AU Firm, OEX Bullish Percentage Infirm, OEF Ripe

Reflation Rally Fading, But AU Firm Short Term Bearishness on the OEX Picking Up Pace The 50-day moving average in the OEX bullish percentage chart is threatening to cross the 100-day moving average. It's a bearish sign that could signal a sell off in the OEX and OEF, the exchange traded fund that tracks OEX. When Moving Averages Cross, Buy Puts on OEF Two of the three times the short-term moving average crosses under the longer-term moving average, OEF has sold off by an average of thirty percent.

Dollar/Euro 1.14....Chart of the Day

Old Man Dollar is preening like the prettiest currency in the pageant, pretending to be something he's not, namely a strong currency. But does this dollar rally have legs? The chart below suggests no...but if the dollar breaks out of that downward channel...look for it to settle again at about 1.14...the level from which it began its last large down move. A lot of traders have spent the last month covering their short dollar positions, fueling the rally. I don't think, personally, that the dollar was oversold. Considering the twin U.S. deficits (both nearly half a TRILLION dollars) and the sketchy employment dynamics in America, it's hard to see how the dollar is any sounder now than it was in September. But the traders are covering, giving the dollar a flush of spring health...and happily coinciding with a string of positive reports about the American economy (March employment, retail sales.)

Quote of the Day: Huh?

"We expect the demand for single-family homes to remain quite strong in coming months, despite the rise in long-term mortgage rates, as growth in employment and household income accelerates. Indeed, the economic and demographic foundations for housing are very solid, supporting both home sales and house prices. Theories of house price 'bubbles' are bound to be discredited in the process." National Association of Homebuilders chief economist David Seiders

Quote of the Day: Anonymously Obvious

From Bloomberg: "The prospect of increased borrowing costs and diminishing tax refunds heightens the importance of job growth to buttress consumer spending, economists said."

The Wages of Sinners

Thursday, April 15th, 2004 London, England Dear Reader, I'd meant to talk more about the Fed's current dilemma, but ended up doing more reading than writing. Hopefully the weekend edition of SI will give a succinct version of what I've found. I'll let you know. Meanwhile, you saw more evidence today of the horns of the dilemma that Fed finds itself on. On one horn, financial assets are deflating. This is a big drag on consumer confidence and spending. You could call it psychologically deflationary. On the other horn, while producer and consumer prices are rising (victory for Greenspan?), consumer incomes are not. Consumers can't spend what they don't have (especially when they ease back on credit.) And they can spend even less when they don't have a job. Today the Labor department reported that the number of Americans filing initial jobless claims increased by 30,000 last week. It was the largest increase in more than year. What will the Fed be looking for? Well tomorrow, you'll see March housing starts and building permit figures. This won't fully reflect the effect of rising rates on housing activity. For that, you'll probably have to wait another month. But a poor number may add fuel to the equity fire. And even a good number could be a sign that the binge building that accompanied historically low interest rates may be topping out. In either case, I'd look closely at buying puts on homebuilders. I know. I know. Nearly every time I've done this in Strategic Options Alert I've been stopped out of the position for a loss. But if homebuilding stocks react to rising rates and slower housing activity the way REITS have (see the chart of the day), there could be some homerun profits. On April 26th and 17th you'll see new and existing home sales for March. It's here you'll probably start to see interest-rate related declines. The Fed will also be keeping a keen eye on the average selling prices for new and existing homes. The data for February showed that existing home prices rose 4% on year over year basis. That was less than half the double-digit pace you saw in July of last year. It's conceivable that in some areas of the country, you'll even pronounced declines in the average selling price for an existing home. What about new homes? February new home sales were up 5.8% year over year. Median prices for new homes rose 9.9% in February, although that was down from the torrid 14.4% of November. The median price of new homes is important. It-and low interest rates-provide the chief incentive for buying a house at all. If new home prices start to decline, prospective buyers are less likely to believe the canard that they can "flip" the home in a few years and trade up for a larger house. I could be wrong, of course. The Fed may be completely insensitive to the unravelling of American balance sheets as the housing market falls apart. After all, it didn't lift a finger to stop the Nasdaq from falling apart. But 68% of Americans own homes. And a loss in the value of your home probably hits, if you'll pardon the pun, closer to home, than a loss in your stock portfolio. Indeed, a loss in the value of your home might be the precursor to the loss of ownership of your home. The Fed knows this. And I suspect by the time it meets on May 4th, it will have plenty to chew on in. Namely, inflationary pressures in consumer and producer prices on the one hand, and falling housing prices and consumer incomes on the other hand. The Fed's next meeting also happens to be just a few days before the April non-farm payroll report comes out. In that report, we'll find out if the March numbers were part of a larger trend (rising employment), or a lot more hollow and ephemeral than they first appeared. We'll also find out what's going on with average hourly and weekly earnings for most Americans. As I showed last month, wage growth in retail service jobs (where most of the jobs are being added) isn't keeping up with inflation. In fact, I went back through historical date for average weekly earnings today. I wanted to compare the increase in retail weekly earnings with goods producing weekly earnings. My thesis was pretty simple: retail wages would be rising faster than goods wages. But as the economy sheds manufacturing jobs and adds retail jobs, both rates of increase wouldn't increase much nominally, and might not even keep up with inflation. Here's what I found: From 1994 to 2004, average weekly earnings in goods producing jobs grew 28%, from $519/week in 1994 to $669/week. That's an average annual increase of 2.8% per year over ten years. During the same period, average weekly earnings in retail trade jobs grew 38%, from $265/week in 1994 to $367/week in 2004. Even though wages here grew at a full percentage point per year faster than goods producing jobs, the average weekly income in retail jobs is still 82% below the average weekly income in a goods producing job. And by the way, for all non-farm jobs combined, average weekly earnings grew from $390 in 1994 to $517 in 2004-a 32% increase over ten years, or 3.2% a year. The point of all this? Ten years does not a long-term trend make. But wage growth in America sucks. Ask about anyone you know. You'll get the same sentiment There are lots of roots to this thorny problem. It's not just China and India. It's higher productivity requiring fewer workers. For example, I was able to cobble together all the data for the above analysis in about two hours. Five years ago, it would have taken me two days, if not more, and required at least two people...to find the data, put in a spreadsheet, create a graph, give it to a graphic designer etc etc. Today, it's just me. And you suspect that as technology becomes more pervasive, it makes employees less valuable-most employees that is. Some end up being much MORE valuable. They're the ones who get the wage increases. And they're the ones Greenspan would like all Americans to become like. The problem is, there are a lot of displaced employees who will have to retrain to be productive in this manufacturing lite, service heavy economy, if they want to make a fat wage that is. I'm not a class agitator. But I get the distinct picture there will be fewer high-paying jobs in America in the future, although they'll pay very very well. On the other hand, there will be a lot of jobs that pay about $11.90 per hour and about $500 per week. That's a tough way to make a living. Tomorrow, a look at which sectors to focus your options energy on to make money off this stagnation in wage growth. And also, more progress on the question of the hour...what does the Fed do next? Until Then, Dan

