Hope is Bearable?

Lets just get this part out of the way: The Bear market is still hear. It is strong and it is (or was) roaring loudly over the past few months. Some might say that an important low as put in over the past few weeks by the financials but at "important" market lows, EVERYONE participates on the downside. Example: Where is Apple today compared to say Merrill Lynch over the past few months? If Apple were cascading or RIMM were tumbling hard along with mother Merrill, along with all those oil stocks to the downside, perhaps a different perspective would be gleaned today. However, the facts are the facts and problems remain.

First, anecdotally, the credit issues remain for the markets. We are in the think of earnings season and I heard somewhere today that some analysts believe that financial earnings will be down over 20% from 2006 levels next year. Lower earnings combined with terrible debt to equtiy situations normally leads one to gets a bit worried about the given situation. One needs income afterall to pay of the intererst payments due from the debt. Thus, while BAC, JPM and WFC were able to show that they can make some money in this environment, the brokers and eveyrone else are having issues (regional banks going under again this weekend). Thus, while over the longer term this is something to watch that could change the tide against the finanicals, shorter term, there is no lift - just more selling.

The second fact to consider is seasonality. Generally speaking, August is the biggest vacation month of the year. Thus, many pro's will be on the sideline, probably working buy stops if they were long or sell stops if they are short. Thus, the moves that come between now and labor day may be range bound. Sure, 2001, which many are citing as a comparable period to the current action, had a major decline in August. Last year we had major issues in August. Thus, putting these instances together (both considered bursting stock market bubble periods), you get the expecation that the selling is right around the corner and things the next leg down to 1100 is in the cards. Taking this fact, and combining it with the credit picture, an ugly red is expected on everyone's trading screens.

However, I see some glimmers of hope for a continuation of the rally. The first support sits with the charts of the markets as a whole and the Nasdaq 100. In the NDX 100, you get the largest 100 companies of the Nasdaq. It is a closely watched index and the futures are liquid enough for me. This index has been outperforming relative to its brothers in arms (the Dow and S&P). Interestingly, over the past week, there has been no mention of this and only mention that markets are going to sink. The NDX 100 though showed me a few things that are worth talking about.

First, it bounced off the 1750 level which triggered an upgrade for me moving it from a minus 3 to a minus 1 (minus three from the beginning of June). If this move up from 1750 continues, the next big target to watch is 1890. A move above that level, when combined with the better power model figures (power model measures postive volume for me) and you have a positive 1 rating. Supporting this is hte increasing amount of stocks, on an MA basis that have jumped over their 150 MA moving average. This made a higher low, breaking a downdward trendline from the begining of 2007. What would support my case would be a good move over 1850 and close this week. If such happens, I would be much more optimistic on things going forward.

The other factor to consider is the bonce factor off a trendline. Generally speaking over the pats 6 years, when the S&P hits the top trendline of my chart model, it bounces to the bottom one - sort of like a ball bouncing off two walls. Since the Bear arrived last fall, the S&P hit a high in November before falling back to a low this spring. Then another bounce took us to 1400 beore the rcent fall back to 1200. The next logical level on this is somwehre between 1300-1325. If the bear still controls things that that point, then the move from that looks like 1150 sometime next year. So with that said, I am looking for a bounce towards the 1300 level in the next few months. We hit 1291 but that does not count in my book. 1300/1325 counts and that is what I am looking for.

The next few days should be interesting. With the jobs report on Friday, I wonder how we set up going into the number. It appears the bulls want a strong number as shown by the response to the ADP data this morning. If the BLS complies, we could NDX 1850 and a major push toward the 1300/1325 range.

Addition and Subtraction

As many in the currency already know, a strong currency and a weak currency benefit the local economy in different ways. A strong currency can combat inflation while a weak currency can spur exports. Since 2002, the world has mainly benefited as the US Dollar has declined by almost 45%, using the Dollar Index (DXY), taking their currency gains and plowing them back into their own markets or other markets globally. This benefit mainly applies to those countries that "peg" their own currency to that of the dollar - mainly the middle east, China, Singapore and others. In addition, many countries have openly intervened to keep their currency from being too strong - essentially selling their currency high and buying the dollar low. This has created imbalances globally and what I call a "dollar bubble."

