Where Are We Now

Wednesday is Day 4 of an attempted Rally, so I am looking for a Follow Through Day (essentially a big move on big volume to show that the boys are interested in owning stocks again).

The US Dollar
The Dollar touched the 50-day (Black Line). Each time the Dollar has hit the 50-day, it has then fallen, while Stocks, Commodities and Corporate Bonds have rallied. Bottoms normally take time, so I would not expect the Dollar to immediately reverse straight up – that would be bad for risky assets like Stocks and Corporate Bonds. The Dollar bottomed in 2008 at about 71. It now sits at 76. So there is still room for the Dollar to fall, but I think it is getting late to make bets against it.

Here is another big chart (sorry).
See how the selloffs in August, September and October reversed in one day, without sitting around or retesting (Blue Arrows)? Each time, the Markets got extremely oversold (Red Arrows) and the markets bounced sharply.

People were expecting the same on this selloff and the Market rallied hard on Thursday, as the 50-day was tested (Black Arrow). The Markets sold off hard on Friday, no doubt pummeling those who bought into Thursday’s CNBC hype (I forget what they hype on that day was about).

See how the Green Line is holding here? But Technical Analysis doesn’t work. All you have to do is listen to Cramer and you will make a fortune…

Summation continues to work its way lower, as more stocks break down and fewer stocks lead (Blue Circle).

What to Do Now?
Look for what has been holding up best. That will tell you to where the money is rotating and what the big boys are interested in owning.

Gold
I didn’t sell any of my Gold or Gold Stocks in October. In aggregate, I am about 30 – 35% invested in these holdings. They paid off big today, after scaring me last week. I just turned off the news and held them, operating under the assumption that either more Government spending is going to be announced or Gold would be bought as a hedge against market uncertainty.

Stimulus 2.0 (Or Potentially QE2) Being Discussed At The Whitehouse
Yesterday, US Commerce Secretary Gary Locke said that "if there is to be another stimulus -- and that’s being hotly discussed and very seriously considered within the administration as well as members of Congress -- it needs to be very targeted, very specific and we need to be very mindful of the deficit as well.”

Stimulus 2.0 can only be financed by the printing of new money. That by definition is what drives Gold higher. Today it was also announced that the Government of India was buying over $6 billion in Gold from the IMF near All Time Highs. That feels like a “sell-the-news” type of headline, so let’s see how Gold and Gold Stocks trade the next few days. I ain’t sellin…

Gold, and especially Silver and Gold Stocks are extremely volatile, so check how much price movement you can tolerate before you ever considering owning this stuff.

Maybe the Fed will announce that it will buy more Government Debt today at the FOMC meeting. Who knows what those idiots are going to do next (My apologies to idiots for comparing you to the Fed)…

Rotation
Here is a chart showing the last few days of trading for the S&P 500 ($SPX), Oil Service (OIH), Financials (XLF) and Semiconductors ($SOX). You can see that today, SPX has been relatively flat, OIH was up sharply, XLF was flat and the SOX was down.

Why is this important? It is important, because the leaders have been Financials and Semiconductors. They lead early in recoveries. Now you are seeing money flow into Gold and Energy. The outperformance of OIH is what rotation looks like. Some of you may be upset to hear this, but Semiconductors now look sellable on any rallies.

My concern is that Energy and Gold take over leadership as the recovery peaks. I think that is why you are starting to get the politicians discussing more Government consumption (Stimulus 2.0). That is the only way they can prop up the economy. I think Gold is up, because if the recovery is soon to stall, then Gold will take leadership and if the Government prints more money, then Gold will rally too – heads I will, Tails you lose.


So the markets have the opportunity to start another leg up from here. Let’s see what the big boys do. If they buy, then I will get stopped in. If they don’t show up, then I will look for another Follow Through Day from lower levels.

Not-So-Available Credit

Banks aren't lending...

The Housing Price Subsidy

To illustrate what Bill Gross was talking about yesterday, Goldman recently released a report discussing the impact of Government intervention on the price of houses. The conclusion – it increases housing prices by 5%.

