Random Banter

it is amazing really what has occurred since I took a break a week ago. We have lost two brokerage houses in LEH and MER and AIG is basically gone - since the government now owns about 80% of the company, I basically feel it is gone (more on that in a later). We have seen crude oil get toppled with it trading down towards the $90 level today. Gold has found a home below the $800 level and the US dollar has had mighty problems with the $80 level. The Euro has collapsed through a 6 year trendline and the Japanese Yen is now one of the strongest, if not the strongest, currency in the world.

What does all of this mean? It means that things are in massive flux. Markets everywhere are locking up and liquidity is drying up faster than one can take a breath. I guess when you essentially eliminate three brokerage houses from the marketplace in the past 18 months, this kind of thing will happen (MER is in flux and with any bank/brokerage marriages, transitions will disrupt things). this continued illiquidity essentially makes many companies insolvent. The amazing thing is that AIG has tons of assets but since they have CDS exposure, they are being taken down hard. GE is being hit hard to the downside because people are speculating about their well being given GE capital's large contribution to revenues.

this is one big story about "what if." Pure speculation and survival of the fittest. the problem is this: what happens if there is nothing left in the end? Here are a few other thoughts on the markets.

• This AIG thing is disturbing to me. I heard someone on CNBC say that this move by the Fed, to essentially take a 80% ownership in a world wide insurer, was in the name of market stability. Essentially if AIG failed, then many things would have toppled over as a result. But to take ownership in the company? Lets just add another trillion to the balance sheet of the Fed. They have a leverage ration of 20:1 now.
  
• Amazing how the dollar is taking this. Between the conservatorship of Fannie/Freddie and this, the government is becoming one very big hedge fund with tons of liabilities and very little equity. If there is a run on the dollar, it could be the end game for our economy. This is an enormous game of risk being played by the folks in treasury.
• Speaking of treasuries and interest rates, Fed Funds futures were forecasting a cut going into the meeting today. What happened? the Fed thankfully did not cut rates as a cut was not needed. that supported the dollar. the problem with this little AIG thing is that rates here are about to shoot higher and people will start selling our assets as a result of tehse purchases. I would love to be optimistic but I don't trust anything the White House is doing these days.
  
• Crude's fall from grace has been quite quiet. nobody is talking about it. Amazing how the black gold has fallen from $148 to $90 earlier today and the top headline is AIG. Perhaps the fact that gasoline and heating oil have not fallen aggressively could be the reason.
• Interesting technical bounce today off the bottom end of a trading range I am using for the S&P. If this holds into the end of the week, we could now see a bounce back towards the top of this range which sits near the 1300 level. In addition, there was a double top of the range last year. If this is not like the 2001/2002 period, then this could be perhaps the lows of this bear market. I am not using that assumption but it is worth thinking about.

I am a bit busy with things but will be back to normal over the next week.

Weekly Equity Market Outlook

Event risk is something that drives me crazy. There is very little one can do to plan for the unforeseeable. There is very little one can do if it goes against them. For example, years ago I was trading and got caught on the wrong side of a Fed rate cut, done during the day and not know. Conversely, when September 11th occurred, I was fortunate enough not to get hurt. When we went to war with Iraq and the bombs rained down, the following three months were difficult as the marketplace tried to gauge whether or not the war was helpful. Lastly, this credit mess, with another chapter today from the US Treasury, Fannie and Freddie, has distorted patterns and created trading conditions are erratic at best and treacherous to say the least.

So essentially here we go again. I was contemplating my possible positioning for this week on Friday as I hard the rumors about this takeover (though to be honest, I had heard a new rumor each Friday over the past month). I dismissed them and dealt with the facts at hand. First, my trend model had turned down as a result of the bloody trade. Second, my long term model supports were taken out at 1250 leaving me wondering how quickly it would take to get to 1070 on the charts. Lastly, I was debating on whether the low for the market would be midweek or at the end of the week. Now that this news comes out about Fannie and Freddie, I am left to wonder - what is going to happen?

