Santa Rally & problems in China

Well, I was wrong and right on events that happened this week in the market.  I was wrong when I stated that the Fed would not taper this week (they did by trimming 10 Billion off of their historic quantitative easing) but I was right when I stated the Christmas rally would commence on Wednesday afternoon right after the FOMC announcement.  Here's a Five minute chart of the S&P on Wednesday and Thursday:

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All the major indexes closed the week at either new all time highs are a fraction off of those highs.  For illustrative purposes here's a daily chart of the S&P 500:

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The S&P closed on Friday at 1818.32 and we still could reach my target of 1860 by year end.   But the market always gives us something to worry about and the long "wick" on Friday's candlestick was representative of some selling pressure going into the close.  I'll address why I think this happened below.

The Ten Year Treasury yield was quickly approaching 3% but backed off those levels on Friday when, in my opinion, a stealth "flight to safety"occurred for reasons I'll explain below.  I'm posting a monthly chart of the Ten Year Treasury yield which shows the yield snagged on a resistance line drawn from the highs in yield going back to 2007:

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In the post crash world we live, where we had a close brush with financial Armageddon and where deflationary pressures still reign, there will be steady but diminishing downward pressure on interest rates for years to come.  Don't misunderstand, if the global economy is healing as well as recent economic reports suggest, interest rates will rise but not at the clip many of us have become accustomed to in our lives.

Gold was roundly trounced this week and is presently testing the crucial $1,200.00 level.  Here's an update of a weekly chart I've posted before:

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Gold needs to hold these levels if it's not going to see substantially lower prices.  However, I am mildly encouraged by the RSI (Relative Strength Indicator) momentum indicator in the top panel which is sporting a positive divergence from price.

 In a world awash in central bank liquidity Gold's price action is testimony to the incredible deflationary forces that still persist in the global economy.  The fact that interest rates have been rising also does not help Gold's cause but I'm not of the opinion as many others are that rising interest rates are the primary reason for the yellow metals persistent fall over the past few months.  We shall see what happens.

Now, here's one of the reasons why I think my prediction of 1860 on the S&P may not occur before year end.  The "spanner thrown into the engine" may be coming from China:

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The Shanghai Composite fell out of bed this week as the country's banking system experienced another liquidity crunch.  The People's Bank of China (PBoC) has been purposely draining liquidity as it struggles to reign in it's "shadow banking" system.  And this is all on the heels of one of the larger coal concerns in the country, the Liansheng Group, defaulting on debts of nearly 30 billion yuan this week.  Evidently, the default caused the PBoC to inject some emergency liquidity into the system on Thursday, only to reverse course on Friday by draining liquidity.  Legendary short seller, Jim Chanos, has been harping on the flaws and weaknesses in the Chinese banking system for years and this recent development is worth watching going forward.  

The market, for the most part, is taking this event in it's stride although I do believe some investors took money off the table on Friday afternoon because of these developments. The Chinese banking system went through a similar crisis earlier in the year and the prevailing view is that the PBoC is doing what is necessary to address these twin issues of excess liquidity and multi billion Yuan bankruptcies, however clumsy their implementation.  To this I would not disagree but to say there never seems to be a banking crisis until there is one and then it's too late.  

Going forward, as our central bank begins it's historic liquidity unwind, if present market price action is telling us anything it's telling us that the economy and financial markets no longer need Fed "training wheels" to grow.  Admittedly, the 10 billion reduction in asset purchases was a token and the Fed was clear that it had the market's back by promising to keep short term rates low for even a longer period of time than was previously promised.  All I'll add is that there was no specificity to those promises (and how could there be) but vague promises are easily broken.  

Whether the S&P reaches 1860 by year end will depend much on the recent events in China which I identified above but I must admit that even if those issues dissolve next week 40 points in five trading days is a tall order and a positive catalyst would be needed to move the needle that much in a short period.  Such a catalyst over the holiday period would not probably happen and if there was one the chances of it being negative would be far greater.

However, I do see stocks moving higher going into the first months of 2014 now that we have some semblance of stability in Washington.  Additionally, seasonality is favorable for equities up to the end of April.

This will be my last commentary until 1/4/2014.

Have a Merry Christmas and a Happy and prosperous New Year!