It was written on the walls that success is a process
No matter how hard I fall I know it is some progress
Notches of the ladder I climb, holdin a bottle of wine
So many paths to take, I’m followin mine
-Common

Yesterday, I wrote about Goldman Sachs lowering their expectations for Q3 GDP to 2.7%. This morning, the Advance GDP number was announced at 3.5%–higher than expectations and far higher than Goldman’s lowered target of 2.7%. This is the first of three GDP announcements. We’ll see preliminary GDP on November 22 and final GDP on December 22. I find it tough to think that an advance number of 3.5% can be lowered all the way down to 2.7%. Then again, don’t count Goldman out. Goldman is Goldman.

No matter where the final Q3 GDP number comes in, the announcement today is significant in that the economy grew in the 3rd quarter for the first time in just over a year. It was widely expected that there would be growth, and now the actual growth numbers will be analyzed and argued about on television.

There will be a myriad of economic releases in the next few weeks that will provide insight into what Q4 GDP will come in at. If Q4 GDP expectations need to be revised downward, there will be large gains by being short the right sectors.

Gross Domestic Product

Risk On, Risk Off

The higher than expected GDP announcement this morning spiked S&P futures and induced a selloff in the US Dollar. I have been referring to the “risk aversion trade.” The risk aversion trade is a risk off trade–when traders and investors run for cover. In the current market, I’d describe the risk off trade as being short the S&P, long the US dollar and long treasuries. Today’s market was the opposite of the risk aversion (risk off) trade. Traders scrambled to the risk on trade–long the S&P, oil, short treasuries, short US Dollar. When the risk on trade is on, the Volatility Index (VIX) trades lower. When the risk off trade is on, the VIX trades higher. From the intraday charts below, you can see that what the S&P lost yesterday, it gained back today. Conversely, what the Volatility Index (VIX) gained yesterday, it gave back today. Yesterday was risk off, today was risk on. You follow?

Volatility Index - 15 Minute

S&P 500 Index - 15 Minute

Phone Calls

Can a phone call change your view of the market? This one quite possibly could. I have long opined in these pages that there is more risk to this market than what it is priced for. Of late, I have written of a sudden spike in the dollar that no one is prepared for. After a phone call with a broker in Japan last night, I think it is best to be short select names in the weakest sectors rather than be short broader indices or sectors. Here is why. My broker in Japan alerted me to something very important: Japanese default swap spreads are at their widest in 6 months. Other sovereign default swaps have seen a significant widening as well. This is a sign of potential dollar weakness to come. If the dollar weakens, it will be tougher for the S&P index to sell off dramatically. It is for this reason that I am once again long some silver options (calls). If this widening of swap spreads is a sign–a tell in poker parlance–of dollar weakness to come, the best way to take advantage is to be long precious metals.

The Wall Street Beat

And there you have it, straight from the gut of Vinnie Vega of the Wall Street Beat, a subsidiary of Volatility News.

And the beat goes on.

Meanwhile, back at the studio, there are several recording and motion picture projects in the works. All of my projects are fueled by trading profits, so let’s get to today’s scores.

The downward trend that has been in place this week continued today. The S&P 500 closed down 1.95% or 20.78 points at 1042.63. The Dow Jones Industrial Index closed off 1.21%, and the Nasdaq composite was off by 2.67%. In small cap land, the Russell 2000 was down 3.51%.

S&P 500 - Daily

Before the open this morning, Goldman Sachs lowered their preliminary Q3 GDP estimates to 2.7%. The consensus is for growth of 3.0%. The number will be announced tomorrow at 8:30 AM EST.

In my September 29th post, GDP, GDP and a Triple, I mentioned that if analysts have to lower their Q3 and Q4 GDP estimates, trouble will ensue. As you can see by the breakdown in the various indices, trouble is ensuing: Q3 GDP will be less than expected and Q4 GDP numbers will need to be ratcheted down significantly. Now that the movie theatre of the market is jam packed, it is not out of the realm of possibility that Q4 GDP will come in flat, or 0%–no growth. For this and many other reasons, I am positioned for the risk aversion trade–short various stocks and indices while long Treasuries. When the market realizes that GDP will be lower than what equities are priced for, the disconnect will cause a panic. Everyone cannot exit the theatre at once. The exits will be jammed.

