In preparation for an appearance by Clive Corcoran later today on European Closing Bell on CNBC television we have decided to follow a slightly different format for today's commentary as we want to focus on macro patterns. This will enable us to compare the current stock market environment which in many ways is at a pivotal level to other market developments over the last two years.

In part this was triggered by our discussion yesterday when discussing the issue of the strong run up in Treasury yields since February of this year. We noted that the recent lowest point in yields for the ten year note coincided with the beginning of the late February "sub-prime" correction. The most recent correction which began in earnest last week coincided with the recent spike in yields. So, clearly the relationship of long term interest rates to equity market conditions is not a straightforward one.

In essence, the very recent correction more resembles the situation from April-July of 2006 when Treasury yields were at their highest levels in more than five years. We are almost back at those levels again and it could be instructive to consider what happened last time yields were above five percent and what the equity indices have done since.

With the benefit of hindsight and knowing the levels that we have seen recently, in comparing the large cap equity indices such as the S&P 500 and DJIA with the smaller cap ones - the Russell 2000 (^RUT) and the Nasdaq Composite (^IXIC) - it is apparent that the large cap issues did not suffer proportionately as much in the early summer 2006 sell off as did the smaller cap indices.

Furthermore the recovery from the early summer 2006 sell off has been more restrained for both of the small cap indices than it has been for the larger cap indices. This can best be illustrated by comparing the retracement/extension patterns from the swing high of the 2006 move to the swing low of that 2006 move with where each of three key indices stand today.

Let us begin by looking at the S&P 500 weekly chart for the period. With yesterday's close of 1509 the index is close to 262% from the swing low of July 2006. At its recent peak value we were closing in on a 300% percent extension of the 2006 retrenchment.



As the chart for the Russell 2000 reveals, the retrenchment in 2006 was more prolonged and more severe than it was for the S&P 500 and since that period the small cap index has recovered with an extension as of the recent top of almost exactly 162%. Interestingly this is almost exactly the same as the extension for the Nasdaq Composite as another of our charts reveals. Apart from the interesting observation that the extension coincides with a well followed fibonacci ratio, perhap the more important factor is the clear evidence that the smaller cap universe has under-performed and under participated in the bull move that took place in the second half of 2006 and which saw record high closes on the DJIA during much of early 2007.

While it is true that the Russell 2000 was itself making new all time highs during the period its much more restrained rate of growth (especially in reference to the severity of the early summer 2006 correction) highlights the fact that the recent bullishness has been concentrated in fewer stocks.



Examining the weekly chart for the Nasdaq Composite for the same period of almost two years shows that the recovery from the swing low in July 06 is again almost exactly 162% and interestingly that extension has all taken place in the last three months or so after the sub-prime sell off brought the index back to tag the April 2006 highs.

When this is compared to the S&P 500 chart it can clearly be seen for that chart that the 2006 correction was relatively less severe for the large cap index, the recovery amd extension since has been more spectacular (almost 300% off the swing low of July 06) and that the sub-prime sell off not only did not test the April 06 highs as happened for the Russell and Nasdaq but remained substantially above those levels.



The fourth of our macro charts covers the price of gold during a similar period to the ones reviewed for the equity indices. We have selected the exchange traded proxy, GLD, and again the focus is on the weekly charts.

Most evident on the chart is the coincidence of the peak in gold prices at $720 in the April/May 2006 time frame with the high yields in the Treasury market. The concerns about inflation and the world economy expanding at an unsustainable pace was clearly a factor in helping to drive the price of the precious metal to multi-year highs.

In reviewing the more recent price action it can be seen that while long yields are rising and approaching the same levels as seen in the early summer of 2006 the metal has not seen renewed buying pressure. A case can even be made from the price congestion pattern and the partial violation of the trend line that we have drawn that the metal could be disappointing its core consituency of inflation vigilantes and that we should expect a possible bout of weakness for the metal and the gold mining sector.

Admittedly this discussion is of a very general nature but the concerns that are driving up long term interest rates do not seem to be uniformly shared by precious metals traders.



TRADE OPPORTUNITIES/SETUPS FOR TUESDAY JUNE 12, 2007

The patterns identified below should be considered as indicative of eventual price direction in forthcoming trading sessions. None of these setups should be seen as specifically opportune for the current trading session.

Continuing in the rather cavalier big picture fashion of this particular commentary (which will not become a template for others) where does the picture for the Dow Jones Utilities Average (^DJU) fit into the scenario we have discussed.

Looking back over the two year period (not shown in the chart) the sector experienced a relatively minor correction in the early summer of 2006 and since then has moved up relentlessly with only the smallest of corrections. Even the sub prime sell-off failed to register much of a dent. But as we moved into late May 2007 the index fell abruptly. The action which coincided with the ratcheting up of long term yields set the backdrop to the recent problems for equities.

As bond yields become more attractive to asset managers there is a tendency to abandon high yielding utilities, especially when the perception is that other managers will be doing so as well.

While asset re-allocation models are still being analysed the peristence of selling and the weak looking chart for the utilities suggests that asset managers are taking the possibility of a new plateau of five percent plus yields on long government securities very seriously.



The final chart is a daily chart for the Euro/USD cross rate and as can be seen the EU currency is also approaching a significant pivot point as well.

The currency rallied during the run up to the sub-prime problems perhaps on concerns that the Federal Reserve may have had to reduce short rates to help avert mortage market difficulties across the whole spectrum. As those fears have been allayed (at least temporarily), and as the Treasury market showed its indifference to these concerns and kept pushing long rates higher, the currency appears now to be facing a re-test of the area just above 1.32 which represented the November 2006 high and the breakout level from mid March 2007.

Once again this key part of the forex market seems to be beholden to the eventual path of long term interest rates in a similar fashion to the equity markets.



Clive Corcoran is the publisher of TradeWithForm.com, which provides daily analysis and commentary on the US stock market. He specializes in market neutral investing and and is currently working on a book about the benefits of trading with long/short strategies, which is scheduled for publication later this year.

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