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Technical Charts Suggest Interest Rates Heading Higher Still If the stock market is to advance further, it is likely to need the stability if not the help of the bond market. Bonds have been in a trading range for what seems like forever. So it seems as if there are a lot of people who are not too worried about a drop in the bond market. This may be because it seems as if the bond market spends similar amounts of time heading down it spends heading up. The long-term monthly chart (1990 to the present) of the 10-year note yield is shown in the chart below below. In the years when interest rates were in a long term downtrend, the 14 month RSI routinely dipped below the 30% level. However since mid-2002 the monthly RSI has not fallen below 41. The 10-year note yield is now threatening to break above a 4 year old down trendline, shown in red. The more important down trendline which began in 1994 (shown in blue) has not yet been threatened.
The 3-year weekly chart provides good medium term perspective. The importance of the 4.85% yield level can clearly be seen. The 14 week RSI shows that since last summer, in spite of interest rate drops (bond market rallies); the 10-year note yield refused to become oversold. Last week’s action saw the 10-year note yield bounce right off of the 40-week (200-day) simple moving average. This week’s action saw the 10-year note yield decisively break about the 10-week moving average. This is all bullish for a rise in interest rates and bearish for the bond market.
The 6-month daily chart of the 10-year note yield provides short term perspective. In Wednesday’s action, the 10-year note yield gapped above the 20-day exponential moving average and crashed through the 50-day moving average (blue) and the down trendline (purple) with a solid white candlestick. This short term action suggests that interest rates are heading up in the short term. At the least, pullbacks back to the moving average and trendline should be bought (and bonds sold).
Gold Dancing With Stocks Daily What’s driving this stock market rally? That is tough to say as I have as much to say about that as the bunnies on TV. But when something appears to be out of whack, it’s my job to talk about it. Since the New Year it appears that a new and different relationship has developed between stocks and gold. Over the long term, gold and stocks generally head in opposite directions. When stocks go up, gold goes down and vice versa. Over the shorter term, the relationship is less defined. One would expect that on a daily basis there would be very little relationship between the movement of stocks and the movement of gold. Through all of 2005, this was the case. There were days when gold was up and stocks were down, days when gold was up and stocks were up, days when gold was down and stocks were down, and days where gold was down and stocks were up. Yet since the New Year of 2006, gold has tracked stocks on practically a daily basis – when stocks went down, gold went down, and when stocks went up, gold went up. This is illustrated in the chart below.
In the daily chart above, a “1” was plotted when gold and stocks finished the day on the same side of the ledger (i.e. both gold and stocks up, or both gold and stocks down). A “0” was plotted when gold and stocks finished opposite each other (i.e. gold up, stocks down, or gold down stocks up). Notice the preponderance of days since the New Year when both stocks and gold tracked in the same direction. Wednesday was a break with the trend. Gold finished up strongly while stocks finished down marginally. I’m open to any reasonable explanations as to why this is occurring. Of course, it could just be a statistical aberration. An Internet Tale It seems to me that the discrepancy in valuation between Google and Ebay is one that will correct over time – maybe very little time. At its current market cap of $128 billion, Google is way overpriced. Their model is fraught with competition and the potential for even more competition. There are precious little in the way of barriers to entry for all of Google’s ventures. A slowing economy will hurt their revenue, which still consist primarily of advertising-related sources. Most Wall Street analysts would take issue with this simple fact. But you must remember that the same people said the same stuff about Yahoo and AOL five years ago before the crash, and only a couple of these people went to jail. Analysts grow nebulous and rhetorical when they try to describe how Google will grow their earnings in the long term future. And Google has become so fashionable that it is not cool to say that you don’t understand how they will become as profitable as their market cap now discounts. The last Wall Street darling that was similarly misunderstood was Enron. On the other hand, Ebay is a successful and growing business that has executed well and has a bright and clear future. Ebay’s business model is simple to understand and relatively simple to execute. Except for valuation and stock option bonanzas and the lack of dividends, they are a company that Warren Buffett would love. They have no competition and as they become bigger and more profitable, they will face even less competition. Ebay’s business will grow in a good economy, and grow faster in a slow economy. When people need some spare cash they sell their stuff on Ebay. (This is especially true now that home refinancing is a less desirable proposition.) They have grown shareholder equity nicely. Except for my internet service provider, Ebay is the only internet company that makes a significant amount of money off of me. And they do it with no specific effort toward my specific needs. The customer’s needs and their profit are all built into their web site and business model. So to summarize, Google is a cloudy and Wall Street-hyped company with competition and threats from future competition. Ebay is an almost perfect business with no competition. Below is a technical chart of the Ebay to Google ratio.
Although it is not an extremely compelling technical case, it appears that the Ebay to Google ratio has bottomed. There are price/momentum divergences, and the current daily momentum is positive. Google has recently shown that it is capable of swooning 17% in 6-days, before staging what I believe is a sucker’s rally. On the other hand, Ebay is just above an intermediate term uptrend as shown below. Assuming the early ’05 gap is not a breakaway gap, Ebay has a gap to fill at above 50. (The stock is now at about 43.5.)
Ebay is one of only two mega-cap technology companies to surpass its 2000-bubble high (Apple Computer is the other). Both companies will drop severely in a technology rout; but it seems to me that Google, fueled on Wall Street hype, will drop at a higher rate than Ebay when a technology rout occurs. It appears to me that things on Wall Street couldn’t be better for Google. If they couldn’t be better, it is likely that they will get worse. This is my assessment of Ebay and Google, and its business, not personal! Today’s Market The market rallied today as the Russell 2000 index surpassed its all-time high in a decisive manner. Updating the Elliott Wave discussion of a few weeks ago, below is a chart of the Russell 2000 showing all components of the proposed diagonal with its current “throw-over” pattern. If we are to get a dramatic reversal, it’s likely to be soon. I’m not trading on this proposed Elliott Wave pattern because, as the paradox goes, “the pattern is not reversed until it is reversed.”
The market rallied strongly today led by semi-conductors, financials, transportation stocks, and small caps. A notable laggard of late is the retail sector as can be seen in the 6-month chart of the S&P 500 ETF (SPY) versus the Retail Holders ETF (RTH).
Another up day for interest rate of the 10-year note, and the resistance levels indicated by the red down trendline is under pressure. While the short term direction of the stock market has been driven by speculative emotion (e.g. Google), the longer term and more important trend will be based on inflation, and interest rates and these are both heading up. Below is a chart of the Central Fund of Canada, a closed-end fund composed of about 65% gold and 45% silver. I see a strong uptrend that is either basing for another push up, or losing upward momentum. Either way the long-term trend is clearly up. In these uncertain times, I’m happy to be on the side of the trade that appears to be on my side in the long term.
With Microsoft reporting good news, tomorrow looks like another bullish day for the market, at least at the open. In spite of a bull market, the mega-capped Microsoft is just a couple of points above where it was when the rip-roaring rally began (plus a special dividend). Have a great evening. Martin Goldberg
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