The Three E’s: A Curious Convergence of Events

The World Is So Far Into The Unknown That Anything Is Possible

The final E, Europe is a slow motion trainwreck of unparalled proportions. The mess is so large that no one will ever really know how bad things were. The only real solution is to scrap everything and start over. Of course, that won't happen, at least not without more pain, which is why the markets are so crazy.

This brings us to our charting session. Today we will feature two charts which will help us to explain how ridiculous things have become with regard to price trends and which suggest that some kind of major move still lies ahead.

Chart Courtesy of StockCharts.com

First, we'd like to look at the U.S. Ten Year note (TNX). Yes, everyone is focusing on the record low yields, which can conceivably go lower, although we expect a snap back at some point.

And here is why. Friday's yield plunge to 1.46%, aside from being an all time low, took yields out of what is considered the most extreme of so called "normal" market behaviors. We are referring to the fact that yields are now well below the lower Bollinger Band which travels with the 200-day moving average.

Consider this. Bollinger Bands (upper and lower blue solid lines on the TNX chart) are usually used as analytic tools around the 20-day moving average. By using the 200-day moving average (dotted blue line), we are looking at very long term "normal trends." To put this another way, we are now seeing a secular bull market in U.S. Treasury bonds possibly reaching its end, with this being its SWan Song move.

Bollinger bands are dynamic envelopes which provide borders for price patterns. In what is considered a "normal" market, these bands offer support and resistance to prices with regard to the 20-day moving average. When prices rise two standard deviations above prices, there is usually a correction back to the mean, the 20-day moving average. When prices fall below the lower band, they usually rebound toward the mean, the 20-day moving average.

In the curent example, bond yields have fallen ten fold what is considered "normal" behavior. This is a rare event, which usually forecasts the end of a very long trend. A similar example of this came in 1999 as prices on the Nasdaq Composite soared above the upper Bollinger band with regard to its 200-day moving average. That move heralded the end of the Internet Bubble.

More important is the fact that the Bollinger Bands shrunk around prices for several days before the plunge in yields. That was a correct forecast of a big move, which has already begun. The point here is that the analytical tools are functioning correctly, which means that the outcome is likely to adhere to "normal" behavior, which in this case would be a rebound of bond yields, and possibly a violent one, given the scope of the move.

A more recent example of Bollinger Bands and the 200-day moving average can be seen in today's chart of the S & P 500 (SPX). As the chart shows, prices walked along the upper band for several days before rolling over and moving to the 200-day moving average, where they spent some time before breaking below the key line. Once again, "normal" behaviour of this complex set of indicators suggests that stock prices should continue to fall until they reach the lower Bollinger Band with relation to the 200-day moving average.

Chart Courtesy of StockCharts.com

More conventional and familiar measures of the stock market's trend and momentum continue to worsen as well. The Nasdaq Advance Decline line (NAAD) made a new low on Friday, and would require some time before it could be considered neutral, much less positive.

Chart Courtesy of StockCharts.com

The action in the Nasdaq Hi-Lo line (NAHL) is also heading lower, a sign that up side momentum for stock prices has reversed.

Chart Courtesy of StockCharts.com

Conclusion

The bond market is malfunctioning. Prices have risen too far and yields have fallen too fast. We are now in totally uncharted waters in the world's most liquid and traded market outside of the currencies.

There is no telling how this will turn out. And there is no way to know how much leverage is hiding in the form of options and credit default swaps. That means that all of the markets, stocks, bonds, currencies, and commodities are now in danger of suffering from convulsive selling in order to meet margin calls.

Aggressive traders should have been raising cash and should have some short positions open. But even that strategy should be monitored carefully as the markets are likely to be extremely volatile over the next few days.

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