Short Term
I am unsure of the short term. The market could look at this Treasury move in both a positive and negative light. Ultimately, I think the best place to look to see if the market likes this plan is the homebuilders (via the HGX) and the banks (BKX). At the moment, both are in upward trends over the intermediate term. An opening higher could be an indication by the market that things were done correctly at the treasury and the conditions will continue to improve in the credit space (and buy extension, real estate). If both of these indexes take a hit, this will continue the selling in stocks. It will also hit the dollar as well (another discussion). if the dollar, housing and financials are coming down, the trend will continue lower. That might make buying later this week risky. At the same time, if it is around 1200, it sets up the bulls for their retest of the lows of this bear market. Thus, short term I will watch what the S&P's do on the open tonight and what the banks and homebuilders do tomorrow.

Intermediate Term
The trend at the moment on the intermediate term chart says this: Things are weak. the trend models are both pointing lower and overall power models argue that the bears control. On the surface, this bailout by treasury removes some uncertainty but now the focus has shifted to the economy anyhow. Housing prices are still falling and unemployment is rising. Sentiment stinks and we have an election coming. This seems like too many variables that make it difficult to change things in favor of the bulls. In terms of the key levels, with 1275 gone, I argue that we are looking for a move down towards the 1175 area before the market bounces again.

In terms of the leaders following the bounce, the Russell and NDX 100, things do not look so promising there either. It appears that 690 will be once in place for the Russell 2000 as the market reversed hard below its major trend indicator. As for the NDX, it is right at support around 1750. A break there argues for a move down another 100 points. This would imply a break of the previous lows. Thus if the bulls have hope for a general market bounce, the NDX has to hold the 1750 level.

Long Term
The Bull/Bear model still points to a bear market. Things have been improving a bit over the past month but nothing major. Credit conditions may improve on the back of the treasury's move but the other variables are not exactly screaming Buy! The break of 1250 on the long term chart in the S&P now argues for the 1150 level next. Of course this is a monthly model which means that there is still time to climb back into the somewhat bullish area of town. The failure by the NDX over the past month argues for a much larger smoking down towards the 1550 level which is past the intermediate term possibilities. Overall, conditions look weak.

So in summary, this week will be interesting. If the banks and the builders bounce higher, we could be looking at much better conditions going forward. The NDX needs to joint his market though and given the selling in that sector, it might be difficult. I maintain my bearish bias on things going forward.

Looking at the Candidates: Barak Obama Part II

This is part II of a series of posts regarding Barak Obama's economic plan. The introduction can be found here and Part I can be found here. In this note, I will focus on trade and manufacturing plans.

In reviewing the plans of for Trade and manufacturing, I found some interesting and not so interesting ideas. The most interesting to me is the idea focused around creating an alternative energy leadership position in the world. I think it was GE Energy's CEO who said that we the ability to create the most wind power in the world here in the United States. Personally, living in the northeast end of this country, I might agree given the weather this summer. The plan is to provide incentives to the industry (a fund in this case) that forces innovation in the alternative's universe. While forcing anything in a free market economy is normally useless, I think this might actually have some potential (as the government forced ethanol and that industry has grown).

On the other side of this trade and manufacturing ledger that I cannot agree with is renegotiating NAFTA. I think it is very important to have low to no trade barriers with our closest economic friends. Canada and Mexico are not the US but they provide means for the US to become more efficient. Overtime that will change and jobs will flow from one country to the other. In the meantime, the US takes the brunt of the job loss. Longer term, I think it makes the US stronger and creates better conditions of living as a result for its citizens. Also, going back on an agreement is not something we should be in the habit of doing. Lastly, Canada has enormous amounts of oil and energy products - by having an economic agreement with them, those flows will not be disrupted. they are an ally (along with Mexico). We should treat them both like such.

Before looking at the rest of the plan, lets look at the key points that Obama argues on the trade side (already mentioned NAFTA).

• Fight for Fair Trade into Foreign Markets
• Improve Transition assistance
• Penalize companies that send jobs overseas and reward those that keep them in the US

On the first point, Fair Trade into foreign markets, I cannot agree more on it. however, this is a global issue and our government has been fighting this issue for over 20 years. Maybe he can open up some countries with his diplomatic sway but I don't hold out much hope for this. As long as we are at war in Iraq, our global diplomacy power is less or weakened and that will slow down everything else.

Improving transition assistance is important. John McCain said last night that transition assistance in this country is based on the 1950's model of an economy. Perhaps. In any event, I think some sort of government/non government joint effort should be put forth here. While I am not too up to speed on this issue, the free market has a remarkable record of creating jobs. As a result, some sort of joint operation in this regard should be employed on the job and education side to get people back into the workforce as quickly as possible.

