Archive for February, 2010

Dollar Dominates Perfromance

Saturday, February 27th, 2010

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Above is the chart of the various asset classes’ performance year-to-date. You can see that the big loser so far is the Ag sector and the big winner is the 30-year treasury bond, followed closely by the dollar.

Readers of this blog know that my view of the dollar is that we are currently in a counter-trend rally within a longer-term bear market. The deficits our country has been running over the years which have lately been kicked into overdrive, combined with the staggering level of our national debt that is projected to continue to grow, guarantees that the dollar will continue to fall in value over the long-term.

Below is the intermediate term view of the dollar in which you can see that we retraced 50% of the move down from last year and bumped up against that level a few times. We then broke above it with the news of the debt problems in Greece.

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As news of European Union support for Greece has filtered into the markets, you can see that we’ve dropped back below the 50% retracement level. What we want to see is consolidation below this 50% line and then a gradual return to the primary downtrend.

Why do we want to see the dollar return to the primary downtrend? Take a look at what has happened to the world’s stock markets so far this year:

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The dollar strength has wreaked havoc on the world’s stock markets year-to-date. It’s a natural reaction for the Brazilian market to retreat 8% given its 130% move off the lows last March, but its still not fun to endure when the fundamentals for their economy are so strong, the demographics of their society are good, and their growth rates are envious. It’s these reasons that waiting out an intermediate-term correction before a resumption of the primary uptrend resumes makes sense.

However, and this is the big gamechanger, if the sovereign debt problems in Greece spread to other countries (Spain seems to be particularly vulnerable and given is size – it is 4X larger than Greece – it could do damage to the world’s economies) we would be significantly reducing our foreign exposure (except potentially Canada and Australia) as we would anticipate a further rally in the dollar and treasuries in a flight-to-quality move by investors.

At this point, though, the world’s financial systems do not seem to be pricing in this sort of potential disruption. I’ve shown you this chart before:

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The chart of the TED spread above shows that the risk of a sovereign debt crisis is not being priced into the market. The TED spread is one of the most reliable indicators of financial upheaval and systemic risk that I follow. You can see that it shows that systemic risk has fallen to normal levels from the post-Lehman Brothers bankruptcy’s impact on the world’s financial system shot it to record highs.

Until we see the TED spread jump, the current sovereign debt crisis in Greece is forecast by the markets to be contained, and by inference, the dollar’s strength is temporary. As long as the dollar’s strength is temporary, foreign and emerging markets should be viewed as attractive relative to US markets.

If we see a change in the fundamentals I will be letting you know about it here on the blog. Until then, we are not going to let the dollar strength disarm our strategy.

Your trivia today revolves around a bit of WWII history. This past week was the 65th anniversary of one of the US’s most memorable battles in the Pacific. One of my favorite books was written about the group of men who became famous because of a photo of them during the battle. Three of the men were killed in the battle and three survived. The photo went on to be used to model the Marine Corp War Memorial at Arlington Cemetery in Washington DC. Can you name the battle, the photo, and the book?

Mark

Yield Curve Sets Record Slope

Thursday, February 18th, 2010

dynamic-yield-curve

The chart above represents the Yield Curve at two points in time: the black line is the curve as it appeared on March 9, 2009, at the bottom of the stock market crash; and the red line represents the yield curve as it appears today. You can see that the slope of the yield curve is significantly steeper today than it was a year ago.

In fact, the slope between 2 year maturities and 10 year maturities is the steepest that it has ever been. That tells me that investors in the bond market, where interest rates are set for everything but Fed Funds, are planning on rates being significantly higher than they are now – most likely due to inflation.

If you are not familiar with the concept of a Yield Curve, it is really just a graph that plots current interest rates along a line from short-term rates to long-term rates. By examining the line, you can get a feel for bond investor expectations for economic activity and inflation. The steeper it is, the more inflation bond investors anticipate, and the higher yields they require to tie up their money in a fixed income investment for longer time periods.

Today’s PPI report on producer price inflation surprised on the upside, almost double what economists were expecting, seemingly supporting the views of bond investors.

This is a pretty critical thing; we’ll keep watching it and talking about it here. If inflation were to raise its ugly head while economic growth is predicted to be slow at best, it presents a situation where everybody hurts.

Your trivia for today has to do with the song in the video above. The album from which this song came had a rather unusual name that meant something to the band. Where did the name of the album come from?

Mark

Manic Monday

Tuesday, February 16th, 2010

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Look at the 5 Minute chart. Since we made an short-term low midday on the 8th, we have had a nice rally – one that seems to have legs, so far at least. However, (and there’s always a however, isn’t there?) the Relative Strength Index is showing that this move has been fast and strong, and we may be due for a bit of a slowdown of the move up – but on such a short timeframe chart, that could all happen in one morning.

