Market commentary

Feb 26, 2008

Take a look at the following new stories that made headlines on Monday and Tuesday.

Confidence plunges, inflation rate soars 

NEW YORK - No good news today on the economic front. Consumer confidence plunged, the wholesale inflation rate soared, the number of homes being foreclosed jumped, home prices fell sharply and a report predicts big increases in health care costs.

The New York-based Conference Board says in a report released on Tuesday that its Consumer Confidence Index plunged in February to 75.0 from a revised 87.3 in January. The reading — the lowest since the index registered 64.8 in February 2003 — is far below the 83.0 analysts expected. Inflation at the wholesale level soared in January, pushed higher by rising costs for food, energy and medicine. The monthly increase carried the annual inflation rate to its fastest jump in a quarter century. Full Story

Reports reflect bleak housing picture

  House prices may still have a long way to fall. Across much of the nation, home values are dropping — even those backed by solid mortgages — and banks are repossessing more every day. Most experts say the dive won't hit bottom for another year and only after excess inventory is sharply reduced and credit markets improve. More government intervention may be needed, too, if the free market system doesn't work quick enough.

U.S. home prices dropped 8.9 percent in the final quarter of 2007 compared with a year ago, according to the Standard & Poor's/Case-Shiller home price index released Tuesday. That marked the steepest decline in the index's 20-year history. Full Story

Worries grow for worse 'stagflation' 

WASHINGTON - It's a toxic economic mix the nation hasn't seen in three decades: Prices are speeding upward at the fastest pace in a quarter century, even as the economy loses steam. Economists call the disease "stagflation," and they're worried it might be coming back. Already, paychecks aren't stretching as far, and jobs are harder to find, threatening to set off a vicious cycle that could make things even worse. The economy nearly stalled in the final three months of last year and probably is barely growing or even shrinking now. That's the "stagnation" part of the ailment. Typically, that slowdown should slow inflation as well — the second part of the diagnosis — but prices are still marching higher.

The latest worrisome news came Tuesday: a government report showing wholesale prices climbed 7.4 percent in the past year. That was the biggest annual leap since 1981. "We're in a slowdown," Press Secretary Dana Perino said at the White House, where the economics talk was still upbeat until recently. Full Story

Now most of these news stories made headlines today (Tuesday) and one would have thought the markets would have crashed or at the very least closed down a 100-150 points.  Instead all it took was a headlines stating that IBM would be buying back up to 15 billion dollars worth of it shares to turn the market around.   When a market climbs a wall of worry it bodes well for the intermediate and longer term pictures.  This is what we call a strong psychological development.  While the overall volume has been dropping in the last few trading days; the markets closed up on higher volume today and that is always a positive. 

Stagflation normally is a very bad word and normally negative in terms of market action. However we are not in normal times. Half of the world still lives on under a dollar a day and they desperately want to climb out of this hole. For them it’s not a matter of trying to get the better things in life; it’s just a matter of trying to get the very basic things in life.  They just want to be able to eat a decent balanced meal everyday, have clean water and a safe and decent place to live in.   Most westerners cannot imagine having to live like this or that such a huge percent of the world’s population lives in conditions that make any Jail in the US almost seem like a luxury palace.  One has to travel there to take a look at this situation with their own eyes and only then can one understand the full reason behind the soaring commodity markets and why this trend will not end anytime soon.  One can dream about or plan on owning a high end luxury car but this is not a necessity; the same thing goes for planning a dream vacation.  But how many of us dream of simply owning a simple car or dream about having a piece of steak or chicken for dinner or having cup of coffee with slice of cheesecake or a cup of tea with scones or crumpets.  The answer would be almost none or 0 but this is not the case in many developing nations.

Commodity prices were down for years because these individuals were denied every single thing you and I take for granted. Prices were kept low because they simply could not afford the very basic things in life. As the economies in Asia and other impoverished nations continue to improve and hundreds of thousands of individuals jump from poverty to the middle class level every few weeks; the demand for these basic items will continue to soar.  Imagine this; most of these individuals have never driven a car, they have never had the luxury to consume meat on a regular basis, no proper sanitation,  no coffee, no pastries and cakes and the list goes on.  So when their incomes start to rise the first thing that probably comes to mind after moving to a better place is the thought of buying a new car; now that TATA motors has come out with a 2500 dollar car this dream is now a reality for millions of individuals.   Then off course they also want to be able to eat more meat, drink coffee, eat pastries, etc .Thus the demand for wheat, cocoa, coffee, sugar, oil, copper, meat, milk, butter etc all start to soar.  It is safe to assume that unless the US economy completely comes to a stand still (highly unlikely) demand for these products will not ease for a long time to come.   It is for this reason we stated that the next leg up will be selective in that not all the sectors are going to rise. Commodity based stocks are going to be the ones that will rise the most and its for this reason we have positioned ourselves in segments of this sector we think are most likely to benefit from this increased demand; certain sectors are going to experience even higher gains as they have been held back and are now in the process of playing catch up.

 Do not for one moment think the ride up is going to be smooth and easy; for if it was every single jackass would be a multimillionaire. It takes patience and discipline to make money.  Look at how patience and discipline have rewarded all the early Palladium bullion traders; initially bullion did nothing then it exploded upwards only to mount a brutal correction.  Palladium soared from 180 (Feb 2004) to over 390 before pulling back.  Weak hands would have bailed out but now this position is up almost 200% and the second position of 330 (April 07) is up another 66.6%.  We feel that the Journey on Palladium has only just begun. 

