Tuesday, June 19, 2007

Summer Trading Ranges

The last two weeks have been unrecognizable as typical trading sessions. Volatility measured by the CBOE Volatility Index (VIX) has picked up as yields on the bonds have also picked up to levels not seen since last summer. That has led the market’s trading sessions to have ever wider trading ranges compared to the typical summer. Let’s take a look at some of the data and ask a few questions to why this might be occurring.

First, take a look at the chart below of the summer trading ranges on a daily basis. To keep things simple we have defined a summer session as June through August. As you can see by the chart below, the bull run of the late 1990s leading up to the dot com bust had high daily trading range averages. Through the first few weeks of June, we are approaching levels we have not seen since 2000. That said, also note that the first few weeks of trading this June have seen the index close near the highs or lows everyday. This could mean there is a great divide between the bulls and bears as both the bulls and bears have closed the index at its respective highs and lows during the session. Who will win the tug of war is still in question at these near record index levels.

Another interesting point to make is the summer trading ranges have typically followed the VIX (see chart below). If you take a closer look at these two charts together (which I would have overlaid, but I had a lot of trouble doing that), you will notice the spikes in VIX coordinate with the higher trading ranges, except for this summer. From 1998-2002, summer trading range averages were all above 17 points. Coincidentally, VIX held above 20 (except for a few dips below) from 1998-2002. VIX has spiked above 20 only once since then and has been hovering in the low teens for most of the past three years.

By analyzing the past 13 years of summer trading ranges and the corresponding VIX index, we see the correlation between the two is quite substantial. So why the dichotomy this summer? Well, it could be that we are in the beginning of the summer and the VIX hasn’t picked up the pace but could trend higher throughout the summer leaving the correlation intact. Or we could have an anomaly on our hands with lower VIX readings (below 20) and higher daily trading ranges (above 15). This could be a new trend where we begin to see this happen more and more often in the forthcoming years. Markets and traders can use historical figures as a standard, yet that is not to say the future will hold the same characteristics of the past or to put it in the all to often said phrase “past performance is not indicative of future results”.

The S&P 500 has looked a little “toppy” yet the bulls have not caved and continue to buy each dip as if it were the only opportunity to catch a ride. Most likely, if the higher trading ranges were to continue at these elevated levels VIX would pick up and the trading ranges will tend to be biased toward the downside (mostly because VIX and the market move inversely). These are some interesting markets and we will continue to spot these small nuances. Keep an eye on the summer movements as we could have a more productive summer in terms of trading opportunities than the past few years.

Inflation Tamed or Skewed?

“Household surveys conducted in April indicated that the median expectation for year-ahead inflation had moved up, consistent with the recent pickup in headline CPI inflation.”
FOMC Minutes – released May 30th, 2007

“Core inflation remains somewhat elevated. Although inflation pressures seem likely to moderate over time, the high level of resource utilization has the potential to sustain those pressures.”
FOMC Statement – released May 9th, 2007

These are the two main statements from the Federal Open Market Committee’s (FOMC) May minutes and statement highlighting inflation concerns. While reading these two statements, it seems as if the Federal Reserve continues its hawkish tone on inflation. However, just last week we received two more pieces of inflation data that will help fill in the puzzle for the FOMC at its next meeting on June 27-28. The numbers in May were more or less in line with estimates (see below) and the bulls embraced the numbers with more than a 1.5% gain throughout the week in all major U.S. indices. The headline number came in at +0.7%, slightly hotter than the expected 0.6% while the core CPI number came in at +0.1%, below the expected +0.2%. But does that mean inflation is tame, or is there a hidden story within the numbers?

If you have read some of my past posts, you understand that I am not a fan of the Bureau of Labor Statistics’ (BLS) methodology for calculating inflation. They completely overlook food and energy prices which can eventually affect monetary policy decisions. Before I jump completely off the topic and into the BLS’ methodology on owner equivalent rents (OER), let me discuss the omitted energy prices and their affect on the consumer’s pocketbook.

Financial media has been coat-tailing the fact that higher oil prices translate into higher gas prices and less disposable income being spent by consumers in other places such as retail. Although it could be argued that higher oil does not necessarily translate into higher gas prices, we will leave that up to energy traders. Consumer spending has continued to support the market to record levels because, well, consumers continue to spend in the face of higher gas prices. How you might ask?

First, let me remind the readers that as long as the consumer can withstand an increase in energy prices because of an increase in income, it should not hinder the consumer’s spending habits. In reality, the consumer has not felt the increase because they are taking home more income. According to Miller-Tabek research, personal income has been rising at an annual 6% rate or 0.7% more than the 15 year average. If we have above average income, there is a good chance the consumer will go ahead and spend instead of save, but can that 0.7% pay for an ever increasing energy bill? The answer is undoubtedly yes! Let’s see what Miller-Tabek has to say:

“The income numbers have simply overwhelmed, providing the best explanation for the resilience in consumer spending in the face of high energy costs. Incomes have increased $1.7 trillion over the past three years to $11.4 trillion, plenty to handle the extra $50 billion to $80 billion of added expense each year. Interesting also is the fact that the price of oil remains below its peak and hasn't really changed much since Katrina over 20 months ago. Since that time households have seen their incomes growth $1.3 trillion.”

So when discussing higher oil prices, let’s also mention income growth and whether or not the consumer will be able to withstand the increase with their income. The outlook for future income growth will most likely be less than the past three years, so keep an eye on income growth over the next few quarters. Currently, the consumer is still able to foot the bill and high oil prices should not be the media’s escape goat for the market not pressing higher.