The dollar found support at the 75 level and has rallied. As stated numerous times on these pages, a rally in the dollar will have vast ramifications for all other asset classes. If you’d rather not be short the S&P, you can be long the US Dollar Index. Whatever way you play it, the gains ahead will be magnanimous if you are positioned correctly. The fundamentals can only remain disconnected from the technicals for so long. The tipping point looms.

US Dollar Index - Daily Chart

The Volatility Index (VIX) has seen it’s largest percent gain since the March bottom–up +/- 35% from the lows of October 21. When the exits of the market become jammed, the VIX will trade higher.

Volatility Index (VIX) - Daily

The rally from the March lows has stretched the market to unsustainable levels. I continue to position myself to profit from the risk aversion trade, which is upon us. As my trading profits persist, my mission continues to permeate.

All the while, the beat goes on.

Mission

Meanwhile, back at the office, Anything Anywhere! and I are going to see Paranormal Activity later. Before that, we are discussing the tape. Friday was significant, and the biggest gains of the year are in front of us, not behind us. Anything Anywhere!, who is in the delivery business, is jumping up an down about the breakdown in the railroads (BNI, UNP, CSX). There is so much to talk about, I’ll start with the broader averages.

The S&P 500 closed down 13.31 points or 1.22% at 1079.60. The Dow Jones Industrial Average closed at 9972.18, down 109.13 or 1.08%. The Nasdaq Composite was only down about half as much. It closed at 2154.47, down .50%. The fall in the Nasdaq was softened by strength in names such as Micrososft (MSFT), Amazon (AMZN), Apple (AAPL), Netflix (NFLX), Bidu (BIDU), and T Rowe Price (TROW).

While equities were weak, the dollar showed signs of support. The US Dollar Index closed higher by .50%. In my prior post, I mentioned the importance of the $75 level in the USD Index. That was two weeks ago, and we continue to hold the line.

US Dollar Index - Weekly

Trading Lesson

Since I anticipate a breakdown in equity prices–and strength in the dollar–I look to be short weakness, not strength. In other words, I’d never be short Amazon (AMZN), or Google (GOOG) here. Rather, I’d look to go short Northern Trust (NTRS) or Knight Trading (NITE). Trading lesson: If you are bullish, buy strength; if you are bearish, short weakness. Write that down.

Dark Pools

Of late, there has been limited media attention to dark pools. Dark pools are off exchange platforms run by large banks (Goldman et al). Dark pools allow traders to remain anonymous, in order to disguise their trading strategies. Important speculation regarding dark pools is currently circulating—if certain proposals are passed, trading rules will alter. And when the rules of a game are changed, it is prudent to be cautious.

The proposal in place seeks to cut the trading limits in a dark pool. Currently, if trading through a dark pool, you are allowed to trade 5% of a company’s daily volume. The proposal–which will be put into effect imminently–will restrict the amount of shares you can trade from 5% of a company’s daily volume down to .25%. You can trade 95% less shares now. By cutting the amount of shares you can trade, regulators are effectively shutting down dark pools.

Knight Trading (NITE) is, through all intents and purposes, a dark pool. It is my opinion that NITE will trade below $1 in the near future. There are plenty of fundamental data points which indicate trouble. Also noteworthy is the tremendous promotion scam which was just recently perpetrated.

It all kicked off in March, when someone figured out that something was wrong with NITE–perhaps it’s business was going away. In order to sell a huge position, someone floated a rumor: NITE was to be taken over by a large online brokerage firm based in San Francisco, CA. These rumors bring in suckers, and allow smart money to position.

On Wednesday August 19th Pali Research raised NITE from hold to buy.

On September 16th, NITE was mentioned positively on CNBC program Mad Money.

On October 9th, takeover chatter made the rounds again—more hitting the bid by insiders.

Now, smart players have sold their positions in NITE and gone short. The setup is complete. If dark pools are shut down, liquidity will be hindered. The ramifications of this will be more significant than what the market is priced for. Coming back full circle, I own put options in NITE. Someone knows something, and I am happy to follow their tracks.

