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Equities:
Financials, real estate related stocks, closed end bond funds, Chinese ADRs, and technology continue to lead the way down. But the list of sectors that are breaking down badly on the charts is very quickly growing (there were over 700 new lows on the NYSE on Friday). CSCO reports on Tuesday after the close, and concerns over slowing growth at the company could provide a catalyst for another leg down in tech, assuming that the collapse in the bond market doesn’t take the entire market with before that. I’d also note that the short interest in the QQQs had its largest drop ever per the most recent data. When the bears start giving up, it’s time to really worry.
Gold and Commodities:
Gold and the HUI slumped to a new low for the year again last week. If the equity market finally begins to come apart this week and interest rates continue to rise, I think there’s a good chance that the gold shares have a quite a bit lower to go regardless of what the metal does. I’ve stated a downside target for the HUI of 140 to 160 (we’re at 168 right now), but I think there could be risk down to 110, which will wipe out the entire rally since March of 2003 (just as I expect to see in the rest of the equity market, as this “reflation trade” nonsense gets completely unwound). So, the moral to the story once again is: all good things come to those who wait. The golds may bottom out before my downside “guesses” are hit, but again, the market action should tell us that, and there will be plenty of time to act when the time comes.
My friend Trey Reik was interviewed in Barron’s this weekend. Everybody should probably give the article a read. I generally agree with his thoughts, although I think he’s a little early. Four years after the bear market began in stocks, people are still acting exactly as they did back in 1999. Nothing has changed. Change takes time, and it’s going to take time for people to lose confidence in the Fed and fully embrace gold. That process is why gold is in a bull market, but as with the process of the Fed regaining the Market’s confidence (after losing it in the 1970s) from 1980 to 2000 (when confidence in the Fed and Uncle Al were at its height), it takes time. The path of a bull market is never a straight line to the upside.
The Dollar:
The dollar’s bear market rally extended its gains last week, as the US dollar index moved back to the high for the year. As the market pushes up rates in the US, the dollar can probably rally further. At some point, however, the market will begin to focus on financial and economic problems in the US, and the dollar will run into trouble again. But we’re not there yet…
Fixed Income:
Don’t look now, but the bond market could be on the edge of a crash. The only thing that’s likely going to halt the self reinforcing selling that is resulting from the unwinding of the carry trade is stocks taking out the March lows and collapsing. $40 crude obviously isn’t helping matters either. At some point, rising interest rates will put so much pressure on stocks that they should collapse much like we’ve seen in the HUI over the last month. At that point treasuries are likely to have a huge rally, but until then, anything goes.
The Big Picture:
Friday’s slide in stocks takes us to a new low for the move since the April peak in most of the major indexes. And a few indexes (like the RUT, SML, and MID) have already taken out their March lows. Sure, there could be a bounce at any time, but we’re getting very close to taking out the March lows in the NASDAQ and S&Ps as well as 10,000 on the Dow, which should lead to an immediate acceleration in the downtrend in all the major indexes. My guess is that this acceleration begins sometime early next week. I might be wrong about that exact time frame, but I do think it’s only a matter of time now before that acceleration takes place. Everything was highly correlated on the upside as the reflation trade unfolded. Thus, that correlation should apply on the downside as well. So far, the industrial metals shares and gold shares are out in front leading us lower. The HUI basically collapsed once it took out its March 2004 lows, and I think the same can be expected of the rest of the equity market, which should play catch-up at some point in the very near future.
The “reflation trade” (which is really just a fancy way of saying that speculators borrowed a bunch of cheap money thanks to the Fed and went out and bought all sort of crazy things all over the world) is now unwinding at an ever accelerating pace as interest rates rise. This entire bear market rally in equities was based on low interest rates and leverage, and now that rates are rising sharply, it’s going to squeeze the life out of stocks until they plunge right back to from whence they came (the March 2003 lows). As they say on cheesy TV commercials, but wait… that’s not all… you also get… a real estate collapse as a result of the rise in interest rates. The real economy of the US is supported by the twin asset bubbles in stocks and real estate. Both were inflated due to low interest rates and leverage, and with the housing stocks coming apart today on the back of the break in the bond market, I think it’s pretty clear that the market thinks the housing bubble is about to pop. And that means the US consumer is in big trouble. So, as the reflation trade unwinds and stocks go down again and drag the real economy down behind them, housing and the consumer will not be there to support the real economy this time. Thus, things could get ugly very fast, and I don’t think the March 2003 lows will be the end of it either.
But, in the very near term, the Dow is still above 10,000 and we are still working towards taking out the March 2004 lows. So, let’s not get ahead of ourselves. I just wanted to lay out the big picture (the way I see it anyway) so readers know where I am coming from. In any event, let’s see if the Chinese do anything with monetary policy this evening and whether the US bond market can keep from breaking out into all-out crash this week or not. The bear sandwich of a slowdown in China and rising US interest rates continues to put increasing pressure on equities. At some point in the very future the dam holding up equities will break, and the pent up wrath of the bear will finally be unleashed once again. Don’t get in its way…
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