Off a Cliff: Chart of the Day

Below is an image of what happens to interest rate sensitive stocks. It's a three-year chart for RWR, an exchange traded fund that tracks the performance of the Wilshire REIT index. Unfortunately, you can't buy put options on RWR, or on IYR, an ETF that tracks the Dow Jones Real Estate Index. Could this happen to other sectors as well? Homebuilders? Mortgage lenders? Financials? Yes. Traders with a keen eye should have a field day if rates keep rising like this. Rate Rise Sinks REITS

Why The Fed Can't Raise Rates, And Why it Will Lower Them Again Before the End of the Year

In today’s Insider: ***The Consumer is the Key ***Gold is Okay ***A Credit Crunch a Comin' Dear Reader, Investors convinced that the recent spate of good economic news will cause the Federal reserve to raise interest rates before the end of the year. They're dead wrong. But that's okay…it's a great opportunity for you to buy gold and precious metals at a discount, and make some short term profits in a few sectors. Here's the fact investor are missing: consumers can't afford rising interest rates. Need proof? Away we go…. First, rewind back to the consumer credit figures from February. Consumer credit was up $4.2 billion from January. But in January, consumer debt had rise by $15.8 billion from December's level. What's going on here? Easy. Interest rates have been creeping up, and are already hurting consumers at the margin, especially on their credit card debt. The February increase was the smallest increase in consumer debt in five months. Rising interest rates are causin consumers to cut back on their use of credit. Of course, that appears to be contradicted by the retail sales report right? Not so fast… True, March retail sales showed the biggest gain in a year—up 8.2% from the same time last year. But here are three striking details. First, department store sales actually fell from February to March by 0.8%. Second, sales of sporting goods, books, and music FELL 0.7% from February to March. And third, sales of building materials grew by 10.8%, the largest gain of any category. Notice a pattern here? This is the kind of behavior you'd expect from a consumer who expects interest rates to rise. He locks in housing related purchases before rates move up from historic lows. And he cuts back on purchases at the margin…the little things that start to make a difference once more of your income goes to servicing your debts. In other words, as rates rise, the consumer starts consuming less. Absent a huge increase in income, rising rates are deflationary to consumer spending. For example, take the most rate sensitive of purchases, your house. The Mortgage Bankers Association said today its refinancing index tumbled 30.7% last week. That was the biggest one week drop since late July, to 2,861.6 from the previous week's 4,126.7. The purchase index, which gauges new loan requests, fell by 9.5%. What's more, the group's weekly mortgage gauge fell for the fourth week in a row to its lowest level since the week of Jan. 9. Even if you excluded the effect of rising rates on borrowers with adjustable rate mortgages, the whole effect of rising interest rates is put a chill on consumer spending. When 70% of GDP comes from consumer spending, the Fed had better be darn sure the recover is on solid ground before it starts raising rates. But if you listen to the Fed, it's not sure at all. Far from it. In fact, I'd say it's downright skeptical. At a luncheon in St. Louis last week (this from my man on the case Greg Weldon) Fed inflation hawk William Poole said,“"We do not want to respond to inflation noise, which would add further instability to the economy. We cannot reliably conclude that today's material price inflation will be tomorrow's finished goods inflation." Poole also said, "It is going to take some string of months, but I cannot really put a time frame on it." Referring to inflationary PPI numbers, Boston Fed Research Director said last week, "We need a good many months like this." And Dallas Fed Research Director Harvey Rosenblum said, "There is room for further disappointment between this number, and the end of June." Does this sound like a central bank that's planning to raise rates to you? It doesn't to me. And even today's consumer price inflation numbers wouldn't bother me much. Consumer prices were up 0.5%. To the market, this suggests that inflation is finally showing up in finished goods. And indeed, that may be true. But the Fed's response to this CANNOT be to raise rates until the final piece of the inflation puzzle is in place: rising consumer incomes. Until that happens, rising prices will simply make consumers cut back on spending. Throw in rising interest rates and energy prices and you have two more factors which lead to slower consumer spending and economic growth. Bottom