As the rally in equities stretches higher, an important inflection point is reached.

SPX Futures Weekly

In today’s edition of Trader Art, I present the S&P 500 Index. As noted on the chart, the same setup from May of last year is taking place this year.

History doesn’t repeat, but it often rhymes.

If history has taught us anything, it’s that history teaches us nothing.

The Setup

Peace

They always say time changes things, but you actually have to change them yourself.
-Andy Warhol

I mentioned in my post from April 13th that if you thought the rally in stocks had more legs, then $CENX was a chart to consider. Obviously, with the absolute crushing taking place in the S&P 500 today, there is absolutely no reason to be long the Base Metals. Stop Out. Movin’ on. I also mentioned Hecla Mining $HL. That’s the one to double up on as you stop out from Century Aluminum.

Peace

This is Mr. Volatility reporting live from around the globe on various frequencies. In the geographies I monitor, markets continue to twist and turn; some fortunes are made, others are lost. Back at headquarters, I met with top advisors last night to discuss some breaking issues.

It appears as though banker tantrums have finally earned regulator mercy in the form of eased accounting rules. Banks may now look better on paper. This indulgent clemency, of course, sent equities—including many banks that are insolvent—even higher.

While the equity rally has been fierce in it’s gains, it is the laughing stock of the S&P pit in Chicago. As you can see from the chart below, the volume on the S&P large futures contract ($250 per point) has been dismal at best. Discussion amongst the pit traders in my fox hole elicited the perfect summation from one intellect: “Locals are not involved in this rally; it’s all the machines.”

With respect to “Terminator X — Rise of the Equities Machines,” be advised that the e-mini (front month is ES M9) futures contract is one-fifth the size of the big contract that the major players trade in the pits. Pay attention to the volume on the big contract, not the small one. The small contract is bid up by the machines. Veterans in the pit have a far better track record than the machines.

Big Institutional Money Not Participating

What Do the Veterans See

The banking system is no where near being fixed. This week’s Economist sums it up best in their article American banks: Payback time.

“However there is still a danger that the American banking system as a whole is nearly insolvent. And if the stress tests are rigorous, they could show that insolvency is indeed some banks’ likely fate: losses may well eat up much of the system’s capital.”

Silver Lining

There is a silver lining evident in the vast amounts of economic data that I monitor. The tenuous good news: the pace of the recession is beginning to slow. Signs of stabilization have begun to appear. These data points are key. However, we are by no means out of the woods.

The FED sees these signs of stability, but they likely want to drive rates lower one last time. In the chart below, I show a target for the rates on the Ten Year at just below 2%. Since the FED sees we are still thick in the thicket, but can’t lower the fed funds rate any more, they can manipulate rates lower by driving Treasuries higher. The only mind on the street that sees rates going this low is David Rosenberg, outgoing chief economist at Merrill Lynch ($BAC). David shines bright in the spotlight for seeing this whole calamitous situation coming. I wouldn’t fade his opinion at this point.

On the flipside of this trade, rates could break above resistance. Given these crosscurrents, this situation will remain in the closely monitored file.

The S&P 500 and Ten Year Rates

Weather Advisory

What is the catalyst? What will spur the sell off in equities, and therein, instigate the rally in bonds, driving rates lower? In the absence of many viable suggestions, I offer some seasonal wisdom that I return to each year: the inverse of the Halloween Indicator.

Perhaps the most important advice in the current “climate”: sell in May and go away. I have never made big gains being long equities during the summer.

Peace

So you thought the overnight fed funds rate was the only rate that the federal reserve has authority over?  Today, the fed announced what is the equivalent of printing dollars.  The Federal Reserve is going to buy US Treasurys.   They increase the amount of dollars in circulation, which dilutes the US dollar.  They then take the diluted dollar and buy US Treasurys.  The dollar sold off hard on this news.  Harder than it has since the year 2000.   US equities rallied.   I wrote recently that if the dollar did not find support, it would add fuel to the equity rally.  The drop in the dollar did just that, added fuel to the recent equity rally.

The Bond was up a massive four points.  There must have been blood all over the the bond pits today.  In my view, this move was scripted.  It shouldn’t have caught anyone off guard.  In fact, if you are reading these pages, you may be long Treasury calls.  The move in Treasurys is just getting started and the calls that I spoke of should expand in value to many many times their cost.  The price of the bond and it’s rate have an inverse relationship.  As the bond trades higher, rates go lower.  So the fed has used another tool in its arsenal to ease monetary policy EVEN MORE.

All of this easing will lead to a massive inflationary cycle, which is why Gold and Silver were so strong today.  The move in the metals could not have been scripted better as they sold off hard early in the day,  stopping many out, only to rise from the basement and zoom to the top floor and close near the highs.

My positions remain, bearish REITs, (RIMM) and Visa (V).  Bullish metals and Treasurys.

No matter how bullish the move becomes in US equities, I will remain bearish on the REITs.  They are special situations for a couple of reasons.  First, some of them are using fraudulent accounting.  Second, FFO is a fallacy.  I will write more on the REITs in a later post, but I am going to own puts in many of these names until they trade below $2.  Why?  Becuase they will trade below $2.  How do I know?  Becuase the math cannot lie.  The mathematics will be forced to face their implications.

Peace

The Ten Year

The Rate on the Ten Year

The US Dollar

Silver

S&P 500 has now pulled back to the Golden Ratio