But look at the 60 Minute chart.

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Notice how we broke through the downward sloping near-term correction trendline. Its also hard to see on the chart, but the blue short-term moving average line has turned up – what we want to see is this move up through the red long-term moving average line. That, if it happens, would lead us to feel better about the rally and its potential length.

So, what happened today to push us higher?

Fundamentally, good news from Barclays Plc (a British financial firm) were stronger than expected and the New York Manufacturing Index came in stronger than expected. These two pieces of news led people to feel better about the prospects for the global economy – and led them to think of something other than sovereign debt problems in the PIIGS.

Technically, on the 5 Minute chart, you can see that the short-term trend line has crossed the long-term trend line. That is always a positive thing for short-term traders who move into buying mode. That, combined with good fundamental news, helped push the market up today.

I had such a crush on the lead singer of this band in the mid-80’s. Your trivia today is to name her as well as the very famous singer who wrote this song. Come on 80’s music buffs, this one is for you!

Mark

Won’t Get Fooled Again

Thursday, February 11th, 2010

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Well, we are offically in rally mode again (small “r” rally so far at least). You can see that we had the head fake rally that fooled us into thinking that we might have one with legs – then we had the news coming out of Europe of a potential sovereign debt default from Greece (and potentially other emerging European economies).

Well, the market has begun to digest that news and we are seeing upward movement again that is the making of a Rally (big “R” rally – one that has legs). We don’t know quite yet, but the pattern of higher highs and higher lows since the low I circled on the chart above (which is clearly lower than the earlier low of the fooled rally we discussed previously) has the early indications of a rally with legs.

No promises though.

We’ve started to put some of the cash to work in companies with solid earnings or the prospect of solid earnings as the economy moves to higher ground. This may or may not be the beginning of a move back to early January prices – the first stop on our trip to the the upper end of our trading range – but it is a good point to put some money to work. So we did.

I received an email the other day from one of my fraternity brothers (which is to say a friend of 30 years) and they asked a very prescient question: “if your favorite bands/musicians are The Who, Neil Young, Led Zeppelin, Guns and Roses, and The Killers, why don’t any of them show up as videos on the blog”?

I had no answer for that so I emailed him and promised to rectify that. So, today, in honor of The Who’s performance at the Superbowl I thought I’d include a bit of their music. Didn’t you just love their halftime performance? Even fat, gray, and 60, they can still rock better than most of the new music being produced today.

In case you missed the Superbowl performance of The Who, here is how the elder statesmen of Rock n Roll should play:

Part 1

Part 2

Even in 2010, Roger still has the cleanest voice in Rock and Pete still plays a wicked guitar. RIP Keith and John.

So here’s your trivia for today: The Who broke new musical ground with the Rock Opera. Name two (both have been made into movies and one has been made into a Broadway production).

Mark

Greece Is The Word

Tuesday, February 9th, 2010

Greece Is The Word
It has been a pretty wild ride in the markets since mid January. The January effect was in full force when bankers got wind of new regulations being imposed upon them, and the market sold off.

Just as that was being digested and the stock market entered into a rally, word leaked of problems in the Greek economy that might cause them to default on their sovereign debt. That brought up concerns about other weak European economies and Goldman Sachs developed the acronym PIIGS (Portugal, Italy, Ireland, Greece, Spain) to identify those European economies that were significantly outside the deficit guidelines for the Euro-zone.

Fears of sovereign debt defaults sent traders fleeing from risk-assets into treasury bonds, from Euro-denominated investments into dollar denominated investments, and the markets sold off in a second leg down.

Given that we have had our first failed rally since last July’s pullback, I’ve spent the past few days reviewing the various markets fundamentals and technicals to get a feel for where we are today and where we are headed.

Systemic Risk

One of the issues we had in the Fall of 2008 is that the entire worldwide financial system was in peril from the subprime mortgage debacle. We follow an indicator that has a pretty solid track record of indicating problems in the financial system that can lead to crashes: the TED Spread

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The TED Spread represents the price difference between three-month futures contracts for U.S. Treasuries and three-month contracts for Eurodollars having identical expiration months. We use it as an indicator of credit risk because U.S. T-bills are considered risk free while the rate associated with the Eurodollar futures is thought to reflect the credit ratings of corporate borrowers. As the Ted Spread increases, default risk is considered to be increasing, and investors will have a preference for safe investments (like U.S. Treasuries) As the spread decreases, the default risk is considered to be decreasing and investors are willing to assume the risk associated with investing in corporate assets (equities and fixed income).

