Market Setup Updated

Get ready for fireworks...a failure of the overhead trendline and control, indicated in red on the chart below, targets 810 to 800. I am currently short EURO from 1.40ish and short TF, EMD, ES and NQ via weekly systems. FYI, weekly trades may add another entry at this friday or next, but the hold time for weekly trades is 3 weeks to 3 months.

Please note that the ten year bond is not confirming the recent highs. In fact this is the largest non-confirmation divergence I have ever seen between Equities and the ten year, indicated in light blue on the chart below...not good.

TLT setup...

This is a chart that I watch for discretionary trading...shows setups well. This setup is at cycle resistance in a confirmed downtrend in a persistent down cycle and a sell setup on the m3WR.

Also, there are multiple resistances at these levels.

From a technical perspective, a breakout of the trendline is a high risk of being false and may reverse to new lows. If that's the case, its another example of why its so hard to trade trendlines.

This is the system chart:

Market Observations - Resistance and Black Candles

The Russell 2000 is an interesting index. It is comprised of a high concentration of energy and financial components. It is also represent speculative small cap companies, so you can gauge the market's risk appetite from it. Well, as you can see below, the Russell has to break its high. This is a difficult task given the strong resistance and overbought nature of this market. Additionally, the Russell has been lagging which adds to the difficulty but also demonstrates a tiring market overall. The Gap Up open with a close below the Open created a Black reversal candle. These are highly reliable signals especially when they occur at trend-line resistance with divergences. Something to keep an eye on.

If the market is going to reverse down or break resistance it has to happen imminently. There is no spare time. It is my impression that people are so tired of calling for a correction that most are looking up. While I recognize this possibility is not trivial...the downside case seem much better to me and upside seems quite limited.

US 30 year Treasuries - not a pretty chart...and not a good omen for the market. Clearly, Corporate Bonds and Treasuries have disconnected...The structure for the Corporate Bonds is very clear and it looks like the ABC pattern is complete. Look out below.

McClellan Oscillator had two small consolidation moves...Friday and today...this portends a large move of some sort is likely tomorrow. Either way you want to be on the right side of what ever that move turns out to be...and it seems likely to be down to me.

Treasuries...what divergence?

thanks to matt fraily, breakpointtrades.com

The chart below is from a post called: All we need now is a big hit to theoretical money - derivatives anyone? I think its worth another look at this point.

Observe the chart below. Each large move in the SP500 was preceded by  period of correlated behavior between treasuries and stocks. We are presently in a significantly correlated pattern.

 

China...effectively declares war on US and Obama taxes Tires?

To start out, this situation is much bigger than trade. When you read the headline, that is not what i am referring to. China and the US in a trade spat would be relatively meaningless. China can inflict relatively little damage on the US with trade sanctions and vice versa. That's not to say there would not be damage from these types of actions. But there are bigger problems.

I believe that markets are not news driven...though news can be a catalyst to reflexive market price reactions. I do believe though that markets are credit driven. A china trade war does not impact credit directly...and therefore, itself, is not a great excuse for the market to selloff or rally. 

However, what has happened recently as illustrated in my recent posts, is that the conflict between the US and China has escalated rather than defused regarding China's authorization of defaults on derivatives agreements that could collapse our entire financial system in very short order. 

China is a counter-party to trillions of dollars of derivatives obligations with JPM, GS, BAC, C etc that they have threatened to default on. This is the main issue going on right now - trade is just a smoke screen. Any affirmative moves in this direction, would create credit issues and trigger the need for huge amounts of cash to be raised very quickly. Obama, in his typical wisdom, decided the best way to prevent China from pursuing their defaults agenda, and thus collapsing the JPM 89 trillion ponzi scheme derivative portfolio (and GS and C portfolios as well) was to add a tariff to imports of tires from china...

China answered back...but this escalation overall raises the stakes and makes it that much more likely that JPM, GS and C will not get paid by China...If China's business with the US is collapsing, why do they need to continue to pay derivative obligations on which they are losing significant sums and on which they believe they were hoodwinked? The upside is too great for them not to do so. If they have little business with us and get into a trade war, why not make a ton of money on their treasuries and long dollar positions by collapsing the theoretical dollar caches that the largest banks have been using to further a bankrupt and corrupt system. If China were to follow through with this (which we can not control), the result WILL collapse the entire US financial system. Additionally, it would enable China to hijack our system by leveraging the strength of the dollar purchasing power (derived from their treasuries and long dollar positions) that they hold. This would work, provided that interest rates remained low. Given the fear of further deflation in bank owned assets and misguided policies from the Fed, it is highly unlikely, even in this case, that US officials or banks will be in a rush to raise interest rates. Rates will likely remain low in an attempt to manage and contain deflationary pressures. 

Effectively, what has happened is that china has suggested they were thinking about declaring war on the US - and the best Obama could answer was - "OK, we are going to tax your Tires"...this situation is much bigger than trade.

