Greenspan's Sucker Punch

One of the reasons you can expect to see a liquidity-induced rush into the stock market are the figures below. Greenspan, somewhat disingenuously, claimed in his Senate testimony that low interest rates have not cause huge growth in the money supply, and therefore not led to a liquidity induced bubble. Partially true. But, by lowering the real return on cash to nearly zero, Greenspan has given money market mutual funds a swift kick in the rear, propelling them directly into the market. He's not doing savers any favors, although he appears to be doing all he can to get everyone into the market for one gigantic top before the election. Give the man a Nobel. Here are some stats from AMG data services and the Investment Company Institute. Notice the relationship. As money market mutual funds witness an exodus, domestic equity mutual funds get manna: * At the retail level, assets of retail money market funds decreased by $4.37 billion to $893.03 billion for the week ended Wednesday, February 11. *Equity funds report net cash inflows totaling $4.1 billion for the week ended February 11. Net investor inflows are now coming into equity funds at a rate of $8.6 billion per week (as measured over four weeks), the heaviest rate since March, 2000; *Domestic Equity funds report inflows totaling $2.79 Billion or 69% of the total net inflows Despite the trash return, there are still over $2 trillion in money market mutual fund assets under management. These funds own T-Bills, CDs, and short-term commercial paper--all of which currently "yield" very little, less than 2% on average. The advantage for savers is liquidity. You can get to your money easily if you need it. The disadvantage is that if you throw in a management fee, add in inflation, and compare it to the yield available in equities (even if it's not historically robust right now), holding cash is pretty painful at low interest rates. One way of looking at that $2 trillion in money market mutual fund assets then, is additional market cap in equities. Dump that on top of the Wilshire 5,000s current market cap of $11.1 trillion and you have a stock market back at levels it hasn't seen since 2000. It would still be off the Wilshire's high at $14.7 trillion. But this is just retail money market money we're talking about. A little kick from some growth from the monetary base and you can see how it's conceivable the market could actually make a new high this year. It's still insane, but conceivable nonetheless.

Trade Deficit Within Kissing Distance of Half a Trillion

Chart below courtesy of briefing.com showing the trade deficit in nominal terms on a monthly basis. The December trade deficit came in at just under half a trillion dollars, $489.4 to be exact. It was up 17% in 2003. The supposedly good news from the numbers is that import prices were up 1.3%. This is a sign that the falling dollar is beginning to make foreign goods more expensive in the U.S. That's fine as theory. But in reality the biggest increases in import prices are in energy, namely a 6.2% increase in oil prices. We've yet to see inflation, or at least noticeably rising prices in finished consumer goods. In other words, I don't think this is the kind of inflation that will force the Fed to raise interest rates before November. Exports, for their part, actually declined--which is not exactly what you want to happen with a depreciating currency. You want it to make your exporters more competitive. Such is the problem with deficits, however. Rather than taking surplus dollars to buy American goods and services, foreigners are using them to buy U.S. government bonds. This has the short-term effect of keeping the dollar from falling even further. But it has the long-term effect of hurting exporters. It's not exactly an ideal situation...a rising deficit, falling exports, and a falling dollar. And quixotically but as I've explained elsewhere, also this macro economic nervousness is bond bullish. Welcome to bizzaro land.

Quote of the Day

"While demands for dollar-denominated assets by foreign private investors are off their record pace of mid-2003, such investors evidently continue to perceive the United States as an excellent place to invest, no doubt owing, in large part, to our vibrant market system and our economy's very strong productivity performance. Moreover, some governments have accumulated large amounts of dollar-denominated debt as a byproduct of resisting upward exchange rate adjustment. Nonetheless, given the already-substantial accumulation of dollar-denominated debt, foreign investors, both private and official, may become less willing to absorb ever-growing claims on U.S. residents." Alan Greenspan, testifying in front of the House Committee on Financial Services, February 11, 2004

Deficits and National Power

Off to make some final changes to an essay on deficits that my friend David Galland is publishing. I'll do a full review of the Greensphinxes statement tomorrow. For now, an quote on deficits and national power from Andrew Sullivan. "The one thing you learn from history is that inattention to national finances is the surest sign of decay in global power."

