Backup to 'interesting' post
From: dcb Aug 18 2006 12:20PM
Title: trend change? (Short Recommendation)
We find out early next week if the trend has changed to up from down. Right now, the strength of the last rally through the 50 day averages could be either a bout of short covering, or accumulation for a new rally.
Fundamentally, there isn't much to cheer about, as the leading indicators from ECRI have now gone to -1.4% (these are much better than the conference board). Corporate spreads have widened, and the yield curve on treasuries is quite inverted now. The jubilence from lower inflation expectations based on the CPI and PPI is somewhat misplaced, as inflation expectations on today's consumer confidence surveys are rising to over 4%. As Bernanke has pointed out on several occasions, keeping inflation expectations LOW is the key to avoiding inflation. By pausing, he has implied that he will not fight inflation. This is not the way to control inflation expectations. As to the UMCS headline number, 78.7, that's a big drop too. The expectations part is taking the biggest hit, suggesting that we are still very early in the slowdown process. Let's not forget that the rate hikes take 6-9 months to do their thing, and we still have two or three hikes to work off.
The housing slowdown is real, persistent, and a considerable drag on the economy. The latest housing market index reading of 32 and the plunge in housing starts to multi-year lows suggest that we have much more to go in this slowdown. The reverse wealth effect, the decreased employment and consumer spending related to home purchases, and the increased rent amounts are all big negatives being priced in to the markets.
Technically, the markets are trying to rally. The Naz is divergent a bit with a somewhat more bullish look. Speculators are bidding up the oversold stocks. We have made a lower high, so far, but that can certainly change if the rally has more legs. The Naz is way under the 200 day average. That means perhaps we "go for it" and rally up to there.
On the other hand, the SPX is showing bearish MACD divergences and is overbought as well. These divergences are not very powerful, and they may be undone by higher price action.
Sentiment was the correct indicator to follow last posting. The sentiment was the major bullish indicator, and we rallied hard despite negative fundamentals and a preponderance of negative technicals. Sentiment is still contrarian bullish, so it would be rather difficult to crash from here. Of course a major tank only happens when people are not expecting it, so any selloff right now should be minor.
Should the selling from today stop at the 50 day average and reverse, we should be expecting considerable upside, especially on the Naz, to the 200 day average. Better yet, for the bulls, no real selling at all, but just digestion of the rally. In either case, the technical strength will increase.
Perhaps the election manipulation has started already. However, in that regard, one would expect a significant number of GOP candidates to lose this election, and that might be a negative for the markets. We will see if that is the case in October.
I took the opportunity yesterday to construct a short position using the mini-NDX, the bulk of which is 162.5 and 160 puts. In other words, a bet that by September expiration, we have not rallied (or rallied and fell) such that we are no higher then, than now. Note my use of MNX, suggesting my true lack of faith in a short! But we are overbought in a downtrend (until the trend change is confirmed, anyway) so that requires me to short.
One last interesting exchange. I have been discussing via emails with Tobin Smith (the bull) and Charlie Minter (the bear) what actually happens when the rate hikes stop.
Tobin says:
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Date Fed Stopped Raising Rates Dow Price at Pause Dow Price 6 Months Later Percent of Dow Change
02/06/1979 822.85 848.55 3%
08/21/1984 1,239.73 1,279.04 3%
05/16/1989 2,453.45 2,635.66 7%
03/28/1995 4,151.81 4,787.64 15%
06/28/2000 10,527.79 10,868.76 3%
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And Charlie and Marty's comments can be read on their website:
comstockfunds.com
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It seems that initially, a runup of 3% (or more if you count the 1994 dreamy soft landing, which is, IMO, rather unlikely today) happens in the first few months after the fed stops. Then, pretty much every time when the yield curve inverts like it is, the market goes into a bear frenzy, troughing at 10 months.
So maybe we are in the last bull phase before the ultimate selloff. But any type of exogenous event will probably trigger the selloff sooner than "expected" so it would be wise not to try too hard to make money on the long side without protection.
best,
dcb
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