As you can see on the chart, in the Summer of 2007, the TED Spread spiked up from its normal level around 25. For clients that remember that time, we completely got out of our positions in the financial industry (stocks and bonds) based upon our experience with the TED Spread and the 1987 stock market crash and the fact that we were telling you about a little known issue that was bothering us, subprime mortgages. A jump in the TED Spread always indicates a problem in the financial system, and that combined with a mortgage problem meant to us that banks and brokers were likely going to see problematic times ahead (little did we imagine we were being the kings of understatement at that point).

That move turned out to be a wise one, but the big spike on the chart up to 475 that coincided with the bankruptcy of Lehman Brothers preceded the crash in the Fall of 2008. All asset classes, other than U. S. Treasuries, fell in concert. However, you can see that the TED Spread is back to its normal level of 25, indicating that the world’s financial system is healthy and dealing with the challenges. Based upon this indicator of systemic risk, the current correction pattern in the market is a normal part of the ebb and flow and not a return to market levels during the crash. Don’t get me wrong, a 10% or 15% correction is not fun – but it can be a healthy part of a recovering market that can allow new money to get in that had been sitting on the sides and push it index up to our target level of 1,250, or the level of the S&P 500 immediately prior to the Lehman Brothers crash.

Stocks

I had previously written that I thought we were likely in a range bound market, but that the upper end of that range would likely prove to be 1,250 during 2010. I still think this is the case because the liquidity that has been pushing the market higher is not going to end, in spite of the jaw boning from the Federal Reserve. The Fed is very worried about the high level of unemployment and they will not do anything to increase it. They understand that raising interest rates is completely out of the question and they won’t consider it until the fourth quarter at the earliest – in fact, when they discuss ending the easy monetary policy they have been employing, raising rates is not even in the discussion notes. It’s always ending their quantitative easing program – another name for printing money by purchasing Treasury securities. In my opinion, they will be unable to do that because our Treasury will have to continue to issue Treasury Notes and Bonds to fund our deficit. The Fed has been the buyer of last resort in many of the recent Treasury auctions, which coincided nicely with the need to stimulate the economy.

Now that they may want to comfort the people that are afraid of potential inflation from too much monetary stimulus, they are talking a good game about ending quantitative easing, but the reality is they will not be able to do it. They may be able to employ a bit of bate and switch as we’ve seen in the past few months – they have bought shaky mortgage securities from China in exchange for China agreeing to buy Treasury securities. It’s a winner for China as they unload questionable mortgage bonds in exchange for Treasury Bonds, it’s a winner for the Treasury Department as their auction gets subscribed, it’s a winner for the investment markets as liquidity keeps flowing into the market, however the Fed ends up with lower rated securities as part of its balance sheet.

I’d look for the market to continue to bounce around as it tries to figure out the problems with the PIIGS, but that once that is determined to not be the next Lehman Brothers (if it was, the TED Spread would be telling us that it was), the market should move back toward its pre-correction levels – and eventually move up to the upper end of our trading range at 1,250.

Bonds

The bond market has been in an upward trend as the stock market has been in a correction phase. This is mostly due to the problems with the PIIGS and their sovereign debt, but it is very likely temporary. Look at things from this perspective: if the Fed does in fact stop their quantitative easing program, interest rates will have to go up to attract foreign buyers to fund our deficit; If quantitative easing continues and the Fed stimulates too much causing a bout of inflation, interest rates will go up. In either scenario, bonds go down in value.

Once the current worries about the PIIGS subsides and investors move away from the historic safety of the dollar and Treasury securities, bonds will move back to early January levels and eventually much lower. This is a good time to buy Treasury Inflation Protection Securities as the rest of the bond market is strong. As interest rates move higher, TIPS will react positively to rising inflation.

The Dollar

The Dollar is reacting to the problems with the PIIGS as investors sell Euros and buy Dollars. This is temporary. Let me say this again – this is temporary. Our economy, with record deficits and borrowings, does not support a higher dollar. The European Central Bank is trying to force the PIIGS to swallow their medicine and get their deficits under control. Short-term, this is negative for the Euro as the pain is being inflicted instead of being kicked down the road as it is in our country. Intermediate- and long-term, this is positive for the Euro. So, the current situation can only be viewed as a good buying opportunity for emerging markets’ equity and debt.

Commodities

The strong dollar is pulling money from gold, oil, and industrial metals. The TED Spread shows us that systemic risk is at normal levels, which combined with a slowly improving world economy, means that demand will again eventually outstrip supply. Any weakness in commodities can be viewed as a buying opportunity for a strengthening world economy.

Strategy Impact

I’ve written that we have had a number of stop loss orders fill during the current sell off. I have not yet begun to add new positions as we need to determine if any rally, like the nice 1.5% rally today, has legs that will take it back to early January levels. I’ll be discussing that on our blog and will let you know when we start initiating positions – I’m looking at industrial chemicals and Canadian stocks, which have shown impressive relative strength recently.

