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Historic Moves Sweep into Bond, Oil Markets

With all the excitement in other markets, stocks have settled down a bit, and remain range bound

From Standard & Poor's Equity ResearchFrom a research report published by Standard & Poor's Equity Research on December 19, 2008

The action in other markets of late is taking some of the attention away from the stock market, and that's probably a good thing, at least for the time being. Treasury yields have plummeted to record lows with t-bill rates at 0% and longer 10-year notes approaching 2%. This has dropped mortgage rates to 5% and in some instances, below 5%.

Crude oil futures have fallen off the proverbial cliff with the December contract (which expired Dec. 19) below $35 per barrel, sending gasoline prices to their lowest levels since 2003 and heating oil to prices not seen since 2005.

Maybe this won't be such a bad holiday season after all.

With all this excitement in other markets, the stock market has settled down a bit, and remains range bound between the early November high and the November 20 bear market low. For the S&P 500, this amounts to a ceiling up at 1006 on a closing basis and 1044 on an intraday basis, and a floor down at 752. This might very well be the range that the index trades in for much of the early part of 2009.

It appears that the S&P is working on a complex, inverse head-and-shoulders (H&S) pattern and to complete this bullish reversal formation, the index will need to break strongly above the 1006 level on a closing basis. This would turn the intermediate-term trend to bullish from the current neutral reading. This, to us, seems like the most likely scenario sometime in the New Year. If the market, however, can't get its footing and 752 is taken out, that would then open the possibility of yet another leg to the downside. This, we think, is the less likely scenario.

In between the current floor and ceiling that defines the trading range sits some minor areas of support and resistance. On the downside, short-term chart support from the recent lows sits between 869 and 885. Additional chart support lies down at 816 from the December 1 closing low. Trendline support, off the lows since November 20, also comes in at 885.

On the upside, initial chart resistance, from the recent high, is at 913. The 50-day exponential average comes in at 929, while the 65-day exponential lies at 960, and either or both could provide some short-term resistance. During an intermediate- to long-term base, it is somewhat common for the stock market to rally up to its 50 or 65-day average, and then see a pause or pullback in prices. While the “500” has not quite reached the 50-day exponential average, the index did run into and slightly above its 50-day simple average during the Fed-induced rally Dec. 17, but prices paused Wednesday and quickly reversed with Thursday's sell-off. An initial Fibonacci retracement of 23.6% of the bear market sits at 944, while a 38.2% retracement lies at 1063, or just above the intraday high of the current base.

With the price stabilization in the major indices over the past couple of months, volatility indices have come crashing down; a welcome sign that fear is abating. The VIX, or market volatility index based on option premiums of the S&P 500, has traced out a fairly large double top as well as a large complex H&S top. With the massive drop in the VIX on Dec. 19, there is no doubt that these bearish patterns are complete, and, therefore, suggest further declines in the VIX.

Focusing on the double top, the VIX topped out on a closing basis up near the 80% level, and since the November 20 closing peak of 80.9%, has come cascading down to near 40% in just 20 days. This is the largest decline in the VIX over a 20-day period since early November 1998, and coincides with a time period when the S&P 500 had completed a very nice double bottom reversal formation. There is a massive layer of chart support for the VIX down in the 20% to 35% zone, so we think we'll see additional declines in this and other volatility indices and the option premiums they measure. Many times, large declines in volatility indices from very high levels have led to a good to very good performance by the overall stock market.

Quite frankly, we are shocked the 10-year Treasury note has plunged to a whopping yield of just over 2%. Yes we know the economy is terrible, and prospects for at least 2009 seem less than robust, but who would lock up funds for 10 years at this kind of pathetic return with a real chance of losing principal if treasury prices fall?

While some funds and institutions are obligated to own the stuff, we think there is more going on behind the scenes. We believe the government is buying treasuries in an effort to bring down mortgage rates, which is working fairly well of late. This might be one of the most powerful things that the government has done over the past couple of months to at least put a floor under the economy.

The recent moves of down in yields and up in prices is historic. The 10-year Treasury future (continuous contract) has surged about 15% since early November, the largest move in that time period in at least the last decade. We suspect that the 10-year Treasury yield will have a tough time breaking substantially through the 2% area, although stranger things have happened lately. Back in June 2003, when deflation fears were running rampant, the 10-year fell to about 3% before bottoming out. Something about big round numbers I guess. The bubble and concern has gone from housing (due to easy credit and low yields), to emerging markets and commodities, and back to Treasuries.

Arbeter, a chartered market technician, is chief technical strategist for Standard Poor's .

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