Short Term Logic

"The world's exchange system should be regarded as completely out of control." So says Lord Rees Mogg in the weekly missive below. I think he's spot on, as the English say. I'll have more to say about it in a different post, looking specifically at Chinese and Japanese currency reserves. And by the way, thank you for all the suggestions on what to call Lord Rees Mogg's weekly contributions. I especially liked Rees-Blogs. Short Term Logic by William Rees Mogg 12 February, 2004 The G7 meeting at Boca Raton has been a failure. This is bad news for everyone. It is bad news for the United States and has been followed by a further fall in the dollar. It is bad news for Japan, which has been buying vast numbers of dollars in order to stabilise the yen. It is bad news for China, under ever greater pressure to revalue or float the renminbi. It is bad news for Europe, with an overvalued euro and a depressed domestic market. It is bad news for Britain, with the pound at its highest rate against the dollar for eleven years. As the G7 communiqué piously observed that “excess volatility and disorderly movements in exchange rates are undesirable for economic growth”, the markets have already given the G7 a massive snub. Some dealers had hoped that the G7 would at least take the pressure off the dollar for a few days. What has actually happened has made the world’s central banks look completely impotent. As their authority is essential to their effectiveness, they have lost their most powerful weapon. The world’s exchange system should be regarded as completely out of control. One view is that the dollar is a problem for everyone else except the United States. So long as the Asian countries lend billions of dollars to the United States, it is possible for the U.S. Government to run the double Budget and trade deficits. And finance them by their borrowing. It is possible for American consumers to continue to buy on borrowed money. This is short term logic. At some point the American economy will have to be brought back into balance. That point is probably closer than most of us think. Whoever wins the Presidential election will have to try to restore the balance of the Budget in the difficult post-election year. The continued decline of the dollar does, in any case, threaten the re-election of President Bush. The Democrats seem to have found their most “Presidential” Presidential candidate in years. Senator Kerry is a war hero with the best senior statesman’s profile in the political casting lot. He seems already to have a united party behind him. He will carry New York and California in November. He could win, and he will win if the American voters believe that the Bush administration have lost control of the economy. As the G7 plainly has lost control of the world’s currency system, American voters could well decide that the U.S. economy was in trouble, even if employment remains high and growth is maintained. Both economics and politics are ruled by expectation, as the Austrian school of economists pointed out. Prosperity is how the economy is doing today; expectation is how the economy is expected to do next year. When the dollar is at $1.27 to the euro, $1.87 to the pound, and only buys 105 yen, one does not need to ask what the expectation is. The markets are telling us that there is trouble on the way, and the trouble is not good news for the re-election campaign. ###

He Huffs... And He Puffs...

Looks like Easy Al is everyone's pal today. Look at gold and the Dow in the hours imediately following his Humphrey-Hawkins testimony on Capitol Hill. He finished up around 11 am: Gold!... ...and the Dow "The economy is set for vigorous growth," said the history's most notorious bubble blower. Investors appear to be skeptical, though (as they should be). The Dow rally may already be breaking down.

Charts of the Day: Put Your Bull Markets in Perspective

Tomorrow night I'm headed up to London to have dinner with some fund managers and investment advisors. It's part of my participation in the investor's roundtable sponsored by the London financial magazine "Moneyweek" and its lovely and charming editor, Merryn Somerset Webb. I don't think gold bulls are too welcome right now. But we do make for good entertainment. Today, I got this shot across the bow, "The writings of ultrabears with their persistent prognostications of Armageddon remind me of nothing as much as the old prophets of Marxism who were continually prophesizing that capitalism would would implode under the weight of its own contradictions....Such apocalpytic commentators see bubbles everywhwere and are extremely bearish on everything...The only acceptable investments seem to be (usually) commodities and (invariably) gold." The followed a chart, similar to the one directly below, with the headline, "Spot the Bubble." My version compares Newmont, a proxy for unhedged gold majors, to the Nasdaq. Nasdaq vs. Newmont, weekly close, Jan. 03 to the present Not so fast, my friend. Let's put our bull (and bear markets) in perspective. Gold is coming off a 20-year bear. It's performance in the last year is the initial stage of what I think is a multi-year bull. Like all stocks, gold stocks can get ahead of earnings. But gold companies are in the business of mining a commodity (and monetary asset) that's increasingly demand. Business is good. On the other hand, the Nasdaq is the George Foreman of indexes. It's taken some big blows. And though it looks sturdier now than a year ago, it's really just one year older, one year fatter, and one year more bloated. As you can see from the chart below...this is a tale of two bull markets. One that's dead and bouncing...and one that's alive and growing. Nasdaq vs. Newmont, 1987 to present