Apparently, the markets now believe inflation is contained. Of course, as I mentioned above this ignores both food and energy prices. However, there are some other slick calculations made by the BLS to complain about. The biggest of those is about the BLS’ methodology in calculating OER which enables them to make higher inflation look like lower inflation. I have to give credit to http://www.bigpicture.typepad.com/ for discussing this in their blog.

First of all, why does OER even matter? Well, housing accounts for 42% of the CPI, which is then broken down even further where OER accounts for 23% (see table below). Therefore, OER should not be taken lightly. Here is a short description of the BLS’ methodology:

“The economic rent is the contract rent (including the value of certain rent reductions) adjusted by the value of any changes in the services the landlord provides. A change in what renters get for their rents is considered to be a quality change, which may be either positive or negative. The value of any changes is applied to the current economic rent to make it consistent with the previous data. For example, adjustments are made for most changes in utilities and facilities.”

Essentially, they net out utility payment so if the rent stays constant and utility payments go up; the OER actually drops. So not only does the core CPI remove food and energy prices from their calculation, but they alter the true price of OER due to netting out utility payments (which have been increasing over the past few years). Talk about creative accounting, this is creative deception. Economists are a slick group of people. Argue with a good economist and they could probably show you that we are in a recession at the same time the same economist argues for steady growth.

Sources: Bureau of Labor Statistics, Miller-Tabek research, Briefing.com, BigPicture.blogspot.com

Tuesday, June 12, 2007

World Asset Bubble: Jeremy Grantham Speaks

“From Indian antiquities to modern Chinese art; from land in Panama to Mayfair; from forestry, infrastructure, and the junkiest bonds to mundane blue chips; it’s bubble time!” By now you have probably heard this quote by Jeremy Grantham in his letter to investors (which includes vice president Dick Cheney and a host of other high profilers) discussing a six week trip around the world and the pending bubble popping events to come (at least by his predictions). Grantham is not the only forecaster that has mentioned the overvalued prices of assets across the globe. Most recently (May 23rd), in one of Alan Greenspan’s consulting appearances he mentioned that Chinese markets were at unsustainable levels.

Remember February 27th, 2007? The 4% drop in the US markets were widely considered to be to the detriment of Greenspan’s comments with regard to his comments that day of a 1/3 probability of the U.S. falling into a recession in 2007-08. Quite possibly he is early, but he obviously wants to go on record with his view just as he did when he was early in his “irrational exuberance” speech in 1996, yet he still has a point. Grantham makes just as good of a case in his letter, which we will take a closer look. Taking into consideration some of the thoughts from Jeremy Grantham, we can see that markets across the globe have been hitting record highs for some time now while others are just beginning to penetrate these new levels. Here’s a list of 10 markets that have posted new record highs in the last week or two (See Chart below). The percentage gains of each market are from the beginning of 2003 through this past week of trading. As you can see, the U.S. markets have been lagging all other indices respecitively.
(There are several other markets that are within a few percentage points of their all-time highs, but I decided to only list some of those that actually broke records).
So what exactly gives? Well, the markets have been driven by steady worldwide growth (see chart below) over the past several years and a liquid credit market making it easy to borrow money and put it to work. U.S. markets have been held up by earnings growth, which has slowed in this past quarter, and a record number of private equity deals or mergers and acquisitions.

See the chart below for an overview of the world’s GDP growth from 1980-2008 projections provided by the International Monetary Fund (IMF). As you can see, since 2003 we have been at a growth rate higher than any of the previous 27 years. That has helped propel worldwide equity markets to the record levels of today.

It is easy to get caught up in all the attention given to markets that are propelling to new highs. Really, who would want to miss out on a major bull market? The problem (as is usually the case) is the timing of the Grantham’s so called “worldwide bubble”. The markets are flatter than ever in terms of connectivity, communication and correlations mainly due to the internet’s rise in accessibility. Does that mean that if our market were to tank the emerging markets will follow? Not likely, as the U.S. markets have been one of the weakest performers over the past 12 months. With that said, we also have the most stable and predictable economy in the world.
Many analysts believe a shock to the Chinese markets may cause a windfall of turbulence for other world markets much like it did in late February.
With that said, the Shanghai index fell 6.5% on May 30th. Those same analysts would have expected a drop in the U.S. markets due to the shock. However, all major U.S. indices opened at the lows only to post record highs. Now, the activity we saw that day is now merely a blip on the screen. Although the world is more globalized and has a horizontal marketplace, one can not assume that market shocks will have worldwide impacts. May 30th is a great example of the isolation to a single financial market with no overflow effects.

If we are truly in an asset bubble at this time, there is always a catalyst to burst the bubble; what is it going to be this time? Jeremy Grantham says that “We (GMO, his investment firm) haven’t agreed yet on a catalyst for 1929, 1987, or 2000, or even the South Sea bubble for that matter.” He does however offer two main areas of concern; inflation and lower profit margins. Inflation may prompt the Federal Reserve to take monetary policy actions; whereas, the drop in profit margins over time could hinder financial market’s ability to maintain these high levels.
It will be interesting to see if either of these two factors come to fruition, but one thing is for sure…market’s around the globe have enjoyed a great amount of growth in the past five years.
Whether we come to a screeching halt or slowly contract these gains over time and the timing of either of these scenarios is the question that no one really knows. That is why the financial markets intrigue so many intelligent individuals. Until next time, enjoy the ride.

Commitment of Traders Analysis

Who’s on for the rally ride?