Essentially what is the dollar bubble? It is a bubble of investment that has benefited from the one way trade in the US dollar over the past 6 years. The likes of Brazil have seen major inflows into their economy as the Real has appreciated dramatically vs the good old greenback. Sure, there was some very interesting and supportive reasons to buy Brazil: high overnight investment rates, rising stock and local financial markets and stability politically. This has taken the Bovespa from the 18000 level a few years ago towards 70000 recently. Interestingly, when the USD was on fire to the upside through the late 90's into this decade, investment flows took the Nasdaq to 5000 (along with many other factors but the dollar was involved). A few months after hitting that 70000 level, the Bovespa is now cracking and guess what is occurring right at the same time - the dollar is stabilizing.

Another economy that has benefited from this one way trade has been China. In my opinion, if you take away the dollar peg, China is not growing at 9%, it is growing at 5% at most. The Yuan has fallen with the dollar over the last few years making their goods the cheapest on the planet by far sending major amounts of dollars and currency into the Chinese economy, leading to massive amounts of demand for infrastructure and commodities, sending crude prices sky high and global grain prices to the moon. The Shanghai comp rallied tremendously and then started to decline as the Yuan appreciated versus the dollar - albeit to a limited extent. Now the economy is slowing as well.

My point here is simple. These two economies, along with likes of Dubai and other mid eastern nations pegged to the USD, have benefited artificially from a weak dollar. What happens then if the dollar rallies like I think we are on the verge of? What happens if the Euro collapses through 1.50 and crude breaks 120? The great unwind occurs. What is the great unwind? the selling that is everything commodity or inverse to the dollar. I think the potential for a dollar rally is growing by the day and once the ECB flinches, and admits that they probably should have not hiked rates a few months ago (they are now tight by my calculations by 40bps), the Euro will be toast. And the one way trade....will be over.

Where is the Money Coming from?

So I am reading through the WSJ.com online today and upon hearing that congress passed the housing bill, I am left wondering is this really a good thing? Wasn't the problems of the past two years from the fact that money was made easy which was a consequence of the bursting stock bubble. Couldn't one say that if money were not so easy over the past five years, housing would have corrected like normal in the early part of this decade, many homes foreclosed today may not even exist (as the builders would not build based on lower demand) and the average American would be in much better shape financially as they were saving instead of using their home as an ATM card?

In the end, this just argues for more garbage out of the US Economy over the foreseeable future. It is once again another policy mistake - one that will probably inflate credit again, create speculation again in housing (why has that occurred to start with?) and push today's problems down the road. So I guess the story is this. Short term, not a bad deal for housing. Long terms, very bad for the US economy and the US Greenback.

Over the short term, the foreclosure rate should slow. With the economy weak, and hung over as the president said of Wall Street the other day, it is inevitable that people will not be able to meet bills in certain circumstances. At the same time, taking some foreclosures out of key areas (read condo's) could help a local market stabilize. While this is not formal intervention, the US Government just became real estate owners in a more formal sense - $300 billion worth actually. Interestingly, my own housing models were actually stabilizing somewhat so if you push this much money into a stable market, does that mean housing actually accelerates and reinflates? Now that would be interseting if possible.

Long term, this once again shows that if people make a mistake, the US government will come out of the treasury with 2 hands full of money for the person who is in trouble. This encourages risk taking and perhaps this country needs some of that now, it does not need it in the long run. It needs measured risk taking - putting $300b into an asset will raise its value, regardless of the current state of an economy. Add to this the fact that this package will be probably paid for by running the printing press at the treasury and you have....wait for it....wait for it...JAPAN, 1992.

The bottom line is simple here. Let people fail. When they fail, they learn and do not repeat the mistake. If you don't let people fail, you create the last five years and the last 2 which have been particularly painful from a trading perspective. Overall, call me a short term bull on the US but longer term...I think there might be other opportunities out there.

All About Dispersion

I follow about 500 stocks actively and rank them to see how many buys I have, how many sells I have and essentially everything in between. In addition, I look at various ETF's and see where the general strength tends to sit.