Gold ETF on the Way...Finally

This is good news. "SAN FRANCISCO--(BUSINESS WIRE)--Feb. 9, 2004--Barclays Global Investors, N.A. (BGI) has filed a Form S-1 Registration Statement for the iShares COMEX Gold Trust with the U.S. Securities and Exchange Commission. The Trust is intended to provide investors with a simple and cost-effective means of making an investment similar to an investment in gold. The objective of the Trust is for its shares to reflect, at any given time, the price of the gold owned by the Trust at that time less the Trust's expenses and liabilities. Once available to investors, shares of the Trust can be purchased and sold throughout the U.S. market trading day. The Net Asset Value (NAV) of the Trust's shares will be determined daily by the Trustee on the basis of the settlement price for spot-month gold futures contracts announced by COMEX. "

The Difference Between Winning and Losing

Looks like the OODA loop (or Boyd cycle) is hitting a critical mass...sort of like Malcolm Gladwell's Tipping Point a few years ago. Or maybe the Boyd cycle has reached a tipping point as a useful metaphor for a good decision making process. I noticed a link to page on OODA loops at from Instapundit today. You can find the link, with a good graphic of the loop itself, here. If Glen Reynolds (Instapundit) links to it, you can be sure it's going to start showing up in a lot of places. In the alternative media/libertarian freelance newsgatherer/subjective opinion maker space....the Instapundit is the King (Drudge is the jester). The quote is taken from Grant Hammond's "The Mind of War," which I have on my recommended reading list at the Insider home page, and which I'm reading now. Despite the title, the book isn't about war so much as it is about John Boyd's contribution to the science of knowing, or epistemology. Boyd simply added the element of time and said that in a competitive environment, from the battlespace to the marketplace, the ability to process new information faster, find what's important, and make a good decision is a key competitive advantage. It is the difference between winning and losing. As Hammond says, "Knowledge of the strategic environment is the first priority. "

