MBS CLOSE: MBS An Innocent Bystander

By: Matthew Graham •

More Thoughts On Recent Market Dynamics In A Nutshell

This week saw what looked like a massive correction for MBS which turned out simply to be a third derivative movement of stocks.  The 2nd derivative of the 5 day stock rally, tsy's, took a beating as well.  But we say it "looked like" a correction and use the "derivative" terminology to allude to the fact that bonds were not down this week of their own accord.  This is in contrast to the time frame preceding the FOMC announcement when the 10yr tapped the ceiling at 4.0%.  At that time, inflation, supply concerns, and certain comments about the US's AAA credit rating were all in play.  Even then, it was the treasury market that was the primary target of market malice with MBS merely capitulating to the rising yield curve. 

But this time it's stocks all the way.  Inflation fears are relatively dormant, the universe has slowly but surely come to terms with massive amounts of treasury supply, and no one even remembers the credit rating comments as indirect participation (foreign investors) and BTC's (bid to cover ratios) were outstanding in the last round of auctions.  So all eyes--or most anyway--have turned to anticipating the timeliness, duration, and scope of a potential economic recovery.  Almost overnight sentiment about "the worst recession since the great depression" seems to have shifted from dire to liveable.  Many now find themselves saying "wait....  Was that it?" 

And it's fact that this question even arises that is indicative of the current situation.  To answer the above question, if "that really is it," then stocks are on the right track with recent bullishness and mortgage rates indeed have no business in the 4's.  And at least as far as the past two weeks have been concerned more of the votes from economic data, earnings, and analysts have been in favor of that.  And even if those votes are wrong, their existence allows traders to play the markets for the time being as if they were right.  So in essence, you're seeing a market response that is more-or-less justified by the short term data.  The shifts in sentiment are drastic because "if that really is it," then stocks should be bought up quickly and fixed income sold with the same haste. 

But I'm NOT saying this is the case.  And we've even seen the other side of the coin where the votes for another recessionary leg down outnumber the bulls on a given day or week.  In either case though, it has been the stock market that has been the primary reflection of those vascillations in sentiment and the primary cue-giver to the 2nd derivative, treasuries, who are themselves informing the innocently bystanding 3rd derivative MBS.  Take the good, take the bad, there you have it...

So What?

Well, we've been over that already.  When volatility ticks up, you should lock more, especially if we've seen a week of gains, but this of course depends on your individual situations.  The GUTFLOP is designed to help you arrive at your own conclusions as much as possible.  Beyond that, the blog is designed to keep you as up to speed and as up to date as possible on the current considerations that might inform the construction of your own personal Gutfloppy ideas.  I know it's not what you want to hear, but neither AQ or I can tell you rates are going up or rates are going down in the short term.  But despite some of the questions and comments on the blog, I'm pretty confident most of you know that.  We're here to help you make more money in the long run, understand more about the industry, increase your staying power, strengthen client and partner relationships, avoid intraday price corrections, and maybe, just maybe be able to give you a fighting chance at knowing whether or not to be floating overnight. 

How strongly we feel about rate trends that go beyond the next few minutes can vary from day to day.  It's not like it was in 2008 when you were looking at rates in the 5's and 6's and we were telling you you'd see 4's in the winter.  Since there's no precedent for our economic situation, there's no telling if my gut instinct is correct and we will get another leg down in this recession, or if the massive intervention efforts have actually gotten us out of this thing faster and better than most were thinking.  All I know is that if I asked: "Is that really it?" and someone answered "yes," my very next statement would be something to the effect of "All seemed a bit too easy didn't it?"  Almost like the cliche movie quote iterations of "It's quiet, too quiet." 

Anyway, that's how I would feel about this most recent uptick in stocks, etc... if it were to continue...  And that's one of the reasons I don't think it will continue unabated.  It's during that "abatement" that you may, once again, be seeing rates creep down in the near future.  And this isn't to say that there isn't some longer term trend looming this winter or sooner where a broader and more stable correction will occur, but at the very least, the old gut can't quite reconcile a veritable flawless vertical launch for Spaceship Stock Market.

Some technicals back that up as well... 

I've read a candlestick book or two in my day and have at least charted and glanced at them daily to see which patterns seem to be doing the best in these unprecedented times.  So noticed some things potentially happening this afternoon and told AQ if we could close below the highs of the day and in line with or under yesterday's close, we'd have not one, but several candlestick patterns.  I won't get too much into the definitions since you'll be able to google those anyway, but I will say that the emergence of all three of the following patterns in conjunction with other technical and fundamental reasons to hope for a correction, while not a surefire prediction of S&P selling next week, at least puts the chances at something better than 50/50.

The three candlesticks highlighted form the following three patterns:

  • "advance block" in which we see decreasing gains as prices rise.  This is thought to represent a decrease in the buying momentum and a hint that selling pressures are building.  In fact, the index did end slightly lower than it's previous close.
  • "inverted hammer" or "hanging man" - which is simply the most recent candlestick thusly named for it's long shadow (the handle of the hammer), and comparatively small real body (the head of the hammer).  It signals a potential reversal when coming at the top of an uptrend, but doesn't mean much unless the next trading session confirms the reversal.
  • "harami cross" or "tweezers top" - this refers to the last 2 candlesticks in conjunction and depending on one's take, could be viewed as either formation.  The harami cross occurs when today's open and close hold within the range created by the open and close of the previous session, or in candle speak today's real body lies within the previous sessions real body.  The "tweezers" apply when the same highs are tested 2 days in a row.  This is almost the case on intraday trading, but as far as closing prices, we're pretty much dead on.  Either way, either formation signals the fizzling out of the previous uptrend and a potential reversal.  But here's the coolest thing about looking at candles today, both formations are only minorly important in and of themselves, but they are considered more suggestive if they are also part of another pattern.  From the candlestick bible by Nisson:
    • "They are minor reversal signals that take on extra importance if the two candlesticks that comprise the tweezers also form another candlestick pattern.  For instance, if both sessions of a harami cross have the same high, it could have more significance since there would be a tweezers top and a bearish harami cross made by the same two candlesticks."

So even though I've mostly gotten out of the habit of reading too much in to candles and other technicals as far as PREDICTIVE ability, I did perk up a little when I saw the several signals being thrown up by the same chart.  So although I would never advise risking any more than you were otherwise planning, perhaps this is indicative of some much needed selling in stocks next week.  To reiterate one of the points from the technical discussions above, if Monday is a net loser, it's an even stronger suggestion for a down week.  And based on MBS being the 3rd derivative of stock movement at the moment, barring any mortgage related surprises, that should help MBS at least stabilize, if not retrace some of thise week's losses. 

Check in once or twice for a potential addendum to this post over the weekend as I have some more charts I want to get to you.  If not, they'll be in Monday's Open.