line: the economy can't grow until the consumer can spend more. And the consumer can't spend more when prices and interest rates are rising. If consumer incomes don't inflate, inflation in producer prices or consumer prices won't matter. Until consumer incomes rise, the Fed stands pat. And here's a prediction for you, the Fed will become so concerned with the market pricing in rising rates (and pushing mortgage rates up) that it will cut rates by 25 basis points at its May 4th or June 30th meeting. That's not to say that the Fed will be effective in stopping the sell-off in bonds and in interest rate sensitive stocks (REITS, for example). But it is to say the Fed still considers deflation its sworn enemy. And until consumers incomes pick up, rising rates are likely to lead to much lower consumer borrowing and spending…which, in the last fifty years, has been very bad for American GDP. It's pretty simple, consumer prices won't rise much if consumers don't have money to spend. ***Gold is Okay I'm going to keep the gold section short because I don't have much to ad and nothing has changed in the last three days to make me alter my bullishness. Yes, gold is getting whacked. But so is everything else. As I said in the weekly edition, the reflation trade is ending…in deflating asset prices. Gold stocks are stocks. And like everything else that's risen on a sea of liquidity, gold stocks are falling as interest rates rise and the credit crunch begins. However if you look at the five-year weekly charts for the XAU and HUI, you’ll see that both hedged and unhedged gold stocks are trading right at their 40-week moving averages. They have not broken down technically. It's possible, of course, that they'll break through those moving averages and trade below them. But I would simply consider that an opportunity to buy more of your favorite gold stocks at a cheaper price. If I'm right about the Fed being deathly afraid of deflation, you'll start to see the Fed become more active in getting money into consumer pockets. This includes expanding the money supply, as I noted yesterday. This is bullion bullish. True, the market may push the dollar up, and gold down as a consequence, while it sorts out the effect of rising rates. But there's a big difference between falling gold prices and falling bond and stock prices right now. Bond prices are falling because bonds have been in a 20-year bull market that's ending---especially as we head towards more inflation in raw materials. Stock prices are falling because the only thing supporting them was money that could be borrowed cheaply and funneled into the market for yield and instant return. Now that money is getting more expensive, stocks are losing the biggest source of their upward momentum. Gold, on the other hand, is rising because commodities have been in a 20-year bear market. It's rising because the central banks of the world find themselves in a monetary no-man's land where no solution is a good solution, and doing nothing is even worse. All gold has to do is sit around and watch the bankers fail one at a time. Don't be surprised if it falls more. As I said, gold stocks are still stocks. And as stocks sell off in financial asset disinflation, gold stocks won't be unaffected. But fundamentally, gold stocks are backed by a real asset. And for that reason, they're a buy. ***A Credit Crunch a Comin’ What's a credit crunch? A liquidity trap? It's when banks get wary of loaning and borrowers get wary of borrowing. It's what happens when money has been too cheap for too long. Why do both parties get wary? Both get burned by higher rates and rising delinquencies and non-performing loans. This is the beginning of the great deflation in financial assets I wrote about in April. It's a giant write-down in the value of assets that rose purely as a function of money cheaply borrowed. Debt deflation. In the long-term, this means stocks, bonds, and houses have the most downside. In the short-term, it will mean everything that reflated in the last twelve months suffers some set backs. As in investor in gold, be prepared. But don't be scared out of what is fundamentally as sound an investment s you can make. What we need to figure out next, and what I'll tackle tomorrow, is what the Fed does to create inflation when it's monetary gun is out of bullets. So far, it's managed to cause a housing bubble, a stock market bubble, and some "flash bubbles" in commodities. But its single greatest failure is also the one that will cause it to try even more desperate measures: it's failed to inflate consumer incomes. If it looked to Japan, it would see that once the consumer has set is mind against expanding his spending, there's not a lot a central bank can do to change it. That won’t keep the Fed from trying though. More on that tomorrow. Best Regards Until Then, Dan