Cracks of Doom

The Insider is a work in progress. And so I've found myself shifting to a longer market review each day...so we can focus on the first things first, money, and then incorporate the other things as they come in. So I'll try each day to review the big themes (through the prism of my five indicators), and then ad other insights as they seem pertinent. Let me know if this style suits you, or if it doesn't. Yesterday I mentioned that I keep an eye on five indicators to tell me where the market’s at and where investors are at. The five were: the Volatility Index (VIX), the S&P 100 (OEX), the Commitment of Traders Report, the put/call ratio, and my own private BEDspread. Some noteworthy developments in a few of those areas yesterday. First, the Chicago Board Options Exchange said volume rose 54% on a year over year basis. The exchange reported volume of 34 million contracts in January versus 22.1 million from the same time last year. Investors are clearly in a gambling mood. It was the second highest level of monthly options activity in the CBOE’s history. And guess what month tops the charts? In March 2000, 35 million contracts traded hands on CBOE. And we all remember what happened THAT month don’t we? By the way, there’s no strict historical correlation between volume on the CBOE and a top in the market, although I haven’t gone back and done the historical research. There very well might be. What I think you can see here is much more intuitive, and sensible at the same time: investors are swapping a lot of options contracts, using a lot of leverage to either chase a big gain or insure against a big loss. It doesn’t take a regression analysis to connect options volume with major turning points in the market. ***Put/Call Ratio, VIX What were all those options buyer buying? Well, Monday’s put/call ratio was up to 0.71 from Friday’s 0.63. For index option buyers, the ratio fell from 1.72 on Friday to 1.75 buyer. Still more put buyers, but with call buyers on the prowl. For individual equities, the put/call ratio went up from .46 on Friday to .59 on Monday. The VIX is still cruising along under 16. And generally, the VIX does not make gentle moves. Panic is not a gentle thing. It happens all at once. This is good news if you’re going to try and trade the VIX, which I mentioned you’d be able to do last week. Yesterday, CBOE announced that the CFTC has approved a listing for the VIX on the new CBOE futures exchange. You’ll be able to trade options on the futures. It’s a little less straight-forward than buying options on an index. In principle, though, you’ll be able to trade the VIX. How would you use it? Well, the VIX is a barometer of investors sentiment. And right now, even though investors are nervous, the VIX is pretty placid. As investors get less placid, the VIX will go up. Be a call buyer. I did get an interesting question regarding the VIX which I’ve published below (more questions coming later this week). Q: Mr. Denning, regarding your blogs about the VIX and the soon to be listed futures options, wouldn't additional trading activity either dilute or otherwise render the VIX as a gauge of market complacency inaccurate? Since it may become yet another security to be traded not unlike stocks and options themselves? Answer: I don’t think so. Derivatives, which is what options are, are priced based on the market value of the underlying asset. The VIX as an index is still going to be computed the same way. That is, the VIX will still measure the volatility of options pricing. Options prices become more volatile when investors are uncertain and much less volatile when investors are unthinking. And because the VIX measures volatility in options pricing on the S&P 500, options trading on the VIX itself won’t be part of what the VIX is measuring. There will be no tail wagging the dog. What will be worth watching is how the VIX functions as a futures product. Options, of course, look ahead into the future as well, and you use them to make a bet on future price direction. But futures, thus far, are generally used to hedge against the future price directions of commodities, interest rates, and currencies…not financial indexes. Traders try and figure out what something will be worth six months from now…and then see if the futures contract on that item is selling at a premium or discount to what they expect the price to be. It’s a bit of a crapshoot, of course. But the idea is that price trends for some things are fairly predictable…except when they aren’t. And that’s where you make a killing as futures trader, when you benefit from the market horribly miss pricing something based on either a wrong expectation or an external event. Some readers may remember profiting of eurodollar calls two summers ago. That was an example of the market thinking one thing, that rates are going up, and pricing futures based on that expectation. The market bought puts on eurodollar futures. We bought calls, thinking rates were going down even more and prices were going up. There was a big gap in the pricing…it was something the market couldn’t know. That’s where we made the money. We’ll have to wait to see how traders use the VIX. But for now, I don’t think any trading on the VIX will distort its usefulness as an indicator of volatility. ***Commitment of Traders, the BEDSpread, and OEX OEX didn’t make any major moves yesterday, nor did any of its major components. The market waits on Greenspan to give a clearer picture of what he means by “patient,” and probably what he thinks about the dollar and the labor market. None of what Greenspan has to say this week in front of Congress will change investment reality. But it may change investment psychology. For now, it’s worth noting that January volume for options on the OEX 1,27 million. That was up 21% from the same period last year. It indicates the growing popularity of option buying on the indexes…and the growing recognition that the OEX is a good proxy for the “financial economy.” On the gold front, the CFTC released the commitment of traders figures for two weeks ago. What was striking is the near symmetry between the decrease in the net long position of large term speculators and the decrease in the net short position of the commercial hedgers. Large speculators are still net long gold. But they reduced their longs by 22,000 contracts. Commercial hedgers are net short. But they reduced their shorts by…22,000. Coincidence? Perhaps. The commercials are shorter short than the speculators are longer long. Large specs are 95K contracts long while the commercials are 176K short. Yet gold stocks seemed to shrug all this off and advance along with price of spot gold. As I write today, April gold is coming of an intra-day high of $411. Newmont (NEM) is back near $45, where I said it had long-term technical support. And the rest of our stable of gold stocks is in good health. The “Remorse Price” is still $400 folks. Gold has been kicked at, spit on, and derided. But it’s hanging above $400. You’ll regret not buying it on the dips. And with European central banker Ottmar Issing essentially telling currency markets the ECB will not intervene against the weak dollar (the way the Bank of Japan is), watch for an even uglier down move in the dollar this week…and more good news for gold. As for the incredible shrinking greenback…it’s falling as I write. But so far, Asian central banks, Japan’s mostly, are keeping bond prices stable with a steady appetite for U.S. bonds. Japan has over $525 billion of U.S. government securities through November, up 44% from the same time last year. The Chinese own $143 billion worth, and that’s up 27% from same time last year. And by the way, the U.K. has quietly added 35% more to its U.S. bond holdings since last November, from $82.3 billion to $111.7. How long will these CBs support the dollar by buying bonds? We shall see…