I touched on the last topic in Part I in regards to the tax side. As I said then, it is a ridiculous measure to employ. We live in an global economy. Our companies must take advantage of that. if they don't, they disappear and innovation is crushed. Giving gifts to those companies who are not globally sales oriented to start with (the second part of the note above) is just a waste of money. Why give Joe and Mary's Supermart a tax break for hiring local people?

In terms of the manufacturing side of the ledger here, Obama indicates the following

• Invest in next generation manufacturing and job creators
• Double funding for the manufacturing extension partnership
• Invest in a clean energy economy creating 5 million green jobs
• Create new job training for clean technologies
• Boost the renewable industry and create new jobs.

This is all about clean energy buildup (away from big oil) and new jobs. It appears he believes that funding on this side of the ledger will be the best way to lead the US into the rest of this century. While I agree this industry is growing, does it really need government interference? On one hand, more money into the industry may encourage much more innovation as the costs to alternative fuels are still higher than that of the established ones in crude and natural gas. On the other hand, if the industry is expecting government handouts, innovation will be slowed. I guess it is a catch 22. The idea is a good one. How to implement it on the other hand is a difficult one.

As for the manufacturing ideas, protecting an industry that really ebbs and flows with the US dollar, is something that is not wise. My guess is that they Dem's will call for a stronger dollar - this in turn will make our manufacturing industries less competitive. Giving incentives to this industry to keep jobs and invest in new technologies is admirable. however, if everyone can make the same widget, ultimately cost becomes an issue. Furthermore, you can bet that if the US companies are employing a very low cost manufacturing process, the international markets will find it too. thus, marginally, this plan is like swimming up a raging river - you get nowhere.

All told, Obama's plans are ambitious to some degree. It argues for moving tax incentives from one industry to another which is ok. creating new one and not eliminating old incentives is not ok because it implies more government involvement in the free market. this historically is a negative and I believe it will continue to be an negative. Let the private sector benefit where the inventive is needed and take it away from the sector that does not need it anymore. As for the other measures mentioned, NAFTA should be enhanced and improved - not renegotiated. Job training is very important and I would make this a top 3 issue. if everyone can be trained quicker for a new job, then the loss of one or two key sectors is not that big of a deal as we can just retrain those who suffered and get them back on their quicker.

Looking at the Candidates: Barak Obama Part I

Earlier in the week, I introduced my miniseries on the candidates of this years election and their primary economic plan to help the economy going forward. I figured i would start with Barak Obama only because this plan is now out there thanks to the Democratic Convention. the republicans are speaking this week as well but since the dems went first, I shall post some comments on Obama's plan first...then McCains.

So on Sunday I started by writing about this two main problems with America: The Rich are not paying enough in taxes and wages are stagnantt. Today I will attempt to give a view on the subsets of these "problems" if you will. The first is the middle class tax situation. Now, I don't claim to be in the middle class though I live very much like one (as I feel like I could lose all my money at any time in this market and thus I don't spend it). Anyhow, Obama indicated in his plan the following issues around the middle class tax situation.

• He will provide a $1000 tax credit for families that will "restore fairness to the tax code." The "making work pay" program will in turn eliminate taxes for 10 million people or about 2.5% of the population (assuming 250 million people).
• He will eliminate taxes on seniors who make less than $50,000 per year. this will immediately knock 7 million people off the tax rolls saving them on average $1400. Furthermore, 27million seniors will not even has to files taxes.
• He will simplify the tax filing process for most Americans so it takes less than 5 minutes to do your taxes. This supposedly will save $2 billion in filing fees.

Ok. so now the analysis. First, in looking at this plan, he pulls essentially 17 million people out of the tax paying pool or roughly 3% give or take. Interestingly, this small percentage accounts for a much even smaller amount of total taxes paid. Furthermore, they are statistically insignificant as it comes to paying down the finances of the US Government. In turn, he will attempt to raise the capital gains tax from the current 15% to the 20% level (not mentioned by the way) and basically tax the richer individuals in this country for taking risk.

Now, as I mentioned in my opening missive, I wonder about the usefulness of going after your biggest tax payers and making them contribute more. this plan mentioned above essentially is all fluff and no substance. If your goal is to penalize risk takers, just come out and say it! of course, this is politics so that will not happen.