In today’s information driven society there never seems to be a dearth of data to rummage through and analyze. Because of regulations and the internet, much of the data is public and can be found by using some simple search methods. In the financial world, analysis is key in making decisions on certain stocks, sectors or industries. One report that has been readily available since 1962 is the Commitment of Traders (COT) report.

First published by the Commodity Futures Trading Commission (CFTC) in 1962, the report provides investors with up-to-date information on futures market positions and operations. Simply put, they were looking to provide better transparency in a market that was misunderstood at the time (some may argue that the futures market is still somewhat vague). The original report consisted of 13 agricultural products that traded in the futures market, but has since expanded to include most futures contracts.

The COT report tracks the trading activity each week of three distinct groups of traders; small traders, large speculators and commercial hedgers. Small traders are defined by trading fewer contracts than the CFTC requires you to report. The S&P 500 futures contract reporting level was changed from 300 contracts to 600 contracts in 1997 and remains at that level today. A large speculator is defined as trading a number of contracts in the required reporting level (greater than 600 contracts). The last group is the commercial hedger who is defined as a corporation which takes a position in a particular commodity for business reasons (i.e. hedging the price of corn for a corn farmer). The individual reports can sometimes be hard to understand, but there are services out there to simplify them for the individual or business. Schaeffer’s Investment Research has done a nice job in disseminating the information into a free and easy to understand charting tool that is free (http://www.schaeffersresearch.com/). After playing around with the COT charting tool, I noticed a few things that you might want to consider in your own analysis of the current market environment.

Let’s take a look at the five year chart below of the S&P 500 index and the related COT report of the small trader’s “net positions”. The red line is the price movement of the S&P 500 index while the blue line tracks the net positions of the COT report on a weekly basis. A negative net positions number indicates that the commodity is short during the selected time-frame while a positive net positions number indicates that the commodity is long.

Notice that while the S&P (red) has continued to move higher since bottoming out in 2003, the small traders have continued to lighten up on their long positions noted by the decrease in net positions. So if the small traders are continuing to lighten up on their long positions (especially right after Feb. 27th), how is the market continuing to pressure new highs each week?
That brings us to the next five year chart, seen below, which depicts the “net positions” of large speculators. Notice that, for the most part, large speculators had a negative net position for much of 2003 and 2004, but have since ramped up the buying efforts and helped propel this market where it is today; all-time highs. This five year chart also shows something that piques my interest. Notice anything?

This next chart overlays the COT report for large speculators and the S&P 500 over the past 12 months. Remember in the first chart what happened after the 4% drop on February 27th? That’s right; the small traders decreased their net positions. In complete contrast, the “smart money” or large speculators bought in on this dip most likely due to a perception that the move was overdone and it was a good buying opportunity. They were absolutely correct as the index has moved approximately 10% from the lows in February. Also make note that these same large speculators were decreasing their net positions leading up to the February 27th sell off. Another smart move.

Now take another look. It is fairly obvious that the increase in net positions didn’t last long and continues to decrease as many analysts, researchers and traders have noted the markets increasing potential for a major correction at what is being considered an above average length bull market and overbought conditionsAre the large speculators and the small traders finally on the same page? According to these COT charts, the answer is yes. But that does not necessarily translate into being correct as the market continues to move higher. They seem to not be participating in what would seem to be an obvious bullish market. I am not the only one out there looking for a pullback in the next few weeks, so take the COT reports (http://www.cftc.gov/) into consideration the next time you are looking for where other traders are putting their money.

Sources: CFTC, Schaeffers Investment Research

Doji Candlestick Company

If you haven’t noticed it, be cognizant that major financial markets around the world have been reaching record highs. I am sure you already knew that, but it’s great news for the everyday investor. Although this is all fine and dandy, be alert that some analysts and researchers have been talking about the “frothiness” of these markets and are noticing some signs of topping out in the U.S. One of the markets we follow closely is the S&P 500 and it turns out there was a major sign of a market topping chart pattern just a few days ago on Tuesday the 16th.

During our analysis of the daily charts, we noticed what is commonly known and referred to as a doji candlestick pattern. A doji looks like a cross, inverted cross or plus sign such as the one below. Technical analysts attempt to look for certain chart patterns over several time frames and theoretically predict future price movements off of chart patterns. A doji candlestick is one of those patterns.

Many technical analysts believe that the doji is the most important candlestick to recognize as it often marks the beginning of a minor, intermediate or major trend reversal on a daily chart. Failing to recognize these patterns could result in being on the wrong side of the market at the wrong time.

Please note that there are four types of dojis; common, long-legged, gravestone and dragonfly. All of them occur when prices opened and closed at the same level so that no real “body” is visible; however, the difference lies in the look of each doji candlestick. See the table below for a better look at the different doji patterns.Let’s take a closer look at the daily chart of the S&P 500 in which a doji candlestick appeared on Tuesday. In this chart of the S&P e-minis (ES M7) you should notice the four highlighted dojis. The first doji came as the market attempted to recoup losses from Feb. 27th; however, the market opened and closed at or around the same level so that no “body” was visible in the candlestick. This doji is referred to as a common doji. Since it was coming on the back of strong gains over the past week, it was a signal that the market needed a rest and subsequently the market began to tumble shortly thereafter.