But looking at the charts I think we can move back to the 1,150 level of early January but we will probably test the 200 day moving average – the bottom end of our trading range for the market – at some point before we run up to the upper end of the trading range at 1,250.

If the market shows us that we can get a rally with legs, we will be adding equity positions (probably in industrial chemicals and Canadian stocks, and other areas that we’ll determine as we move along) but add new stop losses to holdings in weaker areas of the market in case we do move back down for some reason toward the lower end of our trading range at the 200 day moving average.

Your trivia for tonight is to tell me what future star of the movie Good Fellas was a compatriot of the singer in the video above in his early years in the music business.

Mark

Clearly, The Rally Did Not Have Legs

Thursday, February 4th, 2010

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Well, it was one of those days. We had our first failed rally since last July, and the market decided to fail with a purpose.

It was sort of a perfect storm of bad news (sovereign debt problems in Europe, unemployment problems in the US, a rising dollar, and the Treasury Secretary pushing for increased taxes on traders) caught many by surprise and the selling began. The hedge funds were caught leveraged long, and had to sell to cover their loans.

Since we last saw this in July, I thought it might be interesting to see what happened with the market then. In July, we had the failed bounce, we ground around for a few days directionless, then second quarter earnings announcements hit and the market took off higher. Since we are mostly through fourth quarter earnings announcements, and they’ve been good all-in-all, we don’t have that catalyst. We could have a better than expected jobs report in the morning, but that would just contradict this mornings unemployment number that showed that layoffs were continuing.

I’ll be reviewing things to see if I can come up with a catalyst, and if I do, I’ll share it with you. In the meantime, we still have stop loss orders in place.

No trivia tonight – I’m too pooped after talking on the phone with other money managers and traders to get their take on the market. There is an odd dichotomy of people who think S&P 1050 is the bottom of this selloff and that are planning to put money to work and people who think this is the beginning of something bigger. Also, sorry for the sad song on the video – it just reflected my mood.

Here’s wishing us all a better Friday in the market.

Mark

Friday’s Low Holds – For Now

Thursday, February 4th, 2010
Friday's Low Holds - For Now

Friday's Low Holds - For Now

For those of you who find the daily movements of the market interesting, particularly in relation to what we’ve been discussing the past few days on the blog, you’ll find the above chart enlightening.

You can see how the news today of worsening unemployment has impacted the market. We had a big selloff that nearly violated our low from Friday. As of the time of this writing, our low has held, but clearly the market sentiment is being tested.

More on this later!

Mark

Rally Still Looks Good – In Spite of Down Day

Wednesday, February 3rd, 2010
5-Minute Chart - Day Three of Rally

5-Minute Chart - Day Three of Rally

Well we are into day three of the Rally (OK, maybe it’s still a small “r” rally, but let’s be optimistic) and the chart still looks promising. You can see that even though today was a down day with the market absorbing the past two big up days, at no time did the market even approach the low from Friday, the last day prior to the Rally beginning. Also, if you look at the volume for today (you can see it on the chart below, but not the one above) the volume on today’s down day was less than on yesterday’s up day – another encouraging sign.

If you’ve been following this series of posts, you’ll know that for this Rally to have legs, we want to make sure that we don’t have an intraday move in the market below Friday’s low that I’ve circled on the chart. So far so good.

What we want to see in coming days is a big up day on volume that equals or is higher than that of the down days during the sell off that started a couple of weeks ago. IF we see that (and there is no guarantee that we will) then that is a sign that investors sentiment has improved and you can start to put some money to work that you have on the sidelines. No guarantees, of course, but in general we’d be looking for he market to move up toward where it peaked prior to the sell off.

In the chart below, I think there are a couple of things you want to notice.

Does the Current Correction Mirror the October Correction?

Does the Current Correction Mirror the October Correction?

First, you’ll see I’ve drawn in the retracement lines from the peak prior to the selloff to the bottom of the selloff. You can see that we’ve retraced the statistically significant 38.2% of the selloff. It is no wonder that today gave us a bit of a breather – this is very common and actually healthy for a rally. What we want to see is it move up through the 38.2% line and tackle the 50% retracement line.

Second, does this correction and rally look an awful lot like what we saw in October? So far, it does to me with the market on track to continue flying up to new highs. But, its always better to invest what you see than what you hope – that’s why we watch charts.

Your trivia for today has to do with the group singing above. Two of its members left the group at the height of their popularity and went on to have a chart topping single that won a Grammy. Can you name the duo – hint, they were married – and name the hit song. For bonus points, name the TV show that one of the duo hosted in the 80’s.

Mark