Take a Look at THESE Earnings

You just saw a spate of healthy fourth quarter corporate earnings. And I hate to crash the party. But here's a question you should demand a good answer to if someone tells you to buy stocks at these valuations. Question: How can stock prices rise when consumer earnings are falling? Everyone talks about corporate earnings. But the fact is, household earnings are part of what drives demand for stocks. If folks don't have money, they can't buy stocks. And not just money...but money about and beyond what they need to pay rent (or the mortgage), and other expenses. Of course, as the previous post shows, a lot of discretionary spending (cars, consumer goods, food, alcohol) can be financed on credit. And so can stocks too, come to think of it. Yet it gets harder and riskier to run up tabs and spend money when hourly earnings growth is slowing down. And it becomes harder to figure out how corporations will continue to improve earnings and profits when at the household level, consumers are watching their wage growth hit the skids. What kind of skid are we talking about? The Labor Department's non-farm payroll report last week revealed that: * Growth in average hourly earnings has slid five consecutive months. * December's growth of 2% is down 31% from the growth rate in August. * Seven industries posted outright earnings deflation in December: retail trade, durable goods, manufacturing, natural resources, transportation, utilities, and "other services." Am I making a mountain out of a statistical molehill here? After all, growth is growth right, even at slower rates? Wrong. That is, growth in DEBT is faster than growth in INCOME. As my friend Greg Weldon surmised, "Since August, average hourly earnings have CONTRACTED by 31% while consumer debt has EXPANDED by 35%." It doesn't take much marginal difference in disposable income to change the spending habits of consumers. Even if you're comfortable running a household deficit (via credit), you're only likely to do so as long as your income continues to grow. If your income is growing...your debt load as a percentage can grow too...without appearing to change much. But if this dynamic holds--debt loads growing faster than incomes, and incomes disinflating or actually shrinking--you could quickly see some radical changes to consumer behavior...which has obvious consequences for the stock market. More on this as the week progresses...

$2 Trillion in Consumer Credit: Chart of the Day

The Fed didn't release in any charts, so I made a crude one on my own. But Friday's consumer credit data released by the Fed are a historical milestone--and a very bad sign. First, the milestone(s) (hat tip to Greg Weldon): * consumer credit was up $33 billion in December, three times the November increase of $9.3 billion * for the entire fourth quarter, consumer credit grew $54 billion, up 35% from the $30 billion expansion in Q3 * in the fourth quarter total consumer credit topped $2 trillion for the first time in the history of the Republic You might have expected that after the stimulus of tax rebates wore off, consumers would hit the plastic again. But this also comes against the backdrop of disinflating incomes. People are making less and borrowing more. Not a healthy scenario for a recovery...particularly when the jobs aren't coming.

A Daily Bloggering

Just a quick note to introduce you to another blogger on the Insider, Addison Wiggin from the Daily Reckoning (www.dailyreckoning.com). I've been hounding him for a few months to publish some of the nuggets that don't make their way into the Daily Reckoning. He's put himself at the center of the electronic financial publishing world in the last three years...so I think his stuff will be good. And if it's not, he sits in the other room, so I'll just go smack him in the head.