“Uncle Sam’s interventions in the housing market have pushed home prices 5% higher on a national average than they would have been otherwise, Goldman Sachs estimates in a report released late Friday.”

http://blogs.wsj.com/developments/2009/10/24/uncle-sam-adds-5-to-prices-of-homes-goldman-says/

That 5% goes directly to increasing the Equity of homeowners. I think it keeps a lot of people from going into “negative equity” – and that is the goal of the government.

“Strategic Default”
Walking away from Mortgages you can afford to pay but choose to not pay, because you owe more than the property is worth.

http://www.miamiherald.com/251/story/1298873.html

Those underwater tend to walk away. It is a nationwide phenomenon.

I think the solution is to allow (or force) banks to lower the value of mortgages to levels more in line with the real value of the underlying property – “cram downs”. Washington/Wall Street seem to disagree with me…

The government is going to extend the tax credit for home purchases. This effectively decreases the after-tax cost of a home, while maintaining the selling price of the home. Think of it as a government subsidy – because it is one. It is designed to artificially prop up the selling price of the house, while giving the buyer the ability to buy the house at a lower price.

This allows your neighbor to get his house appraised at the sell price and not the buy price. This makes him appear to have more “Equity” in his house, because he is basing his appraisal value on comparable sell prices and makes him less apt to walk away from his not-quite-so-underwater house.

In the mean time, as taxpayers, you and I will be writing another huge check for this subsidy.

Defense Was The Right Call

October 14th I wrote the following –

“You’d Better Know How To Play Defense Real Soon”

Right on!

Indexes were at or near significant resistance and prices had risen too far too fast. Market Internals were deteriorating, some leaders were failing big on earnings and several sectors were starting to implode. I booked a lot of my September/October gains and am looking to reload in November.

Institutional Selling
Mortgage Finance is testing the lows of March!
Financials broke the 50-day – BAC, GE, WFC, JPM, GS!, RY
Regional Banks look worse – STI, STT, ZION, RF, KEY
Retail is starting to break down. Leaders ARO, JNY, GYMB, JOSB, CRI, UA
Home Builders and Home Imporvement are breaking – XHB, HD, TOL, RYL, PHM
Airlines have totally broken down. AMR, LCC, CAL
Railroads are cracking – BNI, UNP
Casinos have topped and are rolling over. Look at BYD!
Steel Stocks have imploded. X, AKS, SCHN, NUE, STLD
Biotech is nose diving – AMGN, CELG, BIIB
Healthcare is blowing up – ILMN, PSYS, CYH
Semiconductors are now definitively below the 50-day. STEC, BRCM, VSEA
Disc Drives are failing after earnings. WDC and STX broke the 50-day today
Semiconductors and Disc Drives always lead!
China. Holy cow, look at high-growth Chinese companies!! FUQI, EJ, SOHU, SNDA

Look at Austria today! South Africa (EZA) looks similar.

Brazil was done huge today (EWZ). So was the Emerging Markets Index (EEM).

What This All Means
For the first time since March, we are getting some serious selling and some sectors are now off the radar for future purchases.

I expect the next rally to have fewer sectors and companies participating. I also expect larger companies to start to lead smaller companies as the big boys look to buy liquid holdings ahead of the next Bear Market. I will also continue to focus on late-stage Bull Market sectors – Energy, Gold…

I expect a lot of money to be taken off the table on the next leg up. The last few weeks, I have had a lot people ask me when they should be selling. I don’t think many of them sold the last few weeks and they will get very anxious over the next few days, thinking they have missed the top and need to get out - the now or never panic of fear...

I will be looking to buy any panic selling in November, in anticipation of a Year-End rally. After that, all bets are off. If the move is accompanied by another spike in the price of Oil and a spike in Gas above $4 per gallon, then the Bull Market will probably be over and the next leg of the Derivative Implosion will smack us in the face.

Is the Hot Money Leaving PALM for Verizon?

Doesn’t Verizon have that new Android rolling out?
Or maybe it is the risk aversion trade going on right now as Institutions sell risk and buy Large Cap Value.

