Watch Bonds not Stocks!

Rally on!

Stocks soared once again today as the "hope" rally rolls on. One of the big rocket boosters today came in the credit markets after a successful 7 year treasury auction was announced.

In the short term folks, it is CRITICAL that you focus on the credit markets versus the stock market. Remember, the bond market is 5-6 times larger than the equity market. The bond market is the dog and the stock market is the tail. Nerver forget that.

The stock market is now being held hostage by two powerful forces: The bond market and government intervention.

The Fed's Biggest Fear

Financing this debt has increasingly become a concern over at the Fed. They know all too well that if the bond market cannot fund the Fed's recovery plan then the game is over. Stocks are rallying because they think the Fed has found a solution to all of our problems. The Fed is also hopeful, but also concerned at the same time:

"NEW YORK/MAUMEE, Ohio (Reuters) - The U.S. recession will drag on for some months before a recovery starts in late 2009 or early 2010, but the future is still clouded by risks, top Federal Reserve officials said on Wednesday.

Monetary and fiscal authorities have plenty of ammunition to combat the deepest downturn in decades and the measures already taken will be critical in driving a recovery, the presidents of the Federal Reserve banks of San Francisco and Cleveland said in separate remarks.

"I'm convinced this is no time to relax our efforts," Janet Yellen, president of the San Francisco Fed, told the Forecasters Club of New York.

Cleveland Fed President Sandra Pianalto, who is not an FOMC voter this year, was similarly cautious in a speech to business leaders in Maumee, Ohio.

"I expect the economy to recover next year as the fiscal stimulus boosts spending and as we work off excess inventories," Pianalto said. "I have to warn you, however, that this outlook is subject to a number of strong downside risks."

In particular, Pianalto said a vicious cycle between the hobbled credit markets and the weak economy could continue and become mutually reinforcing, despite the Fed's "unprecedented" range of policy actions."

Yellen Agreed

"Yellen said an array of unconventional programs put in place by the Treasury and the Fed are "the best hope for recovery."

Yellen, however, cautioned it would be difficult to gauge the size of the impacts of the Fed's various programs. "We are using new policy tools and we simply don't have the experience needed to pin down the magnitude of the impacts," she said."

My Take:

Translation: Well we've(The Fed) never tried anything like this before! We sure hope it works! Gee thats comforting isn't it?

The reality here folks is this is nothing but a giant monetary experiment. The fact that our economy hangs in the balance while we wait and see if this works is quite frightening if you ask me!

The market in the short term could very well trade based on how are successful our treasury sales are in the bond market. This positive auction today is what lit up stocks this afternoon. On the flip side, the bad auction yesterday caused a 300 point selloff in less than 2 hours.

The bottom line here is be very careful trying to trade this market. The treasury auction results combined with constant government intervention can easily put you on the bad side of a trade in a hurry. I am currently sitting on my hands because I think this rally is based on nothing. The street is betting that the Fed's science experiment will save the day. This is a pretty reckless trade if you ask me because all I see in the real world is people struggling to keep their heads above water.

Go outside and conduct your own economic recovery test. Talk to people and ask them how they are doing. Ask them if they feel like their job is safe. Ask them how business is where they work. Take a walk through a shopping mall or head to a restaurant and see how busy they are.

I have done all of the above and I gotta tell you folks: I hear nothing but horror stories. Many have been asking me how in the hell is the market going up when everything they see in the real world is so horrible?

I try to explain to them that this is a common occurence during viscious bear markets:

Bottom Line

We have had a 25+% rally from the lows and as you can see above, this is very common. Hope and intervention can push the market higher at various times througout a long term bear market. The fundementals continue to deteriorate despite what the pundits on Wall St are telling you. I see nothing but anger and despair mounting when I am out and about.

Right now the financial news networks are focusing on nothing but positive news and ignoring the negative stuff. This can create a false sense of security. I read 10 negative articles for every one positive when I do my economic research. The latest today was the potential collapse of the postal system!

I could do a 10 page post everyday on whats wrong with the economy. I try to avoid this because I don't want anyone jumping off a bridge!

Wall St and CNBC are selling the bull with all their might right now because we are on the verge of tipping over. Don't get suckered in especially after a 25% move to the upside.

Play small if you trade the market short term in this environment because you might only be one good or bad treasury auction away from getting slaughtered by this bipolar market.

Currently I am looking for an entry point to get short here because I think this rallies about done. However, I am in no rush to get in front of this freight train. Longer term PUTS are the best option IMO moving forward. Constant governmet interventions combined with almost daily treasury sales in the credit markets make day trading nearly impossible at this point.