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Index Wrap

Economy recovering, but rise in yields draws concern

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The major indexes posted gains, with the bulk of today's action taking place in the first 90-minutes of trade and then the final hour as economic data, hard data, not surveys, showed the U.S. economy growing at a faster pace than some had forecasted. And while a 2.4% annual rate of growth wouldn't be interpreted as strong, the improvement from a 1.4% annual rate of growth from the first quarter gave some vindication to the rise in equities since March.

Ahhhh, but for every silver lining that reveals itself on the economy, there will always be the cloud that surrounds the good news as the continued selling in Treasuries, which would come from a strengthening economy is looked upon as being negative.

We've discussed two potentially negative impacts that would be created by the sharp rise in Treasury YIELDS, specifically the 10-year YIELD ($TNX.X) which jumped another 15.9 basis points to 4.474% and longest-dated 30-year YIELD ($TYX.X) surging 17.3 basis points to 5.410%.

Rising mortgage rates are one negative implication that could create near-term negativity for an economy that looks to be improving. Despite some positive economic data today, the Dow Jones Home Construction Index (DJUSHB) 416.14 -2.34% showed little sign of bullishness during the peak of today's broader market rally, but participated in some late afternoon selling, which saw the S&P 500 Index (SPX.X) 990.31 +0.28% give back 14- points from its session high to show a more fractional 2.8-point gain by session's end.

Banks may also be another group that best represents the silver lining of improved lending spreads being offset by the cloud of rising consumer loan rates, whether it be mortgages or automotive loans also on the rise, which can then find a narrower base of consumers to lend money too at higher rates of interest.

If I were to put the rise of Treasury yields into perspective, its that the bond market sees good things ahead for the economy longer-term, say six to nine months out, but the sharp rise in rates now begins to draw concern that a still weak labor market, has many consumers unconfident that their job prospects will improve, and less likely to borrow money for big ticket items in the near-term at the higher rate of borrowing costs.

Yet some of the signs of economic growth we see from the second- quarter GDP data, may indeed be starting to be reflected in the labor markets. For a second-straight week, weekly jobless claims came in below the 400,000 level. While not yet a longer-term trend, as the 4-week average is still above the 400,000 level where many economists benchmark an improving labor market, the rate of layoffs looks to be abating for a second week. While the weekly jobless claims addresses layoffs and not building demand for workers, today's release of the June Help Wanted Index showed some improvement from the demand side of the equation, with a pick up in job postings by employers.

One stock that is "jobs related" that we've discussed here at OptionInvestor.com in recent sessions has been Monster Worldwide (NASDAQ:MNST) $26.55 +13.3%. While the stock has been quite volatile in recent weeks, today's close above last Thursday's close of $25.36 may give some indication that market participants are beginning to bet on a labor market recovery.

I keep hearing that the labor market is a lagging indicator and is usually the last economic indicator to show improvement and I'd have to say that that has been a very accurate observation as many economists continue to label the recovery as a jobless recovery. Does anyone remember a couple of years ago all of the attention given to the very tight labor markets, when it was good news to see the unemployment rates rise, which at the time would cool fears of wage inflation? Kids coming out of college with a 4-year degree and no prior business experience could easily pull down a $50k per year salary. If you were an engineer, you could slap another $25K on top of that.

And I think that's where we're at right now. Is the economy surging, with a 2.4% annual growth rate? No, but its better than 1.4% forecasted and will probably send some economists back to the drawing board and calculator to figure out what happened. I'm guessing there was some kind of seasonality that took place in the second quarter of 2003, that usually doesn't show up on a historical basis to account for the "error." I think you and I are rite on with the thought that it was the war in Iraq that gave the boost. Still... a dollar banked, is a dollar banked and if it has created stability in the job market, then that counts too.

And while I say there appears to be concern regarding the sharp rise in Treasury YIELDS, I do think it was present again today. Again, the Dow Jones Home Construction Index (DJUSHB) 416.14 -2.34% fell on the session, while both the S&P Banks Index (BIX.X) 306.29 -0.47% and money center banks depicted by the KBW Bank Index (BKX.X) 888.41 -0.55% appeared to lag the move higher today, if not the S&P Banks Index (BIX.X) finding resistance at the 310 level in today's session.