Federal Deficit $72 Billion in March

Another banner month for red ink....total for the fiscal year now stands just shy of $300 billion.

Falluja is a Sell Signal--Even Though the U.S. Will Win

Dear Reader, First, my apologies for the irregular blogging schedule in the last two weeks. Sometimes you have to do a little less writing and a little more reading and thinking if you’re going to have anything worth saying. Today, I’ll get back on track. However, I do want to let you know that next week I’ll be travelling to Dallas for an Options Conference so there may be some small interruption there too. But for now, let’s move on. Before I do any market blogging (bad day for metals stocks, good day for put holders on metals stocks) I want to share with you a small piece of analysis I produced in response to a question by Bill Bonner and the editors of the London financial publication MoneyWeek. The questions was, “Is what’s going on in Iraq at all like the Tet offensive in 1968? And what was the effect of Tet on markets?” The unasked question was, what effect will Iraq have on markets as we head into spring? The short answer: Tet was a sell signal. Here’s the long answer. Tet began late on the night of January 30, 1968. It was the beginning of Tet Nguyen Dan, or the lunar new year’s day. It was a series of forty major attacks and dozens of other minor attacks all over the south by the North Vietnamese Army (NVA) and the Viet Cong (VC). Militarily, Tet was a disaster for the NVA. Military historian Victor Davis Hanson estimates the kill ratio for U.S. forces was over 50-1. The NVA were beaten back nearly everywhere they attacked. But even the fact that attacked everywhere caused political shockwaves in America. Nineteen sixty-eight was an election year. The offensive took place only two months before the New Hampshire primary. In South Vietnam it appeared to catch the Americans and the South Vietnamese by surprise. Tet had been a traditional truce day in the war. And in fact, the NVA made a point of saying in public it would observe a seven day cease-fire beginning on the 31st—a promise it fully intended on breaking. The NVA was looking for some kind of tactical surprise to compensate for its lack of firepower. It got the surprise it wanted. But the campaign—in military terms—failed anyway. Yet it’s strategic success was astounding. Why? The biggest problem was that the American public had been led to believe the war was going well and victory was in sight. And in that sense, the strategy behind the attacks was brilliant. It didn’t aim at American military might, but American public opinion—by far the weakest element of the American campaign. Americans didn’t trust their political leaders, even less so when they saw images of a country seemly on the verge of chaos and anarchy after they’d been told everything was fine. It was a well aimed psychological blow at the morale of the American people. The campaign by NVA general Vo Nguyen Giap was a textbook example of using shock and awe to undermine public support for the war through media images. What the NVA couldn’t accomplish militarily it did through other means—achieving the same goal in the end. The offensive was a tactical disaster. But strategically, it led directly to the U.S. pulling out of Vietnam. The power of the media to shape public opinion by choosing how to report a story was firmly established. We’re seeing the same thing today. But are Western media accounts of Iraq accurate? Maybe, maybe not, although today’s reporters find it a lot harder to misrepresent the truth than they did back in 1968. For example, during the Tet offensive, the NVA was helped tremendously by what may be one of the most infamous instances of lying in the history of journalism. Then-AP correspondent Peter Arnett gave America a phrase that made the logic of the war seem barbaric. Perhaps war is always barbaric and illogical, but Arnett simply made up a story up that changed the course of public opinion. You’ve probably hear the phrase, “It became necessary to destroy the village in order to save it.” Peter Arnett put that quote in a story and attributed it to an unnamed American officer. The quote ran in a February 7th story describing a battle at Ben Tre. It made it sound like the Americans had gone completely insane, flattening villagers to save them from themselves. Ben Tre WAS destroyed, but not by Americans. It was destroyed by the retreating Viet Cong. And it’s doubtful that any American officer ever