Stocks and Bonds May Head Down Together This Week
by Jes Black
November 29/04
Stock Outlook:
Stocks have defied our expectations for even the slightest correction.
But the longer this euphoric mood carries on the more vulnerable the market
becomes. Small caps appear to have completed a “five wave” advance from
the October 25 lows and a break below the second trendline support in
the S&P 500 (shown below) now crossing at 1180 would likely lead to
a healthy correction back to 1160. This means stocks must rally immediately
at the open or fall below this support. So Monday morning will likely
set the tone for the week. However, our forecast is for only a shallow
correction that will then lead to the next and final leg higher targeting
1250 by January.
Meanwhile, recall that we first highlighted the S&P500 to Vix ratio
in September when we pointed out it was heading up to test its all time
high from August 2000. This month the ratio reached new all time highs
above 90.
So, four years later the S&P is 50% off its highs while the Vix has
been cut in half. There is little difference in the euphoria seen today
in the market and that in 2000. On the one hand a lack of fear is bullish
for the market as it is animal spirits that drive prices higher. And certainly,
earnings did improve. But the Dow/Gold ratio has actually declined. This
environment reminds us of the late 1960s when inflationary pressures were
brewing but the public only saw a continuation of the bull market. At
that time interest rates were dramatically higher unlike today where 30-year
yields are below 5%.
Measured by the relative Vix, investors are twice as bullish today than
they were through the late 1990s. The chart above shows a five-month cycle
top window in the SPX/VIX ratio. We feel this may lead to a short-term
correction before the final highs are recorded later this year, or early
next year. Our interpretation of this market since October 26, 2004 is
that we are in the final wave up in the advance from the October 2002
lows. Final waves are built on euphoria and hype and are often fully retraced.
Bond Outlook:
Last week we posted a research piece showing bonds were nearing a significant turn date between December and February. Specifically, we said bond prices should head down hard during this time.
The chart below shows a nine-month cycle top window (blue) and the crash
low cycle turns (orange) that also are spaced nine months apart. The next
turn is scheduled for November 25. If this holds then we expect to see
a major move higher in bond yields on Monday or Tuesday at the latest.
Since the longer maturity bond (represented here by TLT, the Lehman bond
ETF) is more susceptible to a sudden rise in rates we remain short TLT
and look to add to this position.
Jes Black
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Jes Black, hedge fund manager at Black Flag Capital Partners, specializes in foreign exchange and global macro trends. Prior to organizing the fund he helped MG Financial Group launch Forexnews.com. Afterwards he went on to found FX Money Trends, a research firm catering to professional traders.
Mr. Black holds a degree in economics from the University of Kansas and
an MBA from the ESC in France. His market commentary is often featured
in the Wall Street Journal, Financial Times and Reuters. He has also written
numerous strategy pieces for Futures magazine. To find out more about
the fund’s research letter visit www.fxmoneytrends.com. Qualified
prospective investors can find out more about Black Flag Capital Partners
by e-mailing info@blackflagfund.com
Jes Black
FX Money Trends, LLC
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Hoboken, NJ 07030
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