Knight Capital Group - NITE

Gold

Gold has traded in a range over the past two weeks. Gold and precious metals remain vulnerable to a sudden rally in the dollar. I continue to view the metals from the sidelines.

Gold Futures - Daily

Looming Catalyst

Living up to it’s name, the stock market is currently a true market of stocks. There are plenty of names that are showing strength–AMZN, TROW, and MSFT to name three. In my view, we are witnessing one of the greatest liquidity driven rallies of all time. Investors are bought in. The movie theatre of the market is jam packed, standing room only. The lights just went down. At some point, someone is going to stand up and yell fire. A catalyst that will cause a rush to the exits. Everyone can’t get out at once.

As all of this unfolds, fortunes will be made and lost. All the while, the beat goes on.

Meanwhile, back at the office, Pinky Megiston–who I am rumored to have a romantic relationship with and who is my client in that she pays me for P.I. (private investigator) services rendered–is having lunch with my assistant, Tonya. The waitress that is serving them is one of my best undercover agents. She will recap their entire conversation with me later. Before I meet with Tonya for drinks, I am speaking with my team of traders and we are re-capping the week that was on Wall Street.

The stock market continued it’s low volume ascent and the S&P 500 closed higher by 4.5% on the week at 1071.49. Friday saw volume in the SPY the lowest it has been in 2009. Anemic as volume has been since the March lows, buyers have clearly defeated sellers. When the ascent will end is anyone’s guess. Clearly the technicals are disconnected from the fundamentals, a scenario that presents enormous opportunities for traders such as myself.

S&P 500 - Daily

S&P 500 - Weekly

Markets, like all complex systems, consist of agents and networks of agents–some rational and some not. Disconnects in markets occur when the majority have the same opinion all at once. A classic example of such a disconnect was seen in the price of Research In Motion (RIMM) post earnings September 24th.

The majority of the time, markets are topsy-turvy and chaotic in that buyers and sellers are in disagreement. The disagreements–based on opinion, timeframe of trades, size of orders, etc.–tend to balance each other out. When there is a disconnect–like there is now between the technicals and the fundamentals–the disagreement between agents is orderly and balanced. At some point–usually due to some catalyst–the orderly, balanced disagreement of market agents suddenly shifts to a consensus. It is at these junctures of consensus, where suddenly all agents on all timeframes share the same opinion, that the outlier gains are attained. If I am not in front of these gains, my mission becomes sidetracked–a scenario in which I am not in favor. I continue to monitor a myriad of markets for signs of an impending consensus. If I am positioned appropriately, my track record will be further bolstered–and my opinion will be in higher demand.

The Dollar

The US Dollar Index (USD) hit a new year low on Thursday last week, but strengthened on Friday. If the dollar is to catch a sudden bid, the ramifications for all dollar denominated assets will be vast. One of the most reliable quant trades this year (outlined here 15 Sept.) is gunning the Euro Yen cross higher, forcing the dollar lower, and equities higher. Lately, it is taking more and more buying in the EURJPY for the same incremental gain in equities. When this trade breaks down is unknown. However, my quant pals at Goldman tell me it may not last much longer. Regardless, the dollar holds an important key to the market puzzle. There are very few dollar bulls out there. The market has a way of tricking the majority. This time will be no different.

There were some large, loud rumors last week that a consensus is building to re-denominate oil away from the US dollar. The likelihood of this happening is very remote. Even if the dollar continues to decline, what oil rich nation or oil trader would want to be paid in anything else? Oil is the most traded commodity on the planet. Large traders want to settle in the currency with the most liquidity. Any story to the contrary is nothing but politics.

Treasuries

The Treasury market saw selling Thursday upon the release of the $12 billion 30-year bond auction. The bid to cover came in at 2.37 compared to 2.97 in September. Selling in Treasuries exacerbated on Friday due to confusion over the multi message FED heads sending mixed signals on the timing of their tightening and the mystery surrounding the true level of hawkishness amongst FED members.