Right On, Mr. Duncan

"The amount of new yen that Japan 'printed' and converted into dollars during January 2004 alone was enough to finance 13 per cent of the US budget deficit," points out our friend Richard Duncan, author of Dollar Crises: Causes, Consequences, Cures. Duncan's point? While all eyes in the financial media are focused on profligate spending by the Bush administration and historic low rates set by the US Fed, Japan is still taking the cake when it comes to government intervention in the markets. "By accident or by design," Duncan notes in an op ed in the Financial Times, "Japan is carrying out the most audacious endeavour to conjure wealth out of nothing since John Law sold shares in the Mississippi Company in 1720." Duncan: In mid-2003, economists at the US Federal Reserve published a paper explaining why the Fed was not "out of bullets" despite having cut short-term interest rates to 1 per cent. That paper stated that 'the Fed could even implement what is essentially the classic textbook policy of dropping freshly printed money from a helicopter,' if necessary, to stimulate the economy. Today, that helicopter is in the air. But, strangely, it is not the Stars and Stripes that is painted on its side, but rather the Rising Sun. That much is clear. What still is not quite discernible, however, is who is actually in the pilot's seat. Better yet, can it be piloted at all?

Five Signs of Financial Reckoning Day

Note: I'd planned on posting some additional comments on gold hedging, but I've held off in order to make them more complete. Instead, I've posted here what went out to weekly e-mail readers. Redandant, I know. But in case you're getting your updates here and not at www.strategicinvestment.com, wanted to make sure you didn't miss this. Last week was a heavy economic research week. And if you’re a new reader, you may be wondering, “well what about the stock market?” Recent market action confirms what you already know--the financial economy is running out of steam and the stimulus of low-interest rates and tax cuts has lost its potency on the economy--without leading to major new job creation. But what, specifically, do I look at to make these conclusions? There are five major indicators I use. I’ve jokingly called them “five signs of the financial apocalypse.” But only half jokingly. What they DO represent is how close we are to a sudden massive shift away from “financial assets” and into hard assets, or out of the dollar and into gold. When will the femur snap? First I look at the Volatility Index (VIX). The VIX is a gauge of investor sentiment, mostly fear. The lower it is, the more complacent investors are. And right now, it’s about as low as it’s ever been. It did creep up a little early last week. But on Friday, the VIX opened at 17.7 and closed at 16. Fear in retreat. Greed on the march. Stocks on the rise. Below is a ten-day, intraday chart of the VIX and the Philly Gold Bugs Index (HUI). Rising anxiety from investors caused them to even unload gold stocks. But it looks like gold is back in favor--especially with the G7 taking such a spineless stance on the dollar. Second I look at investor appetite for speculation. If investors are feeling lucky and bullish, it tends to show up in the put/call ratio available daily from the Chicago Board Options Exchange. Bullish investors buy calls. Bearish ones buy puts. Of course, a bullish investor may buy puts to hedge his bets. But generally, the put call ratio is a good measure of speculative sentiment. On Friday, the put call ratio fell to 0.63. If you look closely at the numbers, though, you’ll see that the put call ratio for indexes was 1.72, while the put call ratio for individual equities was 0.46. I prefer to look at the put/call ratio for individual equities to get a read on what speculators are feeling. The indexes are traded by institutions and firms looking to hedge big bets. And while companies may speculate in their own individual options, the equity put call ratio tells you more about how strongly bullish or bearish individual investors are. I also prefer this to general surveys about bullish or bearishness because it’s what people are doing with their money, not what they’re saying. It’s one thing to say you’re bullish. Quite another to put your money on the line behind it. The first two indicators I look at tell you about sentiment and strength of sentiment. The next three tell me more about the overall direction of market and the perception of systemic risk. What you’re looking for is an indicator that tells you how close the financial system is to a major shift away from financial speculation and toward hard assets. You’re looking for clues that money is moving out of one asset class or sector and into another. If you don’t believe that we’re in an historic secular bear market, these indicators won’t mean much to you. But if you do, they’ll give you some idea of the level of stress in the system…and whether the levee is going to break. Let me explain… ***OEX and the Financial Economy When I say financial economy, I mean the S&P 100, or OEX. The OEX is made up of the stocks driving this bear market rally. It’s the most powerful concentration of stocks that gain the most from low interest rates, and have the most to lose when interest rates rise. First, the OEX has a market cap of $5.7 trillion. That’s 55% of the S&P 500’s market cap of $10.2 trillion. To put that in perspective, it means that less than 100 companies make up over 50% of the S&P 500’s total capitalization. If you’re looking for a concentration of stock market wealth, this is where you’ll find it. Second, the two sectors that have most benefited from low interest rates (the lynchpin of the financial economy) make up nearly 40% of the OEX. There are 27 financial stocks and information technology stocks in the S&P 100. They have a combined market cap of $2.27 trillion. Financial Assets vs. Hard Assets: the Day of Reckoning Approaches The chart above shows the peroformance of OEX versus HUI since 1996, in