After a posting a 3% gain on Jan 2, the second trading day of the year was a dud for stocks. Meanwhile, other markets – the important ones – have been making some major moves. As I said before, big moves in currencies, commodities and credit markets will LEAD the equities. Let us try to figure out what is happening. [Click all the links for charts.]

1. US Dollar is back above 20 DMA at 82.75 (I was going to say that it is facing gap resistance. But in reality there is no gap as currencies trade round the clock.) In Dec, they said that a weak dollar was good for equities. Now, will they say strong dollar is also good for equities (I tend to agree with this.) Also, Yen is getting weaker against the dollar. This makes Japan stocks an extra buy (I am bullish on Japan stocks now).
2. Today CRB index closed above 20 DMA for the 3rd day in a row. This ‘reflation’ effect ought to be bullish (at least short-term) for stocks. Commodities indices have been rebalanced for the new year. This will have significant impact on various commodities (gold bugs, pay attention). Here is what JP Morgan thinks will happen to some commodities (and hence to  related stocks):
   • In financial terms, we expect the rebalancing to have the greatest impact in gold, COMEX copper, crude oil, gold, and live cattle. We estimate that the rebalancing of the two indices is expected to result in $877 million of selling in gold, $699 million of buying in COMEX copper, $528 million of selling in live cattle, and $523 million of buying in crude oil.
3. Meanwhile in the Treasury land, some huge moves occurred in the last three days. The 30-year bond got crushed with yields closing above 3%. The 10-year also got sold off with yields close to 2.5%. If you bought TBT (Ultra-short 20+ yr Treasuries) at 36, on Dec 30, you would have gained above 15% in 3 days. These are insane moves in Treasuries. Usually, such moves should help equities (sell bonds, buy stocks). However, these moves will also hurt mortgage rates, which should be a drag on financial stocks. [As go the financials, so goes the stock market.]
   
4. Spreads on corporates have improved. The ETF that tracks investment grade corporate bonds (LQD) has outperformed the market since it Oct lows (up about 25%).  This indicates increased risk appetite and hence good for stocks.

If the sell-off in Treasuries is simply rebalancing and a move into other risky assets like stocks – then I agree that it is good for the equities (at least short-term).

On the other hand, if this is the beginning of unraveling of the last big bubble (biggest of all, as they say), or an unwillingness to lend to US at cheap (zero) rates, this cannot be good for anything, let alone stocks. US is expected to sell $2 trillion worth of securities in the next 12-18 months. That is about $6-10 billion per trading day. Who has that kind of money and who in the right mind would buy US debt at these rates?

I would venture to say one thing – Treasuries are telling us to expect a big move in stocks. I just don’t know which way. I think we should closely watch the move in treasuries, mortgage rates and the  financials. They are going to tell where this market is headed. Based on what we are seeing in the last 3 days (concurrent with the big move in Treasuries), financials are relatively weak. Which could mean (of course, my positions are speaking) that we are setting the stage for a sell-off.