The second doji came just after some consolidation after more March gains. This is considered to be a long-legged doji because of the size of the trading range, or size of its “legs”. Again there is no visible body on the candlestick showing the market opened and closed at the similar prices. This particular doji signaled the bullish trend that was present was likely to continue and in fact, the market continued to rally.The third doji appeared after several strong gains in the market. On this day, the market opened higher then began to consolidate by moving lower only to meet more buyers at the lows and recover all the losses to finish near the open, which was higher to begin with. This is considered a dragonfly doji and has bullish implications in a bullish market as the sellers could not hold their ground.The last doji and most important in my mind is another common doji and it has happened at a point of congestion for the markets. New highs continue to be pressured and have since created some resistance near 1515-1519. On Tuesday, the market made new contract highs in the June futures only to find more resistance and retreat back to finish near the open, creating a doji that some will refer to as a short-term to intermediate term end to the bull run. You should also notice the congestion that is beginning to happen near 1500-1520 showing some signs of fatigue in an impressive bull run.

Although I am aware of the potential consequences of the doji candlestick pattern, it will be hard to pressure this market lower if positive economic data continues to come into the Goldilocks’ household. A bearish doji does not imply an immediate move lower, but it signals a good probability of it doing so over the course of the next few sessions. We will continue to watch this play out as it is options expiration week and will tend to have a bullish bias anyway.

Market Momentum Indicating Overbought Levels

Four straight record closes for the SP 500 and six consecutive days of gains leaves us at a point in the market that things have started to diverge. As the SP posts new highs, the yield on the ten-year note has approached its yearly high and sits near 5% for the first time since last June. Interest rates are not a problem until they are. Has the market overlooked this fact?
Today, the market has seen some selling activity mainly because of three factors. First, there are no catalysts to push the market higher and second, the ten-year note approaching 5% has some investors acting a little finicky. Ben Bernanke spoke this morning from South Africa and effectively reiterated the FOMC minutes from last week. He sees economic growth picking up to more normal levels in the coming quarters and although inflation has moderated, the risks are still to the upside. And last, but not least, the market momentum indicators are showing some overbought conditions that need to be relieved.

In this chart of the SP e-mini futures contract I want to take a look at two momentum indicators; Stochastic Oscillator & the Relative Strength Indicator (RSI). First, notice that the market has made a considerably steep rally over the past several months to reach new all-time highs on May 30th. The green circles highlight the market’s buying pressure. The red lines point to “relief” points when the market dropped and relieved an overbought level only to continue moving higher and into overbought territory again.
Another highlighted region is the negative divergence of the RSI line and the market. Eventually, the RSI line will begin to level out when buyers and sellers meet the supply and demand for each other. With the current overbought conditions, there is a chance the market would begin to follow the RSI. Remember, this is not the first time we have seen a negative divergence as the market climbed higher. Just look at December 2006 through early February and you will see similar action.

It is not uncommon for a bull market to be in overbought territory for long periods of time; however, eventually the market needs to rest. One of the things to watch here is how the markets close each day. Yesterday, the market closed near its highs for the day (flat), but it is the buying pressure into the close that is keeping the markets near these overbought levels. Personally, I don’t believe the buying pressure at the end of the day will continue for much longer. We would like to keep an eye on any sharp moves downward that end on high selling pressure. This could lead to the 3-5% correction we are looking for over the next week or two and an interesting summer of trading. Enjoy!

Thursday, April 12, 2007

Mirror Mirror on the Wall - Does Margin Debt Predict Them All?

Recently, I was reading an article that was began discussing the record levels of margin debt on brokerage accounts. It made a deft point that record levels of margin debt “is a red flag that the market is over-inflated by speculation”. This is a bold statement; however, it is on the right path. Let’s take a deeper look into what they might have meant by that statement and what it may mean for today’s markets.

Since 1970, on a monthly basis the NYSE has been reporting the aggregate debits in securities margin accounts in which they kindly organized into tables and excel sheets. The chart below shows this data since 1996 plotted with the S&P 500 cash index.

As you can see in this chart, the margin debt (in $ mils) and the S&P 500 have a very closely related relationship. The record margin debt in February 2007 was $295,870; whereas the previous record was $278,530 in March of 2000. Is it a coincidence that the previous record was also at the peak of the dot-com bubble just before the markets began to crash? Maybe so, but I wouldn’t bet the farm on it.

The most logical reasoning/theory behind the close relationship (if you look at it, their activity almost mirrors each other) is that when the market is racing higher, market participants want in on the action and therefore leverage their brokerage accounts to take advantage of the rally. A high amount of margin debt also means there is a high level of bullishness. On the flipside, margin debts decrease as the market retreats due to a plethora of margin calls and participants having to get out of the way of an incoming steamroller.

Margin debt can be healthy during bull markets as it provides fuel for further market gains. The problem comes in when excessive speculation comes during a “false” bull market, which is where I believe we might be right now (the latest retest of the highs since Feb. 27th is a false rally in my opinion). The pitfall is when a steep decline in stock prices exposes investors to margin calls, requiring them to post additional collateral or sell securities resulting in even steeper declines such as February 27th, 2007. With so many questions in the marketplace; housing, inflation, interest rates, credit tightening, a weakening U.S. economy, trade deficits, budget deficits, weakening dollar, higher energy and commodity prices and equity markets at or near all-time highs, one has to wonder if a decrease in margin debt is necessary to bring the market to less prone levels.

At these levels, a doomsday may not necessarily be in the works, but it does make me wonder how long or how much higher both margin debt and equities can go. Since they mirror each other so closely, both of them are important to watch. At the same time there is a second voice in my head that tells me to be weary of false rallies in the market and to look for opportunities to hedge positions. As always, I hope you enjoyed the read and let’s see where the next few weeks take us. Tomorrow is the release of more inflation data (Produce Price Index) and it will be a market moving event. Which direction the market will go next is anyone’s guess. To paraphrase the JP Morgan, the only thing I know is that the market will oscillate with incoming data and news.

