• Are we moving from a liquidity to a rates driven market?

    The answer is indeed YES. But the transition is not going to be smooth because much liquidity is still available and rates are still low. Expectation for higher rates does not erase liquidity. Insolvency is what destroys liquidity and we are not seeing much distress in the trading community.

    Below are two signs that we are in such a transition:

    1. The 20DMF and The Money Flow on the NQ8 stocks started working again.

    On Friday February 2, the 20DMF started to display a negative divergence early in the day. The market ended on a steep decline, which was followed by the Monday dump.



    On Tuesday February 6, both the 20DMF and the NQ100 displayed positive divergences and the market closed on a strong note.





    On Wednesday 7, early in the day, the NQ8 MF started showing a negative divergence. It closed lower and the next day was another dump day.



    Comment: In the past two years I rarely saw consecutive Money Flow divergence signals that were not overwhelmed by liquidity injections. When the Money Flow displays a divergence, it means that large investors are trading the opposite of the price trend. In the past two years I have often discounted such divergences as we had been accustomed to seeing liquidity coming out of nowhere to push asset prices higher. Large investors now seem to trade their books and valuations instead of following the Central banks liquidity.

    2. The ratio of the sectors that are on a buy wait mode is moving to extremes not seen since January 2016.

    On my February 8 comment, I wrote:

    We can see below that before January 2016 this signal moved often well above the 50% level and offered many buy oversold signals. In the past two years, we have never had a single one of these signals, simply because we have been in a liquidity driven market due to Japanese index investors (Japanese NIRP started early in 2016.)

    http://www.effectivevolume.com/conte...ebruary-8-2018



    This signal is now swiftly pushing to the 50% level. As a reminder, this is a sector based breadth indicator. A 50% level indicates that half of the sectors that I track are in short mode but this mode is deep enough that the next signal to be expected is a buy signal. This happens in deeply oversold markets.



    Comment: Liquidity injections are either not detectable or have been overwhelmed by stop losses and profit taking activities. At this stage I doubt very much that we are witnessing waves of forced selling (margin calls or bankruptcies.) Hence, even if the selling was steep, it is not forcing the Fed's hand because it just erased two months of gains. If the Fed issues comments, it will be to say that this pullback is healthy, that there is no fundamental risk, etc. The same comments that Bernanke made just at the start of the subprime crisis. I do not want to say that we are in a similar event, but only that the Fed will try to talk the markets like it always does. But if the Fed's policy stays unchanged - QE unwind - the market's focus will remain on rates.

    The 20DMF Overbought/Oversold signal

    This OB/OS signal is now at -89.48. We had such a strong oversold signal only twice before: in August 2011 and in August 2015. In both cases the market was higher only a few days later. This tells us that the coming week will be positive - it is an options expiration week.




    The 10Y Rates

    The 10 Y US rates are still rather high, pushing with them the US/Japanese rates differentials.





    Note that the US rates still stayed high even though the S&P500 fell by 10%.



    The US$ index is slightly bouncing as cash is raised.



    With rates unwilling to move down, all the fixed income assets failed to attract money.







    Conclusion:

    Even though technically speaking the equities markets will bounce hard this coming week, the issue is whether the bounce will be sustainable or not. In other words, will liquidity move back into equities?

    If the US rates stay high and the Fed does nothing to talk markets higher then I do not believe that US equities will be able to break to a new high.

    If the US rates pull back down, will this trigger a relief rally with leveraged positions being built again to fuel a new equities uptrend? My opinion is that if US rates pull back, money that was raised during the equities sell-off will move into fixed assets.

    In both cases, the bounce of next week will probably fail.