All we need now is a big hit to theoretical money - derivatives anyone?

Apparently, not for the chinese. 
Now, think about this for a second. China has engaged in hedging and speculation that has not resulted in benefits to its economy. Quite the contrary actually. Their perception is that we have played games and manipulated financial markets. [surprise, surprise since they thought they were free markets ;-) ] In any event, China owns tons of treasuries. Say we were to get an implosion of theoretical dollars within the financial system via some sort of large defaults...that would trigger real dollars to rise in value immeadiately, likely over the longer-term interest rates would also go up, and bonds down. In the big picture, that would further stress the chinese overall, stress their derivatives exposure and their most popular investment - treasuries plus the derivatives on those treasuries. The implications are not a funny thought. 


Now there is an interesting possible scenario here for the shorter term, one I am quite partial to...the chinese know that we need to keep interest rates low to even attempt to keep deflation at bay and that there is a shortage of real money dollars. If they were to force the collapse of large financial institutions, the buying power of their US treasuries paper could increase dramatically. If this were to happen their influence over the US Government would likely also increase dramatically. Also, their ability to influence our economy would also increase dramatically - at least temporarily. This condition would only be possible if interest rates were to remain low for some time after china's defaults forced major banks into receivership. So, if indeed this scenario were to play out, there could be a lot in it for china, since its reasonable to assume they could generate potentially dramatic positive returns by owning cash dollars while collapsing our debt money based financial system and then hijacking it. (see: Derivatives...what the heck were they for?)


Keep in mind that though the article posted below does not specifically discuss oil...oil is one of the markets that china has been playing in the biggest way...and the impacts of their gamesmanship would likely effect oil even more than soybeans, gold and cotton. This is why oil likely was down so substantially on Friday even though the dollar was weaker than the prior day.


In any case, back to the theoretical world of the fed and out financial system, derivatives are only agreements and agreements are susceptible to be broken and altered. Remember, that JP Morgan has 89 trillion of  purportedly "perfectly hedged derivatives".


"Perfectly Hedged"? We know this to be a lie. Why? It is impossible in the first place and secondly the very nature of a derivative agreement makes it highly improbable. So let's keep it simple and examine just the spread risk on those derivatives, despite what they or the fed may try to say, its in the trillions of dollars. 


Imagine if you will, owning one trillion dollars of some index leaps. Just look at the spread in the market now, do the math and then try to get filled at that spread. That risk alone will be 5 to 10% of capital easily - so, you place your order and immediately lose 100 million when you turn around and try to sell it. Now take the instrument make it 100 times more obscure and transacted in a private market that has limited liquidity...and the spread risk on the equity leaps look tame. Now for each component of a derivative position and its hedges there is spread risk. Unlike a simple directional leap position, which itself has 10% risk in taking into account both buy and sell sides...creating a complex position with hedges adds significantly more spread risk relative to capital required to maintain the position. To see this in real life simply model up a butterfly or any limited risk option strategy and then try to execute it. You will see large losses immediately relative to capital employed and the size of the trade. JP Morgan's spread risk (which is much more substantial than a simple options combination trade) alone makes the bank insolvent. Funky accounting and supportive manipulations of accounting rules, off balance sheet entities and SIV's make it possible to hide these inefficiencies by reflecting theoretical or derived values on the balance sheet - where everything can look - well, "perfectly hedged". 


All of these techniques are tacitly endorsed, lobbied or promoted by the Fed...and follow the pattern of regulation created to legalize criminal or inappropriate activity. In fact, the Fed itself uses these conventions themselves in a lot of cases. The fed's reported balance sheet is supposedly up to around 2 trillion dollars...up some 500% or so...their off balance sheet "balance sheet" makes that sum look like peanuts. So, not only does the spread risk alone accomplish that task of bankrupting JPM but that spread risk likely will add trillions  to our national debt when the JP Morgan's obligations are transferred to the tax payer (to be nice, lets assume 5% of 89 trillion is 4.5 trillion). Notice however, that I did not even mention the china situation yet - that's called counter party risk and that risk is much bigger than china alone. Add that to the equation, and the banking system in the US takes a 20 trillion or greater hit from JPM alone (and quite likely much more)....and guess who gets the bill? 


That's a lot of liquidity to take out of a theoretical and fiat system... the shortage of dollars will be tremendous. (see: Derivatives...what the heck were they for?, More dollar what-if discussion, crash warning and recommendations, The Future of the Dollar - the biggest short squeeze ever,  The EURO - starting a trip to oblivion and Warren Buffett - the ultimate bull-market manifestation) 


Now you know why the fed has tried like hell to bail out JP Morgan at every turn (starting with Bear Stearns) and especially tried to protect their reputation and image of solvency. But JP Morgan is broke and when they are proven to be broke the whole system will be broke since most banks will be impacted directly and some indirectly.


Observe the chart below. Each large move in the SP500 was preceded by  period of correlated behavior between treasuries and stocks. We are presently in a significantly correlated pattern.