Sources: NYSE, eSignal

Wednesday, April 11, 2007

Market Analysis

The early part of this week seems to be void of any major economic data releases. However, it is the beginning of earnings season (led by Alcoa’s $0.79/share gain, $0.03 ahead of analysts expectations) and a key inflation report is due on Friday morning. Last Friday’s job report reported an unexpected 180k increase in nonfarm payrolls and a 4.4% unemployment rate, which is low enough to raise concerns about insufficient labor supply and rising labor costs. Since inflation has been a key headache for fed officials, I thought it would be prudent to talk about inflation today.

The continually strong commodity prices we are seeing across the board from heating oil to wheat will certainly have an affect on inflation concerns. The trickle down effect of higher commodity prices may lead to higher inflation, a worried Federal Reserve and a multitude of other problems for the weakening U.S. economy. Before diving into the discussion, let’s take a look at some of the commodity price charts. There are quite a few, but just take a look at each of the price trends. I have taken monthly charts from a basket of commodities from the agricultural, metals and energy sectors.

Heating Oil
Live Cattle

As you can see, each of these charts points have the same trend over the pas 5-8 years; significantly higher. This basket of agricultural commodities, energy products, and base metals has increased substantially. Take a look at the price increases in percentage terms since 2000:
· Aluminum: +88.22%
· Copper: +357.41%
· Corn: +86.5%
· Gold: +135.52%
· Heating Oil: +210.50%
· Live Cattle: +43.37%
· Crude Oil: +132.32%
· KC Wheat: +65.86%

Those numbers make me wish I would have been invested in a basket of commodities from 2000-2007 during the time the S&P 500 has been flat. Either way, I believe these trends could continue in the near future because of strong demand, weather storms disrupting supplies and a general need for commodities. As commodities guru and world traveler Jim Rogers might say, “We are in the greatest commodity bull cycle our generation has seen”

The question is whether or not commodity prices and inflation can be linked. When considering the relationship between commodity prices and inflation, commodity prices have a positive correlation with inflation. Prices can be argued to be a leading indicator as they are quick to reflect economic changes in supply and demand. The resulting higher prices we see today compared with even 2-3 years ago is tremendous and will eventually be reflected in the final product purchased by consumers; and therefore, higher inflation.

Arguably, crude oil prices (and therefore energy prices) have a robust history of influencing inflation measures the most. As all of the commodities I looked at are currently priced within the top quartile of their six year highs, it makes me wonder how much further prices can reach before negatively affecting the economy (that is, more than it has already). Crude oil will be the most influential as prices seem to be supported be a continuation of global tensions with oil exporters and world demand increases.

The Produce Price Index (PPI) will be released on Friday morning. The consensus estimate is for a 0.8% increase in the headline number and a 0.2% increase in the Core PPI. With that said, I would not be surprised to see the core PPI come in slightly hotter than expected given the deluge of higher commodity prices across the board. As the Federal Reserve seemingly reiterates its hawkish tone on inflation, this number could signal a short-term direction for the market.

Thursday, April 5, 2007

Capital Spending Whoas

Lately, I have been writing about the market’s latest push toward the highs as a false rally. Maybe it’s just my nature to scrounge around looking for evidence to support my contrarian views, but I am adamant about backing up my opinions. Most recently I said the reaction to the FOMC policy statement was overblown as traders and investors misread the policy to the effect they saw a rate-cut in the near future. To the contrary, the statement had obviously stated that it plans to maintain the current fed funds rate at 5.25%. The markets react and anticipate, yet sometimes they anticipate incorrectly. This is why we are so fascinated with financial markets and this is why things can become ugly in a hurry.

I don’t believe things will get ugly, but I do think the markets have been overlooking certain aspects of the economy that are suggesting weakness, yet are captivated by other aspects in order to keep the “Goldilocks Scenario” alive. Eventually, according to efficient market theory, all information will be accounted for and the market will price accordingly. That said, the markets should currently be pricing in a modest economic growth of 2-2.5%, slower corporate earnings, higher energy prices, a slowing housing economy (which by the way pushed economic growth for the past several years) and a federal funds rate of 5.25%. However, I don’t think we have seen this. The market is sitting within 1-2% of their 6 year highs and nothing is being discounted. An extremely optimistic market will sooner or later catch up with the real information being released leading to less optimistic markets with a sense of risk.

One of the aspects of the economy the market has simply overlooked is the slowdown in capital spending. Capital spending is the capital spent to acquire or upgrade assets. Think buildings, computers, planes, trucks, equipment and other machinery. Before providing the numbers, let me explain why capital spending is important. When businesses are growing (and the economy expanding), they need equipment and machinery to let their business flourish. Orders are placed with vendors to provide the products and then the businesses begin producing their goods for consumers. If they decide to not invest in their infrastructure then they are not producing more goods; therefore, the economy has fewer goods on the market and it slows the overall business cycle. This is an elementary crude explanation, but it should do for now. On to the numbers.

This morning, the numbers for February factory orders were released. They did nothing to make me believe that the downtrend will be interrupted by a sudden surge of new orders being placed. The first quarterly decline in capital spending in nearly four years was posted in the fourth quarter of 2006, but it passed with hardly a mention. Although Feb. orders were up 1.0%, this was well below the consensus estimate of a 1.9% gain following a -5.7% drop in January orders.

This doesn’t bode well for the overall expansion of businesses growth. Take a look at the chart below. You can see that the drop has the look of the drop in orders from the last recession in 2000.