When the S&P Banks Index (BIX.X) and KBW Bank Index (BKX.X) both turned lower in the session, I did some investigating. Deutsche Bank (NYSE:DB) $64.61 -3.56% was a leading percentage loser among the money center banks. Deutsche Bank, as you might guess, is based out of Germany. The only news I could find that would have this bank declining more than other was that fellow German-based banker HVB Group, said it lost 67 million euro ($76 million) in the recent quarter due to bad loans.

As I think I've mentioned before, the U.S. economy, while not robust, has been much stronger than many of the European economies. The thought I take away from the news out of Germany is that focus now turns back to the consumer. To get continued build for economic growth, the consumer is still important.

I'd argue that if the economy were growing at a 5% clip, then a 6% mortgage would be overlooked and be moved to the back page of newspapers, but with a still anemic jobs market and recent decline in consumer confidence (July consumer confidence fell to 76.6 from June's 83.5) this sharp rise in Treasury YIELDS will not get front page headlines.

Here's our updated pivot matrix with new MONTHLY levels now established after today's trade. The new MONTHLY levels are not that far off from July's and gives me further impression that we may well be set in a trading range through the remainder of the summer, with the consumer and employment data getting the bulk of the attention.

Pivot Analysis Matrix

The scenario of higher Treasury YIELDS now looking to "hurt" banks may be starting to show up when we simply look at the WEEKLY pivot analysis and what has been taking place between the BIX.X and $TNX.X, this opposite poles type of trade where the BIX.X has traded WEEKLY S1 while the $TNX.X has traded WEEKLY R2 gives the observation that higher YIELDS are having greater negative impact as it relates to banks benefiting from a lending spread, which is being negated by few loans being generated. At least, this is what the MARKET seems to be trading. We have perhaps noted a slight drag in the SPX and OEX, which is best explained by the higher weighting of financials that these two indexes have in relation to the Dow Industrials and NASDAQ-100, which has zero, zip, zilch banking exposure.

While not in the pivot matrix, observations made a couple of weeks ago regarding the home builders and the very early observation of weakening adds to the thought that a higher YIELD is becoming a concern, and would continue to be a concern until more improvement is seen on the labor front. I do not disagree that a 6% 30-year mortgage rate isn't still very attractive, but if your pool of borrowers is limited by incomes or their confidence to borrow at some higher rates, then the net effect will be negative.

Let's quickly take a look at the 10-year YIELD ($TNX.X) chart and make some assumptions as it relates to potential impact on the economy.

10-year YIELD ($TNX.X) Chart - Daily Intervals

We've looked at the major equity indexes long enough with MONTHLY pivot analysis retrenchments overlaid, and we haven't seen this type of wide range on any of them. Jaws are dropping among bond traders and Wall Street followers at the rate of increase in YIELDS, caused by selling in just the past month. Fed Chairman Alan Greenspan expressed concern more than a month ago that the Fed didn't see rising YIELDS being harmful if YIELD rose at a gradual pace. He was concerned about the housing sector and potential negative implications if rates rose sharply. At this point, it would be my analysis that for yield rate fears to subside, then we might pick the MONTHLY pivot as a starting point. If YIELDS progress higher still, then impact could be negative near-term and have the economy beginning to weaken, which stocks might then move in advance of. On that type of scenario, then the rush back into bonds, could come as quickly as the money has come out, and if YIELD were to fall back below 3.904%, it becomes sign of trouble and defensive move from the bond market.

When you read the above, think of a cycle, where you almost think... "here we go again." I will say right now, that I think it a very SMALL likelihood that the 10-year YIELD goes back below the 3.898% level in the next 10-years.

