Thursday, June 11, 2015

NASDAQ to test the enthusiasm of the hedge funds

A 1.25% gain for NASDAQ yesterday certainly fits my definition for a sharp gain (although just barely - my threshold for a sharp gain is 1.25%), but was it a truly solid gain or more of the forced buying of a short-covering rally, a classic short squeeze, that is more likely to be followed by an equally sharp sell-off than a couple more days of equally sharp gains? Sure, we could see a little follow-through buying before we fully hit buying exhaustion, where everybody who might buy has already done so, but that's not such a rosy scenario either. It's all up to the hedge funds, whether they choose to push the advance a bit harder at least for a bit longer, until it clearly runs out of steam, or whether or when they decide to flip the switch on their trading bias to more of a risk-off posture in order to seek greater profits by running stocks back down in the trading range.

The bottom line is that we have no clear short-term trend other than volatility within a trading range, especially as we wait for the Fed to speak next Wednesday.

The latest weekly money flow report from the Investment Company Institute showed even stronger outflows from domestic stock mutual funds than the prior week, although inflows to foreign stocks continue. This is not a good sign, but I continue to note that the role of traditional mutual funds may be getting a bit dubious, particularly due to the rise of ETFs, modern investment tools, and hedge funds. Older workers preparing for or in retirement are likely shifting assets out of stocks, while younger workers may choose to invest on their own using modern tools and ETFs. Still, it does make one pause to see such a strong pillar of the stock market look so weak.

NASDAQ futures are up moderately at this moment, indicating a moderate rally at the open, but as always we must caution that futures and the opening move are frequently not reliable indicators of the trajectory of the market for the rest of the day.

We could indeed see a nice little bounce at the open, but there is a high risk that people will sell into it. The wild card is whether some of the sharper and deep-pocketed hedge funds will sense that sentiment, let it run a little until it peters out and the shorts start flooding in, and then leap in and clobber the shorts again with enough buying to extend the rally. Hey, it could happen. Will it? It is one of the equal-probability scenarios, but I wouldn't bet the farm on any of the scenarios. Maybe the most likely scenario is a more-subdued continuation of the rally from yesterday, like a 20 to 40-point gain. But almost equal probability is a 20 to 40-point reversal of the gains from yesterday. My best estimate is that maybe we see a modest gain or loss today, ditto for tomorrow, but then we see a big sell-off on Monday to leave us roughly flat and back where we started - within striking distance of the 5100 level, but without any decent technical support to serve as a solid base for a sustainable advance above the 5100 level.

There is a risk that if NASDAQ fails to secure a close above the May 27 peak of 5106 within short order that people could more seriously abandon hope for the medium-term trend and lighten up their risk allocation for stocks, and that this could lead to at least a mini correction within a month or so. It's certainly not a certainty, but it is a very real risk. But the task immediately before us is to see if NASDAQ can indeed manage to set a new all-time high within the next week or two. Maybe once the infamous June meeting of the Fed FOMC is out of the way, we could see at least some people allocate risk with at least a little more conviction, at least for a short while, enough to keep the longer-term slightly bullish trend alive a bit longer.

Keep in mind that stocks will roughly track the economy (with great volatility, of course), so if the overall outlook for the economy has at least some upside, higher stock prices are supported. Sure, the recovery continues to be rather uneven, but there is no serious prospect for a recession anywhere on the horizon.

Fed funds futures softened a little, but then they reversed and ended up firming a little, so that there is once more a little more than a coin-flip chance for liftoff of Fed interest rates in October, only a 1 in 3 chance for September, a second hike in January, and a third hike to 1.00% in April. My personal forecast remains on October, where it ha been for months now. Only a lot more economic strength than we have seen in recent months, or currently expect to see in the next few months, would put September back on the table. In any case, Fed interest rates will remain quite low for an entire year into the future, which is well beyond the horizon for virtually all traders and short and even medium-term speculators.

What bond market speculators will do over the next four months is anybody's guess. The Fed moves over the next twelve months will primarily effect the short end of the yield curve. The longer-duration treasuries, such as the 10 and 30-year notes and bonds will see some knock-on effects, but more muted. I suggest that longer-duration treasuries will be more affected by moves by corporations to increase stock dividends to make socks even move appealing than longer-duration notes and bonds.

In short, anything can happen and the only certainty is volatility.

-- Jack Krupansky

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