Factory orders consist of durable and non-durable goods. Non-durable goods
include items like food, clothing, and tobacco products. Durable goods are
products that maintain non-durable goods such as washers and dryers, computers
and machinery.

The drop in capital spending is happening at a time of near-record corporate profits. It has been known for some time that CEOs remained cautious in their spending plans, yet they have spending all those profits on share buybacks. That creates some shareholder value, but how does that help an economy that is beginning to show more signs of weakness?
Ben Bernanke has taken notice of the lack of spending by businesses hoarding cash as he gave his testimony to the congress last week adding that there was “an additional downside risk” to the economy if the weakness in business investment continued. I know we have ignored some weaker data points along the way to these multi year highs, but this is not something that we want to ignore.

The lack of spending may have similar effects on the economy as a weaker housing market. It will take some time to see, but as early as next month more capital spending data will be released. Another quarterly decline would mean two consecutive quarterly declines in capital spending at the same time the economy is modestly expanding. Take note that the market has yet to account for this and it again overlooks a vital piece of forward-looking information reflecting the state of the economy. I have not forgotten the 6.5% drop near the beginning of March; however, it took the market no more than ten trading days to recover almost all that was lost during that “correction”. That is not convincing enough for me and the wall of worries is continuing to grow. Maybe I am overly cautious, but I doubt it.

Friday, March 30, 2007

Friday Slough

It is Friday afternoon and the market's have again been very volatile. It was a strong start this morning as the marktes received a deluge of solid data; consumer spending defies the economic slowdown, incomes are up, and the Chicago PMI set a whopping record, jumping from 47 to 63 (largest historical monthly jump); however, inflation (Core PCE) was up 0.3%, or 2.4% yoy (about as expected).

The Chicago PMI number is what is surprising. How does the manufacturing index jump so much in a single month? Was it extremely warm in Chicago in March? Possibly, but we still don't know why this came out so hot.

The morning news crossed the wires and the selling began shortly thereafter when the US government posed tarriffs on Chineses importing paper goods (10-20%). That will mean higher prices for Chinese importers, yet it also means that we are trying to cut into the trade deficit with China. In fact it is interesting to note:

"The action reverses 23 years of U.S. trade policy by treating China, which is
classified as a nonmarket economy, in the same way that other U.S. trading
partners are treated in disputes involving government subsidies."

Oh well, life goes on for the Chinese. Life goes on in America. As the markets are holding steady near the breakeven point, I don't see a whole lot of change happening near the end of the day, unless of course traders decide they don't want to hold on to any long positions over the weekend (could be likely) with geopolitical tensions as they are and oil prices continuing to hover near YTD highs.

That's it for today and I hope everyone enjoys the weekend. I am headed off on a six hour drive to southwest CO to Silverton, CO. I'll leave you with this.

"One Lift Servicing Heaven" Silverton, CO (www.silvertonmountain.com)

Thursday, March 29, 2007

My Other Blogs

I have been writing for almost a year, but mostly for two other blog groups. One is David Kosmider's www.stockweblog.com and the other is Aaron Day's www.commoditytrader.com. Both of them have some great market insight for investors, traders and anyone interested in learning about the markets, but I have decided to start my own blog where I can express my thoughts a little more freely. If I feel like talking about something other than the irrational markets, I can go ahead and post about that damn weekend trip to Silverton, CO (actually, I'm going this weekend and can't wait).

Anyway, here is a link to the articles I have written for these two websites. Enjoy the read and leave me a few comments if you think any of them are itneresting. All of them are more technical than I plan on writing here.

Rocking Wall Street

Gary Marks is by no means average, let alone another average hedge fund manager। Marks is a successful musician, and you can see the unique approach he has to the investment industry when he shows up to give market commentary to CNBC while wearing a blue bandanna. In fact, from the pictures that i’ve seen, he looks like he’d fit in quite well in Sturgis. He has taken his music background and developed a unique approach to the hedge fund industry since 1999. As incomparable as Marks is to anyone else in the industry, when I was recommended by “the humble analyst” John Mauldin to read “Rocking Wall Street” written by Gary, I had to jump in and immerse myself into the book.

”Rocking Wall Street” is not for the average reader, no investor। It is directed toward the high net worth individual who is not conecrned with fickle everyday purchases. Instead these individuals are looking to generate returns with their capital for retirement and even looking for capital preservation for generations to come.

First, a little bio on Gary Marks। Marks is highly regarded in the investment industry. In 1999, he began a hedge fund of funds firm called Sky Bell Asset Management which he still runs as CEO. Today, he is a multi-manager specialist and has assets under management of over $300 million, a respectable size, but still small compared to some behemoths. He has also excelled in the music industry, most recently releasing his 10th CD, “A Whisper Can Change the World” in February 2007. He has taken his lessons in the music industry and transposed them to the hedge fund industry by creating a unique approach to preserving capital and investing with other managers.

His book is written in an extremely one-on-one manner as he provides insight from his daily routines and interaction with clients। The book is based on four main strategies:

  1. Emotional Controls
  2. Knowing the Difference Between Market Stats and Market Hype
  3. Hedged Portfolio Construction
  4. Planning for the Future and Seeking “The End Game”

Throughout the book, Marks uses his personal experiences with clients and combines a narrative over these conversations. His explanations on each interaction with clients provide a real-life insight into what goes on behind closed doors of a fund of funds manager and how intricate the process can be due to personality differences in client-manager relationships. Marks walks the reader through hedge fund definitions, diversification, and portfolio construction for the high net worth individual (although this can be transferred to the everyday investor if you read between the lines). One of the most effective “scared straight” tactics he uses throughout the book is the debilitating effects of losses vs. gains.

