Two weeks ago I shorted the S&P on the basis that the Fed was unlikely to embark on further QE. I thought that they were, perplexingly, rather unworried about deflation, and that it was far from certain that more QE would have much effect on unemployment. The latest statement, however, suggests that they are more concerned about deflation than I thought. This is a news breakout — the big picture has changed because the market will now expect a “Bernanke put“.

The S&P 500 has broken out of its recent trading range and re-tested the breakout level (this was picked up by my new retest scanner, which is proving quite useful — re-tests are shown by the dots above or below the price bars). Although the market fell back yesterday, the consumer sentiment ratio (discretionary vs. staples) actually advanced. A breakout in the news and in the market seems too good a signal not to trade. The original breakout happened on good volume at the right times of the day. Thrust went back to zero during the middle part of the day but took off again at the end. There was another good thrust day after the breakout, and the market made another high on unusually high volume at the end of that day. The supply curve moved outwards when the market got to the top of its recent range, as it had the couple of times before, but moved back again as demand continued to increase, suggesting selling pressure at the top of the recent range has abated for now.

Market personality shows that trading breakouts has not been a good strategy in the S&P recently (top-left two charts, green lines), but trading re-tests has been successful (bottom-left two charts, green lines). Also, when a trade has worked, it has been worth holding it for quite a long time (right hand charts). Short-term downside momentum has been tailing off since the start of July, while upside momentum may be turning around. Volatility, as usual for stocks, is skewed to the downside, which explains why buying a re-test is a more successful strategy (because the stop ends up further away from the breakout). The monitor page shows that other risk assets are also rallying while bond yields drop to recent lows — consistent with a market that expects liquidity support from further QE.

Analysis

I have taken profits on my long S&P 500 trade, for a profit of around 3.25 risk units. I was hoping to hold this trade for a long rally in equities, but I am very concerned about the legal problems in the US mortgage market. I can’t see how bad the story could get and that makes me nervous. The news about dodgy foreclosure practices has been rumbling on for a month or so and the market hasn’t focussed on it, but now there is another scandal brewing involving proper malpractice in the sale of mortgage bonds. The whole thing has the feel of a story that the market is starting to focus on, with a news headline on Bloomberg, a mention in the US (but not the global) overview in the FT and a fairly negative piece on Marketplace yesterday evening.

US bank shares fell yesterday, but this morning the S&P futures are up (they were when I exited, from the bus — but they are flattish in the chart below), giving me a good chance to exit. I remain short USD and long gold, so I am still in the “QE trade”.

Advertisements