In addition to these tax polices, there are also a few other tax situations mentioned in his plan.

• End Tax breaks for companies that send employees overseas.
  
• Reward those companies that hire more Americans with tax breaks.
• Provide a tax break for small business and start ups.
• Enact a windfall profit tax on energy companies that creates $1000 per year for middle class families.
  

These are all admirable positions to take. Personally I like them but I also do not like the practicality of them. By telling companies that they cannot send individuals overseas or you will get penalized for it, you are also indicating then that globalization will cost you - that is a very big negative in my opinion. Globalization is here. Embrace it. do not fight it or we will become like every protectionist state that fell over the past 300 years.

As for the second two, I don't think tax breaks should be given to companies that hire Americans. That is absurd. Companies are going to naturally hire an American. Why given them money to do so! As for the tax break on small business, I think that is admirable and a good policy. However, the taxes that small business faces is the problem - reforming that end of the code, and the double counting of taxes on employees (company pays taxes, the employee pays taxes of the same amount) needs to be fixed. Otherwise, this tax break, while short term useful, long term inadequate.

Finally, I ask, if the energy companies start losing money, will the government create an windfall profit taxes on say the consumer who is benefiting from the falling energy prices? This is a stupid policy that should be tossed out with the trash. it is dangerous to capital formation and will push companies overseas and create less jobs domestically. I just don't see the benefit. yet again, if I were a hard core liberal who does not understand a darn thing about the economy, this would make perfect sense. I am not though.

Roll Over

As I reviewed my charts tonight, something struck me, leaving me with a big black eye. It was the stock market which plunged today from the near 1300 level to the 1277 level on the close. From a chart perspective, many of the supports that have been mentioned in the past have held. However, my trend model, which measure the best time to go long and short stocks, is turning over. This "roll over" and not in AT&T terms, is not good. Essentially it argues that the rally is over and the bear is about to reassert itself. While there are still three days to go in this week, which means that the chart could reverse back up if the markets find some footing to the upside, I am not on alert and holding off on any further purchases to my portfolio.

I will be back this week with my weekly piece on the equity markets. I figured I would share this potential "roll over" with you before then.

HO Could dictate Direction this Fall

As we proceed into the winter season, as far as refiners are concerned, the focus will shift from the unleaded gasoline inventories to the residual fuel or heating oil inventories. When the winter is expected to be a warm one, sort of like what we saw the last few years, HO demand is less than the norm and prices for this product generally lag the price of the crude barrel (crack spread favors crude). When the winter is expected to be a cold one, refiners prepare for the rise in demand of this product. So when things are expected to be warm, lower demand is expected....cold, higher demand is expected. Simple, right?

Well, what happens when the expected does not occur? Two things. First, when the cold sweeps through and is unexpected, more heating oil is used driving inventories lower till the refiners bring the level back into line where supply and demand meet. This drives the price higher, rather quickly. Over the past few years with the warmer than expected winter, the price of heat has been leveling off before the winter really picks up. Basically, the months of October and November have determined the action for the rest of the winter for the price in heating oil.

So here is where the real fun begins. I use two weather models in my forecasts for the winter. I don't actually trade off them directly but I use them to better understand why people are buying and selling on the weather during different times of the year. For example, my reports had Gustav coming into the US at about a cat 1 or 2 whereas the market was looking for much larger and greater damage. That did not occur - crude and natural gas dived! Now, if I had only sold short every crude and natural gas contract on the exchange!!! Anyhow I did partake on the dive (as I mentioned in my crude call a few weeks ago making a quick $4).

Ok, moving on to the winter. Basically, my two models are indicating a colder than normal winter. There does not seem to be a consensus on the weather this winter online though most services require some sort of payment so getting the whole story is somewhat difficult. Anyway, one of my sources indicates temps around 3 to 5 degrees higher than normal for October/November. Interestingly, my trading models have heating oil perhaps finding support around that time period. Furthermore, in terms of residual fuel inventory levels for this time of the year, the level currently resides at its lowest level since 2005. Essentially refiners are not moving into this market aggressively basically with the mindset perhaps that we are not seeing a cold winter coming (on top of cascading prices right now not helping things either).

