Fed's Open Market Operations

Amazing picture which I have to repost from Alea's FRBNY: Domestic Open Market Operations during 2008

Credit indices

The Credit Default Swap indices have been improving this. Even with today's sell off, these indices appear to be heading south -- which should be supportive of equities.

Here's the US Investment Grade Index (from Credit Derivatives Research). By the looks of it, this index put in a lower high -- a lower low would be bullish

CDR's US High Yield index is on the right, a head
and shoulder's formation.

CDR's Europe Investment Grade Index is on the left. Another head and shoulder's formation.







CDR's Europe Crossover (mostly high yield) is on
the right. This is the worst performing index --
it has not yet clearly turned over, a new high would be bearish for equities.




In spite of today's sell off in equities, all four of these indices have signs of improvement.

Markit's ABX and CMBX's indices were also showing signs of improvement, but today they paused. Here's Markit's CMBX-NA-AAA 4 index , it bounced off of the previous lows.

10 year yields jump

The Fed announced that they were "prepared to buy Treasuries" and it appears the market wants to test how serious the Fed is. In the words of Across the Curve, "tarders are now enganged in a game of financial chicken with Federal Reserve as traders attempt to force the Fed's hand." And with that, 10 year yield jumped today.

It is unclear as to whether this is supportive of the broader stock market. Have yields jumped because of excessive supply? Or are increased yields indication of a broader appetite for risk (and yield)?

Signs of improvement - ABX & CMBX indices

As I posted on Thursday, Markit's ABX and CMBX indices have been strong this past week, with both indices pulling back before reaching the extreme levels reached last November.

Markit's AAA ABX indices appeared to have made a higher low last week, but after nitially advancing, have paused. Still, these indices are showing positive divergence to SPX. Here's Markit's AAAA 07-2 series, with SPX (from Stockcharts) superimposed in green



Similar story with Markit's CMBX indices, although these indices have continued to improve all week. Here's Markit's CMBX AAA 4 index (which shows price). I've superimposed the inverse of SPX in blue. Again, note the divergence.

Signs of improvement

While the bad news has been relentless these past few weeks, there have been signs that a recovery is just around the corner. Numerous correlational indicators have improved markedly since New Years, even in the face of the weakness in equities these past two weeks. These indicators include:

A huge decline in the A2/P2 spreads in 2009 (Calculated Risk) indicating that credit is beginning to flow again;

An increase in M3 Money Supply, indicating that the Fed's efforts to reinflate are getting traction;

An increase in 10 year Treasury yields, indicating an increase in risk appetite;

Bullish moves in silver and crude, silver in particular has been tightly correlated to SPX;

A weekly drop in the cash holdings of money market mutual funds, which might indicate that cash on the sidelines is coming back into the markets;

Continued improvement in the BDI, suggesting that global trade is starting to recover;

And strength in Markit's ABX and CMBX indices, again measures that are correlated to SPX.

All this is bullish for equities, although some indicators are becoming overbought (like TRIN from Matt Trivisonno)

Signs of improvement - Money supply

While there were signs that the monetary supply was contracting all of 2008, this contraction accelerated during and after the collapse of Lehman Brothers. The Fed has frantically tried to arrest this collapse by slashing the Fed Fund rate and through various liquidity schemes, moves which were mirrored to varying degrees by other other central banks. It appears that these moves are finally gaining traction, with M3 measures starting to increase again this past month.

Below is a chart of M3 from nowandfutures.com. I've added SPX (from Stochcharts) in red, note the correlation between SPX and M3 growth in blue). Growth M3 has accelerated this year, which, given the previous correlations, is bullish for equities.

Signs of improvement - 10 year Treasury yields

Treasury yields, after plummeting through November and December, have been moving higher for the past month. The move up in yields this past week in the face of continued weakness in equities, suggests a slow increase in risk appetite.

Mind you, the increase in Treasury yields was also driven by in increase in issuance by the Treasury department, as well as Geitner's "China Manipulates" comments. Still, as the chart below shows, 10 year yields are strongly correlated with SPX, so last week's rise is bullish.

Signs of improvement - silver and crude

Since last August, both silver and crude have been tightly correlated to SPX, with all three instruments being synchronized in the timing of their highs and lows. And while the heights of their respective highs and lows varied, the directions of their moves remain correlated. Silver and SPX, in particular, have been strongly correlated.

Below is a Stockcharts chart with silver and SPX in the top panel, crude ($WTIC) and SPX in the second panel, and silver and crude in the third panel. Note how the intermediate lows of the three instruments are synchronized, with silver's 52 week low being put in at the end of October, SPX's low on Nov 21st, and crude's low in late December.

Last week, silver managed to put in a lower high, and this past week, the metal put in a higher high, bullish signs that the uptrend will continue. This is in contrast to SPX, which was down on the week.

Crude, while not as strong as silver, managed a higher low before closing up for the week.

Given the past correlation to equities, these are bullish signs that stocks will rise.

Signs of improvement - changes in cash holdings

Vix and More has his chart of the week: Change of Trend in Cash Holdings?

His chart, reproduced below, plots the size of Institutional and Retail Money Market Funds, which reached an all-time high last week. Their size is thought to reflect the amount of cash sitting on the sidelines, and this week showed the first meaningful drop in money market mutual fund cash levels since September. And as Vix and More writes, if the change in money market mutual fund levels from the past week is the first signs of a change in trend, then this will almost certainly have significant bullish implications for equities.

Signs of improvement - BDI

Here's the Baltic Dry Index. It got absolutely decimated last year -- decimate is actually quite apropos and the index fell to less than 1/10th of its high. But it has been recovering since early December, up almost 50% from its lows.

Here's Stockchart's version of BDI, on a log scale. The drop is horrendous, but at least the index is improving


InvestmentTools.com has another version the BDI, with lots of charts