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Index Wrap

When Morgan Stanley talks, trader might want to listen

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Stocks retreated notably in today's session, and without trying to analyze it from an ECONOMIC point of view, or talk about the Fed and yesterday's decision to raise interest rates, I want to bring some rather obscure observations to your attention.

Let's quickly look at today's U.S. Market Watch, and other than December Crude Oil futures (cl04z) closing at an all-time contract high, there wasn't a lot of "news" between yesterday's close and tonight's close to really explain today's action. At least I don't think so.

Perhaps that suspicious spat of selling in the final half-hour of yesterday's close among 4 and 5-lettered stocks was a predecessor of determined selling at today's open. Fine, then so be it, but tonight I want to touch on a couple of things I feel are important for traders and investors to be aware of.

U.S. Market Watch - 09/22/04

I've said before that when "things don't make sense, traders, investors and analysts will say it was short covering that created the move."

Everyone expected weekly U.S. Crude oil inventories to show a decline in the latest week after Hurricane Ivan impacted some of the Gulf of Mexico production and had tanker ships anchored offshore further out in the gulf and unable to dock and unload their precious oil cargo. However, today's surge in Oil above the $47.00 may not have been discounted by the broader equity markets.

From the opening bell, stocks were lower and for the most part, fell to the close as if it was a PREDETERMINED trade.

Market Snapshot / Internals - 09/22/04 Close

TRIN and VIX both gapped higher and closed at/near their highs. Volume was brisk at both the NYSE and NASDAQ, and while advancing issues did show some improvement during the session, neither exchange breached the 1,000 advance mark when the big hand reached the top of each hour.

Now look at the 10-year YIELD ($TNX.X). Rather normal looking in the first 90-minutes of trade. The ONLY news I find relevant, or coincidental with the change we wee from 10:00 (up 1.2 basis points) to 11:00 (down 0.4 basis point) would be the weekly energy inventory report.

Aha! but there is perhaps one little item, which I'll cover in a minute.

Pivot Analysis Matrix -

In last night's Index Wrap, I quickly touched on a YIELD trade I would look for to mark a REVERSAL in Treasury yield. It did NOT happen today. But note the HIGH and CLOSE of the 10-year YIELD ($TNX.X) as it relates to WEEKLY S2 and WEEKLY S1 in our pivot matrix. Pretty darned close, and somewhat computerized perhaps.

I've marked various support/resistance correlations in the Pivot Matrix, but with limited time, I want to discuss the scenario that it is SHORT COVERING in the Treasury market that is diving YIELD right now.

Is it INFLATION from higher energy prices? Not if you believe that INFLATION is harmful to interest bearing securities.

Is it a FLIGHT to quality trade? It could be.

After the market close, I made mention (in the Market Monitor) that CNBC's Rick Santelli, who primarily cover interest rates, bonds and futures, made what I feel is a VERY important comment/observation regarding somewhat of a short-squeeze developing in Treasuries. I feel it IMPERATIVE for traders and investors to at least understand what may be happening in the bond market right now.

Take it with a grain of salt if you like, but understand the possibility that some BIG traders are simply on the WRONG side of the trade in Treasuries. They didn't just get on the wrong side of things yesterday either. It probably started earlier this spring.

iShares Lehman 20-year - Daily Intervals

I'm showing the Lehman iShares 20-year (AMEX:TLT) $89.68 +1.03%, which is the security we use in the "Beetle's Balanced Benchmark" fund as a PRICE depicter of longer-dated Treasuries. The reason I'm showing this chart tonight, is that I can show VOLUME. Today, this security, traded an impressive 2.5 million shares.

One of the scenarios that is currently "in play" is the thought that Treasury YIELD (moves INVERSE of PRICE) is moving sharply lower because some traders/investors are on the WRONG side of the trade and perhaps misjudged the Fed and overreacted on thought that INFLATION was about to ramp out of control.

If you have not been with OptionInvestor.com prior to June of this year, in early May we were alerted traders and investors to the bearish scenario of hyper inflation (see 05/06/04 Index Trader Wrap) . On the above chart, that would be just about the time the TLT was trading between $80.51 and $83.00. Actually, May 6 was the BAR on the above chart that proceeded that PRICE gap lower to just above the horizontal green line marked "08/14/03 Low."