As of the close today, the findings show that I have 19 Strong Buys and 26 Strong sells on the stock side. Widening it out to Buys and sells, 62 Buys and 63 sells. This is an improvement from last week where there was about 3x the sells as there buys. Since last week, we have seen a surge in most names that were shorted and the covering, as you probably know, has been dramatic.

On the ETF side, of the 50+ that I follow, only 7 are listed as a buy. On the sell side, 27 stocks are now listed as shorts. Among those sectors that are now short, from my models, they include a large amount of International ETF's along with some energy sectors and broad based indexes. On the buy side, the Mexican Peso and Consumer Staples are leading the way for me.

From this data, I would list it all as essentially neutral for the US and bearish for the global marketplace. With so many international ETF's breaking down and the essential neutral status of the US markets, I wonder if foreign and domestic investors are looking back at the US for opportunities, thinking perhaps the worst is over? In any event, the next few weeks should show a break of the neutral status on the stock side and weakness in the international sphere.

Policy Update: Looking at the Gaps

As you will probably read, I have been an ardent bull if the Euro vs the USD for few years (though bullish overall since 2002). It was purely a technical call and had nothing to do with the "pending collapse" of the US economy, as many bears will have you believe or the housing bubble. Just quantitative metrics and a few charts to boot. Anyhow, one of the metrics that favored the Euro over the dollar was the policy gap. The policy gap, as I term it, is essentially a measure of how easy or tight overnight policy is for a given central bank. At this point, I only follow three central banks for this metric: The European Central Bank, the Bank of England and the US Federal Reserve.

I find the policy gap to be very helpful in many ways from a trading perspective. Of course if I gave you all of those "ways" I might be giving away state secrets so I will just give an update of these gaps each week or from time to time along with the implications for such policy. Here is the first installment of "Policy Update: Looking at the Gaps."

ECB Now Tight (Fair Value of Repo Target: 4.08%)
With its latest rate hike of 25 bps a few weeks back, taking the overnight repo target to 4.25%, the ECB adopted an overly tight stance on policy. Many in the marketplace questioned this move and honestly, so did I. This move reminded me of our Federal Reserve in 2000 when it raised rates essentially giving the markets a punch in the gut and creating or hastening the greatest equity market plunge ever in the Nasdaq. Since this move by the ECB, financial markets have been in flux and stocks have been mostly falling. Did they make the right move? Well, if gold is any indication lately, these merry men may have jumped the gun as I think inflation is about to roll lower and not higher in the Eurozone. This means that rate policy will have to come down in the future - this implies that the Euro may be in trouble as a result.

Fed and Easy Money (Fair Value of Repo Target: 4.67%)
So lets me guess. You took a double take when you saw where I think the overnight Funds target should currently reside? I bet you did. From what I can see in my forecast, the funds target needs to come up to this level and hikes should start soon. Interestingly though in the 2000 to 2002 period, the gap was just as wide and the Fed dropped rates even further taking the overnight target down to 1%. Now with 2.67% of funds hikes needed, does the Fed hike at this juncture? Well Plosser was pretty adamant about raising rates but I think the Fed may have something working for it: the correlation between the PCE and CPI. Essentially, they are moving in opposite directions with the CPI higher and the PCE lower. This reveals shrinking margins in the corporate world. Weaker earnings in the corporate world will lead to lower demand as people are layed off. Historically the Fed does not make a habit of raising rates in such an environment.

So what are the implications? Well, I think once the market realizes that the ECB needs to cut, the Euro could be in for some major correction. When and where is the question. I will be out with a currency update in the days ahead.

Welcome to TC's World

Well, after some very tough months in the markets, I am finally sitting at my desk, ready and willing to talk to you the reader about what is going on in the financial markets. Sure, I could say that the stock market stinks, the dollar is weak, interest rates are moving higher and the government is way to involved but is that original? Thoughtful? I don't believe so. What I will try to do on this site is post from time to time some interesting thoughts on the world. They will be unique (one hopes) and perhaps these notes will make you pause and think. Anyhow, I will begin posting in the days ahead. The focus mainly here is from a macro perspective. There may be some other micro stories but all intent and purposes, you will be reading about the globe and not Microsoft.