I'm not much for repeating rumors, but I've seen some postings in today's Market Monitor and have heard similar rumors outside of the OptionInvestor.com network that there may be a large bank that is very sideways in bond position. I will say, the fractional weakness, but "lagging" that I was in the banks today, and we've been noticing a bit in recent sessions is what had me looking at some of the larger banking stocks, where my attention was drawn to Deutsche Bank (DB) and its weakness relative to other large banks. I'm not saying that the rumor has any credibility, but point and figure chartists will have made some notes that a trade at $63 in DB would be a triple-bottom sell signal and there looks to be some air to a past triple-top buy signal at $57 and its longer-term bullish support trend of $50.

S&P 500 Index Chart - Daily Interval

"Bear-ly" alive is my thinking when the SPX broke free from its WEEKLY pivot this morning, in what seemed like a delayed reaction after the 10:00 economic data. As noted in today's intra-day commentary, the SPX didn't break free and make the move higher until 10:35. All be darned if our "old" trend didn't come into play and hold as resistance, keeping the SPX from testing or breaking above the upper end of our zone.

Is it coincidence where this index settled at the close? Right smack dab in-between the MONTHLY and WEEKLY pivot? The SPX still has that neutral look to it as the wedge still defines the range. Daily Stochastics are working well, which Stochastics tend to do in a range-bound type of trade.

The way I look to close out the previously profiled bearish trade from SPX 983 is this. If I get the break below 975, then I'm going to guard the gain with a stop just above 977.

Then.... if that break does come, and Treasury YIELDS are just holding steady, I'd look for support at/near the 968 level, and then look to trade a partial bullish position back higher to 996.

Let's also keep an eye on the BIX.X as it was the only observation I could make today to keep me from telling traders to just stop out of the SPX, on thought that the SPX was eventually going to work its way above trend and WEEKLY R1.

Today's trade saw the broader S&P 500 Bullish % ($BPSPX) see a net gain of 3 stocks to point and figure buy signals. This has the bullish % edging up to 77.8% after a recent low reading of 76.00%.

Dow Industrials Chart - Daily Interval

I think it will be difficult near-term to get a Dow break back under the WEEKLY S1 of 9,120. While we will get new weekly pivots at the conclusion of tomorrow's trade, current trade would most likely have the weekly Pivot retracement moving modestly higher.

The sharp move higher and break of my gradual bearish trend at the 9,300 level gives hint that there is/was a great amount of pressure built up that got released today and has the INDU looking almost exactly like the SPX did back on July 14th, when it matched a relative high, then pulled back into its WEEKLY S1 by July 21st. Here's a link to that Index Trader Wrap of July 21st and why I think in a range bound market, how Stochastics on the Dow Industrials has me thinking a more likely level of support is WEEKLY S1, with a 9,505 max downside on any type of panic move lower near-term. It is also notable how the SPX bounced from a rising 50-day SMA, and the Dow's 50-day SMA is rising at 9,066.

As I write this evening wrap, I really get the feeling that it may have to be weakness in banks, that leads to weakness in the SPX/OEX, that then lends to weakness in the Dow and NDX.

Today's trade saw no net change in the very narrow Dow Industrials Bullish % ($BPINDU) and status remains "bull confirmed" at 83.33%. I made note yesterday that IBM (NYSE:IBM) $81.25 gave a double bottom sell signal at $81.00 yesterday, which had this bullish % slipping back 3.33% from 86.66%.

NASDAQ-100 Tracking Stock (AMEX:QQQ) - Daily interval

Last night I place a trend at Tuesday's high to try and depict a bearish wedge, and it would have held by the close. Instead of having that trend on the chart, I'm placing a more "reasonable" trend at today's high, where the QQQ did find some sellers just below WEEKLY R1, and with an "old" downward trend in place, that looks to have found support back near $30.68, we might get the impression of a bearish channel starting to form. I'll believe it when I see it and perhaps get a "bear confirmed" reading in the NASDAQ-100 Bullish % ($BPNDX) which holds unchanged again today at 75% bullish, or at least find the QQQ breaking below its still bullish channel.

There's another round of economic data due out tomorrow, and once again... I'm expecting a high degree of volatility.

I run way late when I have to adjust the MONTHLY pivot retracement during the week, but I'll have an OEX chart in tomorrow morning's updated.

The OEX Bullish % ($BPOEX) remained unchanged at 83% bullish.

Jeff Bailey

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