I would like EVERY trader or INVESTOR to imagine they are SHORT the TLT between $80.51 and $83.00. For some, you may NOT have to imagine this, and I do hope you utilized stops if you've been short the past few months. I do NOT know for certain what the TLT's dividend yield was in May to June, but I do know it was HIGHER than the August 31, 2004 stated yield of 4.88%. The point here is not only are some trader's SHORT the longer-dated maturity, but they also owe some yield the past two quarters, say at least another 2% on top of a losing trade from $83.00 to yesterday's close of $88.50.

Mr. Santelli's comments this afternoon really grabbed my attention, as he has provided some very good reads on what shape bond trader's are in, and what is taking place.

In brief, Mr. Santelli suggested that his trading contacts on the floor were mentioning today's "order flow" (buying and selling of Treasuries) was rather brisk with a strong buy side bias, which suggested to some that there were some traders on the WRONG SIDE of the trade. In trader lingo, this means losses are mounting and prior analysis (economic or technical) may have been incorrect (i.e. INFLATION).

What I've done tonight with the TLT is placed a "fitted retracement" on this security, where once again I utilize the 38.2% retracement and fit it to what appears to be a key inflection point. I fit the 38.2% at the 07/16/04 closing high (see data box on chart, which is set to 07/16/04) where we also see the TLT traded a brisk 2.97 million shares that day. OK, this becomes some type of "key" level where the VOLUME spike depicts some sudden interest in the security. Perhaps a change of thought.

It appears that this "fitted retracement" is and has been in play at various times during the bullish price move higher. Certainly the rising 50-day SMA could have been an important technical support level as the TLT pulled into the 19.1% (result of fit). Candlestickers will note the "doji" on 07/28/04 as the TLT had just tested the rising 50-day. A reversal point? Yes.

When the TLT gapped above 38.2% on 08/06/04 the TLT never came back to test the $85.49 level did it? There was a slight volume spike, but nothing major. Right?

Wrong! One of Morgan Stanley's (NYSE:MWD) $48.72 -6.98% reasons for missing earnings this quarter was not only because stock trading revenues were weak in the June to August quarter, but the broker admitted it had misjudged the bond market's direction.

A very INTERESTING and IMPORTANT disclosure. Lehman Brothers (NYSE:LEH) $79.57 -0.22% is the biggest bond house of the major brokers and they easily surpassed earnings estimates when they reported quarterly earnings yesterday.

I remember Lehman (LEH) getting pummeled lower when the bond market was getting pummeled lower.

This stock to stock comparison and thoughts that Lehman might have had a little better "feel" or handle on the bond market that Morgan Stanley could be a hint that there are indeed some traders on the WRONG side of the bond market, and today's volume spike in the TLT is perhaps sign of a short-squeeze taking place in Treasuries.

If you don't believe this, then we might also want to look at the iShares Lehman 1-3 year (AMEX:SHY) $82.16 +0.09%. Today, a day AFTER the FOMC raised rates 25 basis points, the SHY traded a rather average 153,900 shares. However, on close inspection, Monday's trade (09/20/04) as the SHY has been struggling to get above its 200-day SMA ($82.08) the SHY traded an eye-catching 1.06 million shares.

This trade volume in the SHY could well be some aftermath of quarterly option expiration (you can trade options on Treasury YIELD), or it could have been some type of activity ahead of Tuesday's FOMC meeting.

What I want to make certain of is that traders and investors aren't make a sudden RUSH to judgment, that recent bond action (lower YIELD) is an automatic sign of RECESSION.

I continue to go back to the May commentary and discussions of INFLATION and what the BOND market was doing, to try and prevent traders and investors from making a rush to judgment on what the bond market may be saying, or more importantly, NOT saying.

Banks, as depicted by the S&P Banks Index (BIX.X) 358.22 -1.79% were weak today, and for the BIX.X, a 1.79% decline is a rather big move. We will want to monitor the BIX.X in coming weeks as it is a bit concerning when we see banks decline when Treasury yields are falling. This relationship was a NEGATIVE during the most recent bear market.

But remember what some were thinking in May of this year, when the BIX.X had fallen to 325.00.

Jeff Bailey

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