For example, if you return 50% on $100,000 you have $150,000. But if you
lose that same amount (50%), all of a sudden you are left with $75,000 or a 25%
loss even though the percentages never changed. Losses are difficult to
overcome, yet that is the nature of the business.

As marks continues to educate the reader delicately, he leads us to “The End Game”। Essentially, this is when an individual has reached a point in his/her life where they have enough capital to live a very high standard of life. They have enough capital to not take certain risks even though a loss of X amount of capital or a double up of X amount of capital would not change their lifestyle. This individual has reached “The End Game”. At this point, the individual should be looking for capital preservation and to provide for generations to come (if that is the choice the individual makes). It is an interesting point and one that is too often overlooked as we see American’s trying to keep up with the Joneses.

Gary Marks continues to excel wherever he puts his mind to work. Whether it be managing client’s capital creating musical works of art or even writing though-provoking books. He has integrated several skill sets into the financial industry and into a book that is a reasonably easy read for anyone with a financial background. Many people will look at this book as biased toward a select few high net worth individuals in the world; however, while reading this book I found it a great look into the inside track of what has been called the sexiest industry in the financial world. Derailing all traditional rules for success in the financial industry, Marks makes his mark.

Friday, March 23, 2007

Jim Cramer Shoots Himself in the Foot With Another Wacky Interview

It seems as if everyone now knows who Jim Cramer is; host of CNBC's cult-like show, "Mad Money", co-founder of TheStreet.com and a former well-known hedge fund manager. If you haven't noticed, he is extremely adamant about letting the smaller investor play with the big boys. But if you haven't seen this clip of Cramer on the show, "Wall Street Confidential", then you have missed out on his hypocritical comments (click here to see the 10 min clip).

I am miffed about how this guy could go on TV and actually say some of the stuff that he says. First of all, any person could go out and pick a portfolio of stocks and do as well as many money managers in the investment wolrd that get paid to do it. I'm not saying that the average person is as good as the professionals, but financial markets are fickle and can make a genius look average and an average person look like a genius. It's the nature of the game.

However, Cramer takes it several steps further. In fact he gets on a TV show, Wall Street Confidential, and essentially pleads guilty to stock manipulation.

"You know, a lot of times when I was short at my hedge fund—when I was
positioned short, meaning I needed it down—I would create a level of activity
beforehand that could drive the futures. It doesn't take much money. Similarly,
if I were long, and I wanted to make things a little bit rosy, I would go in and
take a bunch of stocks and make sure that they're higher. Maybe commit $5
million in capital, and I could affect it. What you're seeing now is maybe it's
probably a bigger market. Maybe you need $10 million in capital to knock the
stuff down.

But it's a fun game, and it's a lucrative game. You can move it up and then
fade it—that often creates a very negative feel. So let's say you take a longer
term view intraday, and you say, 'Listen, I'm going to boost the futures, and
the when the real sellers come in—the real market comes in—they're going to
knock it down and that's going to create a negative view.' That's a strategy
very worth doing when you're valuing on a day-to-day basis. I would encourage
anyone who's in the hedge fund game to do it. Because it's legal. And it is a
very quick way to make money. And very satisfying.

By the way, no one else in the world would ever admit that. But I don't
care. And I'm not going to"

Jim Cramer said it's illegal, but in fact this is ludicrous. Yes, it's legal
in the sense that anyone can go in and short a stock or bid a stock up, but then
he continues to say something that is in fact, illegal:

"Now, you can't "foment." That's a violation. You can't create yourself an
impression that a stock's down. But you do it anyway, because the SEC doesn't
understand it. That's the only sense that I would say this is illegal. But a
hedge fund that's not up a lot really has to do a lot now to save itself.

What I used to do was called— If I wanted it to go higher, I would take and
bid, take and bid, take and bid, and if I wanted it to go lower, I'd hit and
offer, hit and offer, hit and offer. And I could get a stock like RIM for
maybe—that might cost me $15 to $20 million to knock RIM down—but it would be
fabulous, because it would beleaguer all the moron longs who are also keying on
Research in Motion.

So we're seeing that. Again, when your company is in survival mode, it's
really important to defeat Research in Motion, and get the Pisanis of the world
and people talking about it as if there's something wrong with RIM. Then you
would call the Journal and you would get the bozo reporter on Research in
Motion, and you would feed that Palm's got a killer that it's going to give
away. These are all the things you must do on a day like today, and if you're
not doing it, maybe you shouldn't be in the game."

Now why would you say such a thing? Why would Jim Cramer, who has a cult-like following from his tv show, say that he attempts to manipulate a stock price because he needed to make money. Yes, Wall Street is a cut-throat game, but to admit this on TV could be a bad move. Actually, he admitted that this was a bad move. From his website, he issued an explantion (click here) that "when I was a hedge fund trader in the 1990s, I played fair, and I did nothing that violated those laws." Yet if you scroll back to the beginning of this article, you notice that he in fact admitted to doing such things as "You know, a lot of times when I was short at my hedge fund—when I was positioned short, meaning I needed it down—I would create a level of activity beforehand that could drive the futures. It doesn't take much money. Similarly, if I were long, and I wanted to make things a little bit rosy, I would go in and take a bunch of stocks and make sure that they're higher."

I have a lot of respect for Jim Cramer as a trader, but I have no respect for him as a TV figure and the manipulation that he has on everyday investors. It's almost a sick game to him. "Hmmm...how many people can I manipulate in this world without it affecting my everyday life. That sounds like fun today." Instead, listen to your guts and not some guru who has admitted to and denied manipulating stock prices in the same week.