It is my opinion that the move lower in Treasuries is not the result of elevated inflation expectations. To date, there is still very little, if any, evidence of inflation. Deflation remains the issue, in spite of what the headlines read. The poor 30-year results were the initial catalyst for the selling. Overnight rumors of large dealer liquidations and a bond market holiday Monday all caused the move lower to be exaggerated.

Ten Year Futures - 15 Minute Chart

Corporate Bonds

The weakness in the treasury market points to portfolio managers adding risk exposure (equities as opposed to US bonds) last week. However, the corporate bond market told a different story. Generally thought of as a more important tell as to the pricing of risk, corporate bonds sat out the equity rally last week. With equities higher, volatility and treasuries lower (rates higher), the consensus seems to be that adding risk (as opposed to mitigating it) into year end is the money trade. Not so fast says the corporate bond market, which continues to price in more risk than do stocks. If the corporate market continues to underperform equities–as it did last week–the risk of a significant decline in stocks is amplified. The iShares Investment Grade Bond Fund ETF (LQD) when paired against the Spyders (SPY) exhibits the disagreement between the two markets. This disagreement will likely lead to a disconnect in price. It is not a matter of if, but when.

SPY / LQD - Daily Chart

Gold

After four weeks of consolidation, gold took the path of least resistance higher this week. Spot gold closed at $1,048.25. From a pure technical standpoint, the chart of gold conveys that the inflation trade is on. I cannot argue with the strength of the technicals or the breakout to an all time high. It is the fundamentals–a deflationary environment–that have me cautious on gold. That said, I continue to keep an eye on the yellow metal for possible entries, either long or short.

Spot Gold - Weekly

Earnings

Earnings season kicks off next week. Some names of interest are INTC, LLTC, XLNX, IBM, AMD, GOOG, and NOK. Alcoa (AA) reported the ninth consecutive quarter of year/year sales declines last week. Across the board, it is doubtful that earnings will be substantially higher than last year. The reaction to the earnings will be more important than the earnings themselves. If traders focus on sales beating already ratcheted lower expectations, than equities could continue their upward ascent. However, if traders focus on the fact that sales and earnings are declining–independent of analysts and their beat the lowered expectations games–then we may just see equity prices begin to correct.

Whatever scenario plays out on whatever timeframe, the beat goes on.

The stock market showed strength Monday as we began the first full trading week of October. The S&P 500 closed +1.49% or +15.25 points at 1040.46. There were 5 advancers for every decliner on the NYSE. The Nasdaq Composite closed at 2068.15 or +.98% with 2.7 advancers for every decliner.

Oil showed weakness at the open of the pit session on the NYMEX at 9AM EST. After initially trading lower, it found support at the lows from Friday. It then showed strength for the remainder of the session and closed at $70.41–just below the high of Friday–off a low of $68.05.

Light Sweet Crude Oil - Pit Session

On Wednesday September 30th, Crude Oil and the U.S. Oil Fund ETF (USO) rallied strongly. Since that time, any attempt to take oil lower has been met with buyers. If a meaningful correction is in the cards in the S&P 500, the dollar needs to strengthen. The recent strength in oil has been due to dollar weakness. If oil is strong, the dollar is not. As the dollar weakens, stocks inflate. Oil is the key to the equity puzzle into the end of the year. For that reason, X is traveling around to oil rich nations and meeting with business leaders. Any data he gathers will be important to my year end positioning.

USO - Daily Chart

Gold closed higher by 1.5% in what smelled like a rally that was due to more than just softness in the greenback.

Gold Futures - Daily

I continue to see a deflationary–as opposed to inflationary–macroeconomic landscape and I am positioned accordingly.

Tomorrow is the William Blair Emerging Growth Stock Conference, ICSC/UBSW Chain Store Sales are due out at 7:45 EST–last 0.1%, Redbook Retail Sales at 8:55–last -2.3%.

After the bell this evening Mosaic (MOS) announced Q1 $0.23 versus $0.35 expected, revenues $1.50 billion versus $1.54 billion expected. Margins were 37% versus 52% year/year.

Research In Motion was notably weak today. After the bell we found out why: Bernstein initiated (RIMM) with an underperform rating and a $60 price target.

And the beat goes on.