log-scale, on a weekly close basis. The OEX is driven by financial and tech stocks. And the companies on the OEX represent the most actively traded stocks in America, in terms of dollar volume. Keep in mind OEX companies are listed on the three major exchanges, (NYSE, AMEX, and NASDAQ). This truly is a cluster of the most actively traded stocks in America--the ones critical to a new bull market, or an even worse bear market. On Friday, for example, twenty-one of the twenty-six most heavily traded stocks (in terms of dollar volume) were OEX stocks. And of those twenty-one, eight were financial and tech stocks. If you’re looking for a broad indicator of where the stock market is headed, you look to the OEX. It’s a pure proxy for the financial economy. Here's the one sentence summary of the chart here: the OEX began what I think is a new major downward leg in the bear market on January 26th. And if you look around, you’ll see it’s not alone. ***November’s Forecast Comes True In November, I laid out the case for a “wealth reflation rally” in financial and tech stocks. I was right about the rally but wrong about the time frame. At that time, I used the Wilshire 5,000 (TMWX) and said “If the index pulls off a full 50% retracement of the bear market loss -- it will rise another 11% from its current level.” I added that, “An 11% rise on the DJIA from the current level of 9,800 would put it about 10,878,” and that “And an 11% rise on the S&P 500 from the 1,046 level would bring us to 1,161.” The rally happened. It took longer than I thought, however. Here’s what we saw, using January 26 closes as “highs”: Dow predicted level: 10,878. Dow actual level 10,702. TMWX predicted level: 11,323. TMWX actual level: 11,281 S&P 500 predicted level: 1,161. S&P 500 actual level: 1155. And so the rally in the financial economy has come, taking all the broad indexes up almost exactly 11% from November levels…and leaving them all at or near a 50% retracement of the total point loss from the top of the market in 2000 to October 2001 lows. What next? Nothing notable happened on the 26th that would single it out as the day the second big down leg of the bear began. But stocks did reach some technical achievements that day. And two days later, Greenspan and the Fed issued their infamous “patient” statement. Maybe the market successfully forecasted the change in interest rate tone. Interest rate policy hasn’t changed, of course. But for a stock market so rigged to low interest rates, even changing the tone of the discussion may have been enough to convey the message that absent powerful new stimulus, stocks have gained back as much of their bear market loss as they can. Where will new stimulus come from? From the Fed? It can’t do more than it’s doing. From government spending? Bush and Congress are certainly blowing out all the stops on the budget. But is government spending on defense capital goods or simple income redistribution enough to justify a stock market that’s 10-15% higher from here. I don’t see it. ***Commitment of Traders and the BEDspread If the OEX tells us what the financial economy is doing, the commitment of traders report and the BEDspread tell us what’s going on behind the scenes. First, I use the COT report to judge the “smart money’s” interest in gold. If large speculators and commercial gold companies are bullish on the future price of gold in can mean one of two things, or both. First, being bullish on gold might mean a general bull market in commodities (which I happen to think is true right now). Second, gold bulls are also “financial” bears. The more bullish large speculators are on gold, the more dire the prospects for OEX and the financial economy. What’s intriguing, as long-time readers know, is the current grudge match between the large gold speculators and the commercials. The commercials continue to be massively short gold, while the speculators are massively long. My contention, unproven so far, is that gold companies are “short” gold in the futures market in order to keep the price of spot gold from exploding to the upside. They’re hoping for an “orderly ascent” by gold that won’t force them to deliver hedged gold at prices less that the market value. This doesn’t amount to a “conspiracy,” I think. Just a business problem. The hedgers hedged too much. And now it could cost them. So they’re massively short in the futures market. Not everyone agrees with me on this. I asked Jim Rogers in an e-mail what the thought and said simply, “ I don’t buy conspiracy theories about gold.” Neither do I. But there you have it. And the truth is, as long as the dollar keeps falling, the gold price will rise. I believe there’s a great deal of upward pressure building under gold right now…ready to pop. I’ll keep my eye on the COT report and let you know what it says. ***The BEDspread And finally, the BEDspread. The flip side of gold bullishness is dollar bearishness. And the ultimate measurement of dollar risk, for me anyway, is the spread between U.S. debt and emerging market debt, as measured by my proprietary BEDspread. In short, this tells me how close the market is to bailing on the dollar and forcing interest rates up. It’s the difference between the yield on GVT and EMD, two indexes that represent U.S government debt and emerging market debt, respectively. The BEDspread has been hovering around 4.5 for a month now. Emerging market debt yields went up on sell-offs in the last two weeks, driving the yield on GVT to 9.25%. Some would describe this as a flight to quality. I would not. With an annual deficit of $521 billion and a cumulative Federal deficit getting on $7 trillion, the U.S. government is hardly a “quality” borrower. But for now, the market is content to punish the dollar for the government’s spending sins while sparing the bond market. For now. When the yields start converging, with GVT's rising and EMD's falling, we’ll know a seriously blow has been dealt to the psychological health of the bond market. The dollar pain will begin to have bond consequences.

