Archive for November, 2009

Two Outcomes for the Dollar Carry Trade

Right now the dollar carry trade is fueling the stock market as traders borrow the buck and buy riskier assets (anything else). So when will it all go bust? I’m not sure, i’m not Miss Cleo. But I do see two possible outcomes.

Outcome #1 : Dramatic Fed tightening pushes the buck higher as carry traders sell off their assets and buy back the dollar. In this scenario, markets would plummet viciously.

Outcome #2: The Fed raises rates slower than the rest of the world and the carry trade continues. Eventually, higher interest rates  make the carry trade less profitable and the Japanese Yen, which also has near 0% interest rates, becomes the carry trade of choice. In this scenario, the market keeps moving higher.

What the Feds do depends on inflation expectations. If everyone anticipates higher inflation, the Feds will jack up interest rates quickly. But if  inflation isn’t a concern (the view at the moment) then interest rates won’t move up so quickly.

The economy is running on pointless tax credits and stimulus spending, nothing else. And the U-6 unemployment rate will likely hit 25% by the time this thing bottoms out. So I doubt the Feds will raise rates before the second half of 2010. And if the Feds do raise rates earlier, it just means that inflation expectations had gotten severely out of whack.

That’s why the dollar carry trade will soldier on and keep fueling this market until next year. Sure, we might see a few minor 5% – 10% sell-offs over the next few months. Hell, the Dow may never pass 11,000.  But I doubt we’ll ever see 6,000 on the Dow Jones ever again.

MARKET TREND OUTLOOK

The trend is still up, but the major indexes are all overbought. So we’ll probably see a 3%-5% sell-off.

Use any major sell-offs as entry points unless we see a lower-high, lower-low pattern forming.

Richard Russell’s Now a BULL

After staying most of the day in the red yesteday, all three indexes advanced to close the day in slightly positive territory. The Dow Transports even rose past its October high.

Overnight, oil pushed higher on news that crude inventories dropped 4.37 million barrels last week. Gold fell a little off its highs of $1,144 an ounce and the dollar strengthened a little bit.

Even Richard Russell, the editor of the Dow Theory Letters, has become bullish on this market. To him and other followers of the theory, the fact that the Dow Transports broke above its October high while the Dow Jones is making new 52-week highs signals a bull market.

Other Dow Theorists of course believe that the market isn’t in a bull run. You see, one of the prerequisites for having a genuine bull run is that a rally must overcome a “significant” correction. And so, the drop from September 2008 until March of 2009 was simply too short to be considered “significant”.

What I can pull from this is that there is still a lot of debate as to whether this rally is real or not, even among the traders of one investing theory.

At this point, economic data will matter more than ever in persuading traders to buy or sell. A big report comes next week when we see a revision of 3rd quarter GDP. Most analysts expect it to drop, as the preliminary GDP figures didn’t account so well for the pain small businesses are in.

If we see a big drop, we’re likely to see the catalyst for a nicely sized correction.

But my money is still on the rally continuing into next year. In the end, the dollar carry trade is fueling this reliquidation. And it will take deliberate monetary policy to stop that.

Cash for Clunkers FAIL: Factory Production Drops in October

WASHINGTON (AP) — A decline in factory production in October signals that consumers and businesses remain cautious in their spending, with the economic recovery likely to be sluggish.

http://finance.yahoo.com/news/Factory-production-dips-apf-1631895568.html?x=0

What a shocker. Factory production dropped in October thanks to the car manufacturers.

Let’s face it, Cash for Clunkers could only pump up numbers for so long. But who knows, maybe Obama and team will find it “effective” to have another Cash for Clunkers program for every month of 2010. That way, they can keep production and retail sales to whee they want them.

Call me an old fashioned libertarian, but instead of the government subsidizing car and home prices (I didn’t mention the new home buyer tax credit extension, yet) is a waste of money. Instead, the government should let supply and demand take over.

Eventually, prices will be low enough that people will see the value in buying a car or home.

No debt needed.

My Newfound Love for the VIX

There’s always calm before the storm, right?

I didn’t learn that from a movie, I learned it in Florida. After dealing with so many hurricanes, you begin to appreciate the calm right before the hurricane’s effects are felt.

With that knowledge in mind, it’s pretty easy to tell when the markets are too calm. Typically, the VIX index hovers in the low 20’s. And if you are savvy enough to buy a call option at that point, then you’ll be rewarded when a sell-off pushes the VIX back up to around 30.

That’s what I did during the last sell-off, and made a pretty penny. It’s also what I’m doing now to take advantage of the next sell-off.

Oh, and if you really have balls of steel, you can buy a put option on the VIX once it’s around 30 and make some cash as it drops.

Now you see why i love the VIX so damn much. It’s almost as simple as credit spreads.

Yesterdays Shocking Retail Sales Report

The three major US indexes hit fresh 52-week highs on the back of comments Bernanke made yesterday to the Economic Club of New York.

Why the celebration? Shockingly enough, car sales pushed retail sales higher. And this time, there was no cash for clunkers to explain the pickup. We attribute this to pent up demand and better access to credit at the dealerships.

So traders bought. It appears the market was pricing in a slower fourth and first quarter.

Overnight, the dollar strengthened slightly and gold came off its record highs to rest at $1,126 an ounce. Silver and oil both dropped as well.

The weakness worked into today’s market as all three indexes struggled to reach the green.

From this point forward, economic data will matter more than ever. Today, we saw traders looking for an indication that the fourth and first quarter will do better than expected. And so any other economic data that shows this outcome (especially the leading economic indicator report) will likely push the market higher.

I’ve always been suspect about how far this rally could go on government support. And to be fair, we’re likely to keep seeing the economy do a little better than expected due to the massive stimulus Congress passed early last year (We’ll continue to feel the effects of that splurge well into late next year and 2011.).

But there are a few things which would end this rally.

1) The Fed tightening too fast, too soon
2) An end to the dollar carry trade
3) Higher taxes
4) Rising protectionism

If you haven’t bought yet, you probably shouldn’t start. Wait for the market to come back 3-5% and then go ‘balls in’ and buy some strong stocks (I prefer commodity stocks at the moment)