.

With all that said, The S&P and DJI are only 3% off their all time highs. Market tops take time to develop. This could just be a simple correction. I’ll keep a keen eye on the technical strength of the market to determine if this indeed the beginning of the next bear market or just another head fake.

By proceeding, I acknowledge that I have read and understood the Disclaimer, Performance Reporting Disclosure and Copyright Statements .

The following is an update of a post that I wrote on April 17th, 2007 regarding the probability of a Goldilocks scenario versus Stagflation. I’ll update the data on the last day of each month and repost it. The purpose of this post and subsequent updates is to objectively examine the changes in both economic and inflationary data since the Federal Reserve made the decision to quit raising rates in the Summer of 2006. (Click here to view original post.)

In the month of April, Inflation figures moderated a bit. Specifically, the CRB Index and the PPI came down some but that was after a scorching hot February so they were due for some moderating. Energy prices are still climbing and the price of gas at the pump reached an all-time high a couple of weeks ago at $3.22/gallon (Nationwide average according to AAA.) The market is focused on Year over Year (YOY) figures on PCE, CPI and PPI but these are all skewed down because of the big dip in energy and metals prices last fall. PPI and CPI for the trailing 6 months (since November) are at 4.8% and 2% respectively which would be 9.6% and 4% annualized.

The big news is on the economic front. A mixed bag of improving manufacturing and construction data but a big dip in consumer spending. The other significant development was the much larger than expected dip in existing home sales below 6M annualized units. The average home price for existing sales did move up. This can be attributed to the fact that subprime borrows who would buy cheaper homes are being squeezed out of the market by stricter lending standards. While the consumer curtailed his spending, he still has a pretty optimistic outlook of the future as both Confidence and Sentiment improved.

By proceeding, I acknowledge that I have read and understood the Disclaimer, Performance Reporting Disclosure and Copyright Statements .

Dear Clients,

As I was putting notes together for this month’s update, I came across an interesting piece from Ed Easterling of Crestmont Research. It’s titled “Capture: Less Ups Needed if You Avoid Downs”. The purpose of his research was to answer the following question:

What percent of the gains during positive months is needed to match a buy and hold strategy if an investor avoids the declines?…The answer: if an investor can avoid the losses, it takes only 28% of the positive gains to match the market! (emphasis mine)

Easterling used the S&P 500 Benchmark index from 1956 – 2005 for his data. (I’ll send you a hard copy of Easterling’s work in my written update next month. In the interim, you can check it out by Clicking here.) Easterling’s study does exclude dividends from his data, but if you assume that the interest you earn in cash while out of the market is equal to the dividend yield, then the two would wash out. (In 2000, the yield on cash would have been much more than the dividend yield of the market but by 2002, dividends would have exceeded earnings in a cash account. Currently, the money market account I use for your account is paying approximately 3% more than the dividend yield on the S&P.) Read the rest of this entry »