 

see the original reuters article here or read it below:
US commodities rattled by China derivatives stance

* China lets state firms default on derivative contracts- report

* US soy, gold and cotton pressured by report

* Lawyers doubt legal standing of the move

* Market suspects more potential losses prompt the move

* Foreign banks dismayed (Updates with US gold, soy and cotton markets weighed down by reported move; adds analyst quotes, adds CHICAGO to dateline)

By Eadie Chen and Chen Aizhu

BEIJING/CHICAGO, Aug 31 (Reuters) - U.S. gold and soybean markets fell on Monday following a weekend report that China's state companies may default on commodity derivative contracts with banks providing over-the-counter hedging services.

Traders in other commodities markets in the United States were cautious, underscoring China's predominance as a buyer in global markets from metals to grain to oil after it played a key role in rallying prices to record highs last year.

In a measure of the country's influence over the global economy, U.S. stocks fell after the Shanghai Composite index .SSEC fell nearly 7 percent to a three-month low on fears Beijing is trying to moderate growth and choke off speculation in its stock market by tightening bank lending.

Commodities markets were chilled by a report in Caijing magazine quoting an unnamed industry source as saying Chinese state-owned companies will be allowed to default on commodity derivative contracts. The report provoked anger and dismay among investment banks that feared a damaging precedent.

China's regulator of state owned enterprises, the Assets Supervision and Administration Commission (SASAC), has told six foreign banks that SOEs reserved the right to default on contracts, the magazine said in an article published on Saturday.

A government official said that the Bureau of Financial Supervision and Evaluation under SASAC was handling the issue. The official declined to be named and did not elaborate.

"A Chinese agency said they reserve the right to walk away from bad derivatives contracts and that stirred up a lot of worry not only about the stock market but soybeans as well," said Paul Haugens, vice president at Newedge USA.

China, the world's top importer of soybeans, has been an aggressive buyer of U.S. supplies, helping drive prices higher as stockpiles fell to the lowest level in over three decades.

US SOY, GOLD MARKETS FALL, COTTON RECOVERS

Chicago Board of Trade soybean futures for November delivery SX9 fell 31-1/2 cents, or 3 percent, to $9.79-1/2.

December gold GCZ9 fell $5.30 to $953.50 an ounce at the New York Mercantile Exchange's COMEX division. U.S. cotton futures fell in early trading due to the news, but closed higher on month-end position squaring.

"Historically, it is not so unusual for China to either renegotiate or abandon some deals that have been made. Some traders who have been around for a while are certainly aware of that possibility," said Bill O'Neill, managing partner at New Jersey-based LOGIC Advisors.

Spokespersons at Goldman Sachs (GS.N), UBS (UBSN.VX), JPMorgan (JPM.N) and Morgan Stanley declined to comment, along with the Securities Industry and Financial Markets Association and International Swaps and Derivatives Association Inc.

The reported letter to the six banks follows an order from SASAC in July that required all state companies trading in derivatives to make quarterly reports about their investments, including details of holdings and performance.

"I won't be surprised if more state firms emerged with big derivatives trading losses. Or else SASAC won't come out with such a radical move," a Hong Kong-based derivatives analyst said.

"As far as I know, there are another number of state firms bogged down in such losses besides those surfaced ones," said the analyst, who declined to be named due to the sensitivity of the issue.

'ABNORMAL PRACTICE'

A SASAC media official said he was waiting for the "relevant department's" official comment before clarifying the situation with the media.

The report deals another blow to investment banks hoping to sell more derivatives hedges in China, the world's fastest-expanding major economy and top commodities consumer.

"It's a handful of companies who are being encouraged by regulators to renegotiate. It's outrageous, but it's China so everyone is treading very carefully," said a banking source.

Beijing-based derivatives lawyers said the so-called "legal letter" has no legal standing -- SASAC as a shareholder of SOEs has no business relationship with international banks.

"This can also lead to market chaos. For example, a foreign bank can tell its Chinese clients that it can reserve the right to default on contracts that will bring losses to the bank," said a lawyer from the derivatives risks committee of the Beijing Lawyers Association.

No bank names were reported in the Caijing report. The SASAC media officer also declined to specify any.

Chinese state firms, especially those that have suffered big losses in derivatives trading, have been complaining that their foreign banks sometimes did not disclose full information of potential risks when selling them complicated products. 

DBA - Ready for wave 5 down?

After a very long wave 4...DBA, despite Jim Rogers prognostications, looks rather negative here...again Tuesday is make or break. Given that the weakness in the dollar did not help DBA and the condition of oil - this does look like 4th time could be a charm. If indeed this is occurring this is a picture of deflation in progress...and likely herald the same for the stock markets.

Just a simple chart...

Utilities also made a very unconvincing bounce after their pullback...its at a support area could try to bounce a bit more...but looks weak.

Junk Bonds ratio to treasuries sport a completed impulse wave. This is something to keep an eye on.