Somethings gotta give

Something’s gotta give.  Yesterday, being a quiet news day, allowed traders to follow on positive sentiment and rally equity indices and bonds (yes you read it correctly, bonds).  The day started with some M&A news as Pepsi announced its intention to acquire SodaStream and the news was followed by Tyson announcing its plans to acquire Keystone foods.  “OK, so maybe we can get back to business as usual despite all of the negative sentiment floating around”, wondered equity traders.  By now the markets have been digesting the trade war for some time and there appears to be hints that traders are learning to live with it as a fact of life… for now.  Finally, last week’s strong showing from the retail sector carried into yesterday’s session as Nordstrom continued its ascension and even fallen angel Macy’s took a turn at leading the pack trading up over 6% following its rough post-earnings ride.  Finally, if left unchecked by news or other stimuli, markets tend to trade to magnetic points and regions.  You read my notes going on and on about a line, pivot, inflection point, etc.  There is a lot of logic behind those and… can you tell that I am setting you up for tomorrow’s geek-out Wednesday note?  Anyway, we are very near the high level mark on the S&P 500 and traders tend to shoot for waypoints such as new highs especially on light news days. All that said, yesterday was a perfect setup for markets to log a solid gain day.  The S&P 500 closed right below a weak resistance level of 2863, which is the only hurdle in front of its all time high of 2872 (see chart 4 in my attached daily chartbook).  The Dow Jones Industrial Average posted a solid close above a resistance line confirming its breakout on Friday, which is very positive for the index (see chart 6 in my attached daily chartbook).  While the Dow has a way to go before it reaches its all time high of 26616, there is little in the way of resistance in its way.  The Russell 2000 had low volatility and traded up yesterday as well (see chart 7 in my attached daily chartbook).  It remains just below its all time high of 1708 and the index has failed in its last 2 attempts to break through.  Traders will surely attempt to make history in upcoming sessions.  The NASDAQ 100 index has been the lagger of the indices though it did manage to close marginally up from Friday’s close.  The NASDAQ has lost some of its momentum since failing to make new highs 2 weeks ago.  The index, which is a proxy for growth stocks has been left behind in recent sessions as traders focus on the more defensive stocks that dominate the S&P and Dow.

But what about bonds?  How is it that they rallied as well?  It is true that, generally, bonds tend to trade in the opposite direction of equities.  Generally.  Bonds had an interesting session yesterday which was largely driven by the animal instincts of traders.  The recent rally in bonds has left traders feeling that they are too expensive, so they began shorting treasuries and futures hoping to capitalize on a pullback.  Well, the pullback hasn’t happened yet leaving the short traders with losses.  Eventually traders, exhausted by the pain, cover their shorts (covering means buying) and, in essence, accentuating the rally further (see chart 19 in my daily attached chartbook).  This is referred to as short squeeze and yesterday’s bond trading session is the first signs of that occurrence.  A very similar situation is happening with the yield curve.  I have spent a great deal of ink discussing the recession predicting capabilities of the yield curve but it is important to recognize that the curve is also actively traded by fixed income traders.  Traders can sell 2 year notes and buy 10 year notes betting that the yield curve will flatten (this is also called a swap). That means the spread between the two will become smaller.  As 10 year notes have continued to rally pushing their yields down the curve continues to flatten (see chart 18 in my attached daily chartbook). The curve hit new lows in yesterday’s session and will start today at 23 basis points.  With no real news until tomorrow’s FOMC minutes release, traders will continue to push limits and the game of chicken being played between stocks and bonds will continue to test which will blink first.

daily chartbook 2018-08-21