Available Credit

Credit peaked last year and has been falling since. By now we all know that the US Economy is driven by credit. Falling credit either means falling consumption or it means that the Government has to print more money to keep consumption up.


Available Credit for business loans has contracted at the fastest rate on record. This tells you that banks aren’t lending and money available for buy bonds has flowed into Mortgages and Government Issued Debt.


Europe
It is not just in the US. Here is the headline today from Euroland –

“Bank lending to companies operating in the Eurozone fell in September for the first time on record, according to the European Central Bank.”

http://news.bbc.co.uk/2/hi/business/8327809.stm

The US Government
In an effort to make up for tightening credit at banks, the Fed has been pumping money into the system to try and prop up the system. The Monetary Base is at a new all time high, so does it surprise you that Gold hit an all time high and Oil is rallying again?


Here is a visual example at what is occurring in the lending markets. The US Government (Ginnie Mae, Fannie Mae and Freddie Mac) have gone from originating about 55% of all mortgages in 2007 to over 90% in 2009. Banks and private lenders simply aren’t willing to lend money (or can’t lend) at these low interest rates.


http://www.pimco.com/LeftNav/Featured+Market+Commentary/IO/2009/Midnight+Candles+Gross+November.htm

Why do we need all of this cheap money? Bill Gross at PIMCO describes it like this –

“(A)lmost all assets appear to be overvalued on a long-term basis, and, therefore, policymakers need to maintain artificially low interest rates and supportive easing measures in order to keep economies on the ‘right side of the grass.’”

Let me know if what Mr. Gross says next sounds familiar –

“Let me start out by summarizing a long-standing PIMCO thesis: The U.S. and most other G-7 economies have been significantly and artificially influenced by asset price appreciation for decades. Stock and home prices went up – then consumers liquefied and spent the capital gains either by borrowing against them or selling outright. Growth, in other words, was influenced on the upside by leverage, securitization, and the belief that wealth creation was a function of asset appreciation as opposed to the production of goods and services.”

This is probably the most important thing Bill Gross will write over the rest of my career –

“Asset prices are embedded not only in our psyche, but the actual growth rate of our economy. If they don’t go up – economies don’t do well, and when they go down, the economy can be horrid.”

Asset Price Appreciation as a policy tool…

“Asset appreciation in U.S. and other G-7 economies has been artificially elevated for years. In order to prevent prices sinking even lower than recent downtrends averaging 30% for stocks, homes, commercial real estate, and certain high yield bonds, central banks must keep policy rates historically low for an extended period of time. If policy rates are artificially low then bond investors should recognize that artificial buyers of notes and bonds (quantitative easing programs and Chinese currency fixing) have compressed almost all interest rates.”

“(The Fed, the Treasury, the FDIC) recognize… that asset prices must be supported in order to generate positive future nominal GDP growth somewhere close to historical norms. The virus has infected far too many parts of the economy’s body, for far too long, to go cold turkey.”

“That support, of course, comes in numerous ways. Financial system guarantees, TARP recapitalization of banks, TAFs, TALFs, PPIFs – and in Europe and the UK, low interest rate term financing, semi-bank nationalizations, and asset purchase programs similar to the United States. In the case of the U.S., the amount of the implicit and explicit financial support given by policymakers totals perhaps as much as $5 trillion, which goes part way to support the $15 trillion overvaluation of assets theoretically calculated in the PIMCO model (100% of nominal GDP).”

“At the center of U.S. policy support, however, rests the “extraordinarily low” or 0% policy rate. How long the Fed remains there is dependent on the pace of the recovery of nominal GDP as well as the mix of that nominal rate between real growth and inflation.”

Any way you slice it, the name of the game is for the Government to use newly printed money to buy stuff from those who are looking to sell and deleverage.

The Market Narrows

For the first time in a while, I am seeing sectors starting to top and roll over. The Market is narrowing. The Summation Index fell to 960 today, after breaking the key 1,140 level late last week. The Bullish Percent Index has put in its first lower high since early June.

Transportation
Airlines


Real Estate Related
Mortgage Finance


Home Construction


Healthcare
Biotech


Health Care Providers