One also has to remember that one cannot win on all the stocks one has positions in because that’s just how the markets operate, bullion could trade higher but some rat in the company starts to play with the books or mismanages the business and the stock plunges. It’s for this reason we have spread ourselves and invested in several different companies.  

The Dow transports continue to behave in a healthy manner; they appear to be locked in a range right now between 4590-4860.  Two things need to transpire now; first they need to break past 4860 for 9 days but the more important hurdle is 4950. If they can trade above this range for 18-21 days in a row then there is a very good chance that they could trade up to 5220 before pulling back. If they get to 5220 another new development will occur; the transports will experience a phase shift. The phase will move from down to up. Right now the phase is downwards. Phase and trend are not the same; the trend can be upwards but the phase down. When the phase is down the power of the move is usually diminished so strongest move is achieved when an index or stock is in an uptrend and in an upward phase.  Once the Transports experience a phase shift it will only be a matter of time before the Dow plays catch up.  When it comes to the Dow the main hurdle for the Dow is now 12800. We feel that when the transports take out 4950 the Dow should be able to surge past 12800.  Once the Dow can trade past 12800 for 21-24 days in a row it will be in a position to test the 13250-13450 ranges before pulling back. 

The 3 moving averages of new highs that we maintain all surged past their counterpart moving averages of new lows for the first time in weeks; this illustrates underlying strength in the markets. At least from the inside the markets are slowly building up strength; keyword being slowly.  What makes the current conditions maddening for many is that both the bears and the bulls are confused. In others words neither one is sure which direction to bet on so they keep jumping in and out. However at some point in time the masses will start to follow the smart money which so far does not appear to be shorting the markets in an aggressive manner.  In the interim this is the best time to build positions in the early leaders for these chaps will truly explode when the market conditions change. Already we have several stocks from our portfolio putting in new 52 week highs.

NYSE short interest ratio continues to trade at record levels week after week after week; to date no bear market has begun with the short interest ratio in record territory.  Also many so called top analysts and market technicians have already stated that we are in a bear market; this is very good contrarian indicator and bodes well for the markets in the long run. 

Another very interesting fact is that the  average public investor’s cash position has increased significantly in the past few months.  This sort of action signifies fear and uncertainty; both are perfect ingredients for the markets as markets usually climb walls of worries and fall down cliffs of joy.

As we stated last week and the week before last one negative that we have in this market is that there is simply too much bullishness in the OEX options arena and we would like to see some fear sink into these traders. In addition the odd lotters are still not shorting the markets aggressively as we would like them too. Until OEX option traders or odd lotters turn extremely bearish we feel the markets will continue their range bound action. The only thing that could bypass all this would be a buy signal from our smart money indicator.

 Conclusion

The OEX March 620 call options we are following are now up even more.  As we stated before we are just roughly following these and the rough entry price we listed last time were in the 10-12 dollar ranges; the low for this option was 11.80. To be fair we are going to increase the entry points to 13-14 dollars.  The option is currently trading at 24 dollars. We would go ahead and sell this for a profit. Those that got into Dow or QQQQ options should also close these options.

Just to clarify matters, our primary method of following gains is going to be via the number of points the Dow has gained since we issued our call to go long and the secondary method is going to be via an OEX option that we monitor from a distance.  In Feb 6^th issue we recommended going long in the 12000-12070 ranges; the Dow traded within this range and so from a points basis we are now sitting on roughly 660 points; for futures traders this translates into 3300 dollars per contract on the mini Dow contracts or 6600 on the full contracts.  

Right now it looks like the markets are slowly building up steam for an upwards move; only time will tell how powerful this move will end up being. However based on the fact that the markets continue to trade sideways or trend upwards on bad news days, the high Short interest ratio on the NYSE, the increasing NYSE specialist/Public short interest figures and no sell signals from our indicators all lead us to believe that the potential for a powerful rally is still significant.  To date we have two buy signals from our smart money indicator on the hourly charts; a buy signal on the daily charts would be one of the most powerful bullish confirmations we could get. Continue to add to or purchase stocks listed in our main portfolio.

New additional Comments March 6^th, 2008

Bernake the Fed Head indicated the challenge the feds were facing when he made the following comments recently.

“I don’t know how to fix it,” he said during testimony before the Senate banking committee last Thursday. “I don’t know what to do about it.  

From a mass psychology perspective though this indicates that fear levels are running quite high now that even the Feds are temporarily stumped. As everyone knows market bottoms usually occur when pessimism levels are sky high; right now these levels continue to increase. We feel that in the not to distant future central bankers on a world wide basis will sit down and hammer out some sort of plan for if not things could get progressively worse and this is not in their interests.   The smart money seems to be betting that the markets are going to mount some sort of turnaround in the not too distant future as they are not aggressively shorting the markets. The high NYSE short interest ratio is another positive contrarian development; no market has crashed with such a high short interest ratio. 

The transports also seem to be holding up remarkably well given the record high oil prices. Finally the trading volume has eased a bi; after hitting the 6 billion and then 7 billion mark for one day; current trading acgtivity has fallen below the 5 billion mark.  The largest trading volume day ever took place on a day when the markets close up so this is still a very huge positive.  This market now is a traders market and only those positioned in the right sectors will do well; the next leg up is going to be selective and not all the stocks will trend higher, some will actually trend lower while the markets trend higher.

THE MACRO OUTLOOK

Our outlooks are updated once a month. We will update our views here again in the next issue.