This all comes together and sets the market up for a surprise. Essentially if we get colder than expected weather temps, demand will be higher for heat. This will put stress on the already low inventory levels and push upward prices perhaps putting a floor on crude prices through the winter. Interestingly, year over year inventory levels for natural gas are also the lowest since 2005 at this time of the year - another market perhaps not looking for a colder winter (though electricity demand is playing a roll here....8% lower y/y from what I have read last). A cold weather demand push would give both of these products higher demand and thus higher prices.

Easy vs Tight Policy

What has been interesting about this dollar rally has been what the waves have done in destroying the rallies in the other majors. For example, from the double top in the Euro around 1.60 and the double bottom in the USD around 71.70, several currencies have been pummelled lower. The Aussie dollar, suffering from overtight policy, has been crippled by almost 20% from the highs. This is a currency we are talking about by the way and not a tech stock. The British Pound, another currency suffering from overtight policy, also has taken a beating lower, falling almost 14% lower. Lastly, the Euro has backed off by about 10% - it too also suffering from overtight policy.

On the other side of the ledger, the Canadian Dollar, which has been tracking crude somewhat closely, is trading decently for the most part as the Bank of Canada (BOC) has been maintaining policy somewhat easy relative to its fundamentals. The Bank of Japan, the current proud member of a government in disarray but also featuring an easy policy mandate, has seen the Yen hold up well globally. Lastly, the good old greenback, the one that every bear has come to hate and blame for the current blow ups globally, also features ultraeasy policy.

So essentially what the currency market is doing is giving those currencies with easy policy mandates the benefit of the doubt going forward that essentially these currencies will be hiking rates in the coming future thanks to stable inflation pictures and rising growth. Those currencies that have tight policies will only feature rising growth if the policy is loosened. Till that point, the selling will follow which makes the Euro extremely interesting over the next six months.

The European Central Banks' current overnight rate, 4.25%, is restrictive in my opinion using a combination of models that have the core rate of inflation, growth, market inflation and market growth. I could explain these in more depth but that might take many pages so lets just summarize. Generally speaking, when growth is rising and policy is easy, the understanding in the marketplace is that the local central bank will have to hike rates. This will drive up overnight interest rates and support the given currency - sort of what we saw with the euro for the pats few years or even the Aussie the past few years.

At the moment, the Eurozone features shrinking growth, moderating core inflation, moderating market inflation (just watch the CRB for a good correlation there) and moderating growth (bull or bear model I often site is involved here). Going forward from here, the forecasts for European economy are for lower growth, moderating core inflation (last flash estimate dropped) and I believe that the market inflation picture will continue to moderate and on the growth side, I maintain we remain in a bear market so I don't expect that to rise anytime soon. All of this while the ECB is about 50bps too tight at the moment - meaning rates should be 3.75% vs the 4.25% used. The longer this persists, the more likely that the Eurozone variables, growth and inflation, will continue to fall and this will make conditions even tighter.

As we saw with the US economy following the breakdown in the dollar earlier in the decade, it took ultraeasy policy just to reverse the downward pressure that the strong dollar and tight policy, combined with a bursting equity bubble, to change the trend (and even that did not work as well). Back in 2000, the Federal Reserve was tight by almost 100bps when the stock market began its decent following the rallies in August 2000. The day the ECB hiked a few months ago began or increased the volatility throughout the marketplace. It also punched the EU economy in the gut and here we are today.

So what does this have to do with the Euro? Well, as it probably has been well chronicled, the Euro has fallen hard over the past month. Like my crude has support at 111.50 level call a few weeks ago (once that level broke today, crude collapsed), the Euro now has a similar setup showing on the chart. As the long term chart here shows, is sitting on a trendline that has held support since 2002. A break of this trendline very well confirms the breakout in the dollar to the upside. The dollar index has already climbed past its long term downward drawn trendline - now if the Euro breaks through, currency trading over the next 4-6 years might be much different. This could also create interesting changes to the US economy (that will be covered in another piece sometime).

Bottom line is simple here. If the month of September continues to be a month where the dollar is supported, the Euro could be on its way towards the 1.35 level and then the 1.20 level. If the ECB responds by cutting rates in the next few months or at least signals that such might occur, I think the 1.35 level will hold. Otherwise, I would argue that the 1.20 level is coming over the next few years. the longer the ECB holds out, the longer it will take to fix the damage.