Until next time, Enjoy the show!

Tuesday, March 20, 2007

Skills Like This (The Movie)

I have a friend here in Denver who had some extra capital to put to work and he has been putting it into different side ventures. One recent venture was to help finance a movie called, "Skills Like This". It was filmed right here in Denver and Arvada, CO.

I haven't seen it yet, but I have heard great reviews. It was recently shown in Austin at the SXSW Film and Music Festival (which I went to my freshman year of college at the University of Texas). I hope it does well, so check out the trailer when you have a chance.

Five Day Rally, For Real?

Just looking at the charts for the S&P 500 today, I am a little surprised at the move we are seeing so far today. We are coming off of a down week last week, but nothing too surprising given the circumstance that the market was trading off. Since a new low was made last Wednesday at 1364 (and a subsequent reversal rally that day), the market has rallied nearly 50 points (3.5%) from those lows. That is a pretty substantial move in a market that reading the media, you would have thought the world’s economies were crumbling. Quite to the contrary, world markets look to have stabilized, although it could very well be a head fake in another move lower. The Shanghai Index, which fell 9% on February 27th, has regained 5.2%. Hong Kong’s Hang Seng index has regained 3.1% in the past five trading days and even the German Dax index has increased 3.7% in the last week. These are all great rallies, but what is the core reasoning behind the move?

Let’s focus on the U.S. since that is really what we know most about. First, last week was an expiration week; therefore, historically it has a bullish bias. Could that be the main reason for the market’s gains? The follow through the first two trading days this week has me thinking that something else is behind the move.

The data that has been presented in the past week has been mixed at best, so this might not be the greatest catalyst. On Tuesday, retail sales came in at +0.1% vs. +0.3% expected, while sales ex-auto were -0.1% vs. a +0.3% estimate. These are weak and the downtrend in consumer spending has continued (see chart below, click to enlarge).

Wednesday is what I believe could have been a key reversal day, yet it was the same day that Asian markets were down 2-3% and European markets were down 1-2% respectively. It looked like the morning weakness was based on overseas trading and the subprime mortgage mess, but midday, the markets reversed. Why? It is possible that all the sellers were washed out and the bulls took control, but there was no real catalyst to the move. With inflation numbers out the next two mornings, it could have been ugly. When the PPI and CPI report came out slightly hotter than expected the markets continued to try and push higher, but the end of week volatility and expiration closed the markets near 1400, or about the same point the key reversal day closed its interesting day. No change for the last two days of trading for the week.

That brings us to yesterday and today. Yesterday, the morning gap of 10 points was never filled in throughout the day as the market traded higher just as overseas markets had done the same morning. The slow grind upward lacked both volatility and the presence of sellers. Why wouldn’t the sellers have come in at any point and started pressuring the market? It could be because they are waiting to hear what the Fed has to say on Wednesday during the FOMC announcement. They are expected to keep rates at 5.25% (a 98% chance, according to the markets), yet their statement may have some indication of the latest subprime meltdown. If the statement is upbeat, it will be good news for the bulls, but if it has any tone of worry, we may see the sellers come back to play and drive the S&P back to its lows near 1364 or even lower.

Take a look at the chart below. You can see the market is sitting right at the thick red line, which is one I have drawn as a resistance area. Technically, it is very strong as the red line indicates both a prior resistance area and a 38.2% retracement using the February highs and the first low made in March (see below, click to enlarge). This number is critical as it also happens to come into play during the FOMC meeting. It could very well be a re-test before breaking lower. We will see what happens tomorrow afternoon, but keep in mind the intermediate trend is still downward, even with a 3% gain in the past five trading sessions.

Source: Briefing.com, eSignal

Friday, March 16, 2007

Uncomfortable Market Thoughts

I have just a few thoughts on the market today. The market has been acting quite suspiciously and I am not too comfortable with this. Some of the activity may well be due to today’s expiration and the typical bullish bias during expiration week, but I believe investors (the market) have ignored some pretty stern “warnings” over the past few days.

The sub-prime lending issue is an isolated event, but it has further implications in the housing market, which ultimately has an effect on the health of the economy. The decrease in unemployment over the past few years can be mainly attributed to the housing market. If the housing market continues to weaken (as it easily could), then the economy will feel the ill effects in the form of lost jobs and lost growth. The economy is already slowing as seen in both manufacturing numbers and earnings guidance. Throw in slightly higher oil prices, inflation pressures, global tensions/risks, the “yen carry trade”, hawkish comments from Alan Greenspan and investors that have seen their egos battered for better or worse and we have a market that might just pay attention to the economy’s health.

A side note on Greenspan: Now that he is out of the public office as
chairman of the Federal Reserve, he feels as if he can more freely talk about
the economy and his views on certain risks. In fact, groups of banks and
institutional firms pay a hefty price tag for his opinions at conferences and
meetings. Let it be known that he does see risks in the economy, specifically
the housing market as he noted in a March 15th speech mentioning that “if home
prices go down from here, I think we’ll have problems”. Maybe this is his
irrational exuberance speech from the 1990s. Is it going to be a time that we
look back 6 months later and said, the warnings were there, why didn’t we see
this coming? I guess we’ll see.
Although Wednesday was a technical key reversal day (hitting new lows at 1363, then bouncing and finishing substantially higher at 1387). A 10% correction may not have been made quite yet, but may be in for a little rough and tumble ride over the next few months while the housing market, inflation and global tensions play out even further. False rallies, false bottoms and higher volatility is what I see in the coming months.

Source: eSignal