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Tuesday, March 5, 2013

Money Flow Setup in Bonds Could Mark Another Consolidation Period For Stocks Ahead

A wave of 'new' money chasing momentum, more often than not, becomes the bag holders of most directional moves.  The only force in the market that matters is the invisible hand; this force buys and sells extreme pessimism and optimism, respectively.

Sentiment towards stocks oscillates from positive to negative extremes.  Positive extremes, or bearish setups, form during rally phases.  Negative extreme, or bullish setups, form during decline phases. The last positive extreme was generated on 1/24/13 (chart 1).  The subsequent downturn in sentiment increases the probability that an extreme negative reading is next.  This tends to happen as stocks 'correct'.  Correction don't always mean lower stock prices, though.

Chart 1: S&P 500 And American Association of Individual Investors Sentiment Survey Bulls As % of Bulls and Bears Sigma)

The steep decline after the third count in the US Treasury bonds urges at least caution towards stocks.  This (money flow) setup has preceded the two largest equity consolidation within the 2009 up trend.

Chart 2: S&P 500 (SPX) And US Treasury Bond Diffusion Index (DI)

Headline: New ‘Powerful Force’ to Underpin Stock Rally

A wave of new money coming into equity markets is a "powerful force" to reckon with and means that risks such as the U.S. budget cuts and uncertainty in Italy are unlikely to derail a stellar rally in the markets, one expert told CNBC.

While there has been much talk of a "Great Rotation," a shift by long-term funds into equities from bonds amid improving sentiment, the real driving force behind recent gains in equities has been an inflow of new money that was previously held in cash, said Laura Fitzsimmons, vice president for futures and options at JPMorgan Investment Bank.

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