The Bond Market could Stall the Santa Rally

December 19, 2013, 10:51 am ET, BY Thomas H. Kee Jr- Editor, Stock Traders Daily| Editor: Thomas H. Kee Jr. (Follow on LinkedIn)

After the FOMC decision on Wednesday the market rallied, but that rally is something that almost everyone expected, and that is a risk.  The bigger risk is that everyone, almost without exception, also expects the market to rally through the end of the year.  I am not necessarily against that possibility, and I too expected the Market to increase yesterday so long as the news was not horrible, but something else is happening that must be considered.

The emotional state of the expectations in the equity market neglected the elephant in the room, the 10-year note.  Check the 7-10 year ETF (NYSE:PST) and you will see that instead of gyrating like the stock market, the bond market was darn stable yesterday, but something else happened yesterday too.

The bond market was essentially assured that the FOMC was on a path to halt all bond purchases, and for holders of long term Treasury bonds that means they are likely to experience capital losses over time, more than what they have experienced already.  This is especially true of course in bond funds and bond ETFs that are not designed to return principle (only individual bonds are designed to return principle).

Looking at the Bond Market today we can see that the 10-year Treasury is a hair away from 3%, a level that could turn the stock market on a dime.  The emotions that drove the market higher on Wednesday were also associated with an overwhelming expectation that the market certainly would rally for the rest of the year too, but when everyone expects the same thing the Market has a tendency to do the opposite. 

In fact, when everyone thinks the same thing, I get concerned, and thus far today that concern is warranted.  I discussed the risks with clients yesterday after the rally, and I conceded that the feeling was definitely bullish, but feelings and emotions do little to make us money.  Instead, emotions can get us hurt, so i shared with them what I do best.

The technical reads for the Dow Jones Industrial Average (NYSE:DIA), S&P 500 (NYSE:SPY), NASDAQ (NYSE:QQQ), and Russell 2000 (NYSE:IWM)are all bearish on a midterm basis, and they point to official tests of longer term support before the market can turn higher with more sustainability. This will be true so long as the market stays below midterm resistance levels, which are slightly higher than Wednesday's closing prices.

The emotional ride on Wednesday was fun, but Smart Money, namely those big investors in bonds, realize that they need to continue to sell, that will drive rates up, and if there is any reason to sell a little more than they have already the 10-year note will be above 3% officially.  The Stock market may just decline to test our longer term support levels if that happens. 

Conclusion:  do not let emotions control your trading decisions.  All that matters is price, and if resistance levels hold we are expecting tests of longer term support officially.

Support and Resistance Plot Chart for

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