S&P 100: Chart of the Day

More comments on the S&P 100 in the forthcoming weekly e-mail. But in the meantime, here's the chart. It shows the S&P 100 in log scale, ten years back, monthly closes, with a 40-month moving average. Mega-long term moving average, you could say. If you use the 50% retracement rule for looking at this chart, the S&P 100 has recoverd half its bear market loss. But does it have the momentum to go higer from here? That is, from its bull market high of 832 on March 24, 2000 to its bear market low (thus far) of 392 on October 9, 2002, OEX fell a total of 440 points. Half of that total (50%) is 220. Add 220 to 392 and a 50% retracement of the total bear market loss would be...612. On Jan. 26, the OEX reached 573 before losing some steam. The last time it traded above 612...was in early August of 2001, when it closed at 618. Almost all the indexes made multi-year highs on the 26th...and a few days later the Fed crashed the party. The 26th may mark the beginning of the second leg down in this secular bear market.

Intolerance will not be tolerated

Canadian hockey commentator Don Cherry said some disparaging things about French Canadian hockey players. Actually, what he said, from what I can gather, is that the only players who wear visors on their helmets to protect their face are "European or French guys." That's not quite true, of course. I haven't watched a hockey game for awhile. But I know Joe Sakic for the Colorado Avalanche, who's neither French nor European, has worn a visor in the past. I'm sure there are others. But check out the reaction from officialdom in Canada below. My goodness. First...Minister of State for Multiculturalism? I'm pretty miffed that Bush is increasing the funding for the NEA...but at least we don't have a minister of State for Multiculturalism...yet. National Post: "Jean Augustine, Minister of State for Multiculturalism, said 'the government will not tolerate statements that create dissonance in our society and disrespect for others.'" What I want to know is when offending someone became a crime? What does it mean to say that expressing your opinion causes "dissonance in society?" And surely there are some times when it's not proper to show respect for others, right? Should we respect thieves, liars, murderers..or people who are just plain stupid? Can't we disagree anymore and say so? And if not...on what basis does the Ministry of Multiculturalism decide what kind of speech is permissible? It's all absurd, of course. Strangely, most alleged "crushing of dissent" doesn't come from John Ashcroft and the Justice Department...it comes from the Left...where even thinking the wrong thing appears to be socially intolerable these days... Absurd...absurd and scary. National Post: "Jean Augustine, Minister of State for Multiculturalism, said 'the government will not tolerate statements that create dissonance in our society and disrespect for others.'"