said anything of the sort to Arnett. The closest you’ll find is an American officer who recalls telling Arnett, “It was a shame the village was destroyed.” The American war effort was also destroyed, at least psychologically. As Sun Tzu and Liddell Hart have both said, you defeat your enemy by collapsing his will to resist. The will of the American population to fight in Vietnam was effectively destroyed. Just a month after Arnett’s dispatch from Vietnam, Eugene McCarthy humiliated Johnson by polling at 42% of the vote in the Democratic primary compared to 49% (less than a majority) for the sitting President of the United States. Johnson couldn’t even carry a majority of his own party in a primary, and by April, he’d abandoned the race altogether. During the first six days of Tet, the S&P 500 showed little reaction, going from 92.90 on the 30th to 91.90 on the sixth. But in the first three trading days AFTER Arnett’s AP story was published, the S&P fell 3.2%. The psychological worm had turned. By the fifth of March it had fallen to 87.70. It wasn’t until Johnson officially left the race on March 31st the index appeared to take off. It was a sucker’s rally, though. Between March 31st and December second, the S&P tacked on a 16.7% gain to close at 108. However, by May of 1970, it would shed 36%. In fact, the S&P wouldn’t trade near 108 again until March of 1972. And by then, it was on its way to making a blow off-top at 120. Another sucker’s rally. What came next was the hideous bear market of 1973-1974. The S&P lost nearly 50% before settling in at 62. It wouldn’t close above 120 again until July of 1980—six years later. Tet was a sell signal, even though in military terms, it was a victory. It’s a testament to the psychological fragility of investor. But then again, maybe people felt bearish already…bearish on Johnson, bearish on Vietnam…and when they came to their senses…bearish on stocks. Maybe Tet was just the emotional reason investors used to sell. In that respect, today’s situation in Iraq bears looking at. The market is overbought. The economy gives conflicting signs of its fundamental health. America finds itself in the midst of another contentious election and another contentious war. Is Falluja a sell signal? The military reality and investor perception may be entirely at odds. That is, the U.S. may come out of this situation better of militarily. But investors may still use it as an excuse to sell, no matter what ends up happening in Iraq. Militarily, it’s impossible for me to say what’s really going on on the ground. But my suspicion is that the so-called uprising in Iraq is probably going to be even less successful than the NVA’s calculated military gamble. Why? There’s no Ho Chi Minh trail in Iraq. True, there are Syrian and Iranian element of support for Shiites in Iraq. But these Iraqis aren’t well supplied to win a long fight with the U.S. Second, there’s no global superpower behind the events in Iraq—making it much harder for whoever’s fighting the U.S.—Sunnis OR Shias—to outlast the Marines and the Army. Third, even a hostile media is going to have a much harder time distorting what’s actually going on in the country. You don’t have to hop on a plane and see for yourself of even be an expert to realize that many Iraqis have no respect for the people fighting the Americans. This doesn’t mean Iraqis LIKE Americans necessarily, or the occupation. But it does mean, if you take Iraqi bloggers at their word, there is a lot less support for a “civil war” than you’d guess from reading Western newspapers. The real target in this uprising is the U.S. voter. Show him images of dead Americans being mutilated and you can drive the Americans out of the country, or at least Bush out of office. That is the strategic goal in Iraq. Undermine the morale of America. It could work. But even if it doesn’t, it’s a sell signal for investors. Pre-Falluja highs on the S&P (for this rally) are at about 1,155. The most recent attempt to break through that was on April 5, when the S&P closed at 1,150. But even there, the S&P is still 20 points below its initial bear-market rally of 1,170—a level it last reached in March of 2002. Your best investment decision? Sell stocks because they're pricey and America’s coming off an enormous credit binge. You don’t need any other reasons. And if other investor’s want to wait until some other event triggers their selling instinct, that’s their affair. No use panicking later when you can sell now and avoid the rush.