Money Flows Out Of Bonds, Into Stocks?

NOTE: Please click on the charts below to enlarge them if they do not appear clearly.

Stocks scored a solid round of gains yesterday, but it was anything but smooth sailing.  After gapping lower on the open, buyers immediately lifted the major indices into positive territory.  The broad market subsequently began to rally sharply at mid-day, but a vicious round of selling struck shortly thereafter.  Noting that stocks held support of their morning lows, the bulls returned again in the final thirty minutes, enabling the major indices to close higher.  The S&P 500 advanced 0.8%, the Nasdaq Composite 0.6%, and the Dow Jones Industrial Average 0.4%.  Small and mid-caps saw the most buying interest.  The Russell 2000 rallied 1.5% and the S&P Midcap 400 climbed 1.0%. After the dust had settled from the roller-coaster session, the major stock market indexes settled just above the middle of their intraday ranges.

Turnover rose across the board, giving both the S&P and Nasdaq a rare "accumulation day."  Total volume in the NYSE was 14% above the previous day's level, while volume in the Nasdaq ticked 25% higher.  In both exchanges, advancing volume exceeded declining volume by approximately 2 to 1.  Though market internals were not overly strong, the ratios ascended from rather negative levels in the early morning.

On the surface, yesterday's closing gains may seem mild in comparison with recent losses.  But there were encouraging signs beneath the surface.  Aside from the higher volume that indicated institutional demand, we noted relative strength among many former market-leading stocks such as Priceline (PCLN), Amazon (AMZN), and DryShips (DRYS).  Although their daily chart patterns leave much to be desired, it was clear that substantial money was rotating into many stocks with strong earnings growth.  Supporting this notion was major rotation out of the "safe haven" bond markets and into the equities markets.  To illustrate this, take a look at the daily chart of the iShares 20+ year T-Bond Fund (TLT):

TLT failed its breakout to a new high on January 23, then sliced through support of its 50-day moving average yesterday.  Volume was also higher than average in many of the fixed-income ETFs.  While we are not advocating selling short these bond ETFs, it's notable that funds definitely seemed to be rotating out of the fixed-income arena and back into the stock market.  How long such rotation can last is the big question, but we viewed the weakness in bonds as a positive sign for the market.

Over the past month, we've netted significant profits on our ETF trades through trading the short-term moves in the market, both long and short.  This strategy has worked better than simply selling short the primary trend and risking getting stopped out on sudden reversals ("short squeezes").  Upon observing the higher volume, relative strength among leaders, and broad-based buying interest, we jumped back in the long side of the market yesterday.  However, without much confirmation that another near-term bottom has formed, we only bought one position.  With buying interest among the tech sectors, we initiated a new long position in the Ultra Nasdaq 100 ProShares (QLD).

Like the popular QQQQ, QLD mirrors the direction of the Nasdaq 100 index, but at a margin of 2 to 1 the actual gain or loss of the actual underlying index.  We bought this broad-based ETF in the afternoon, when it rallied above its morning high and broke support of its three-day downtrend.  This is illustrated on the 15-minute intraday chart below:

The sudden afternoon "shakeout" that tested the resolve of bulls can easily be seen on the chart above.  Still, the important factor is that QLD held above support at the low of its morning consolidation, then moved back up into the close.  On an intermediate-term basis, QLD also formed a "higher low" above its January 23 low.  The other broad-based indexes did as well.  From here, we are looking for a short-term move back to test resistance of the February 1 high.  In case the primary bear market holds the rally attempt in check, we will also trail a protective stop to lock in gains along the way.  Our protective stop is just below yesterday's low.  If that level breaks, all bets must be removed from the long side of the market.

It's obviously too early to definitively know if a true "higher low" has formed.  As such, any new long entries should be taken conservatively, reducing risk with smaller than average share size and/or a minimal number of new long positions.  Obviously, a lot will depend on today's follow-up action to yesterday's major indecision.  A continued focus on capital preservation enables us to protect recent gains on other ETF trades, while still enabling us to selectively profit from short-term trades in the stocks and ETFs with relative strength and higher than average volume.

Open ETF positions:


Long - QLD

Short - (none)




NOTE: Regular subscribers to The Wagner Daily receive daily updates on the open positions above, as well as new ETF trade setups, including trigger, stop, and target prices.  Intraday e-mail alerts are also sent on as-needed basis.





Deron Wagner is the head trader of Morpheus Capital Hedge Fund and founder of Morpheus Trading Group (morpheustrading.com), which he launched in 2001.  Wagner appears on his best-selling video, Sector Trading Strategies (Marketplace Books, June 2002), and is co-author of both The Long-Term Day Trader (Career Press, April 2000) and The After-Hours Trader (McGraw Hill, August 2000). Past television appearances include CNBC, ABC, and Yahoo! FinanceVision. He is also a frequent guest speaker at various trading and financial conferences around the world.  Wagner is currently working on this third book, scheduled for publication in early 2008.





For a free trial to the full version of The Wagner Daily above, which includes detailed ETF trade setups and daily position updates, or to learn about our other newsletters, visit morpheustrading.com or send an e-mail to deron@morpheustrading.com.

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