Macro View Points

Blame it on China

The stock market dropped a little bit yesterday thanks to Alcoa bombing its earnings report and dropping 11%.  It seems investors are starting to worry a little bit more about how the economy is doing.

A bigger problem for today is what’s happening in China. China decided to raise reserve deposits for the banks. This spooked investors who think that China… the country that is leading the global recovery… will kill the global recovery. Overnight, Japan’s Nikkei 225 stock average was down 1.3 percent, and Hong Kong’s Hang Seng slid 2.3 percent.  The Shanghai benchmark tumbled 3.1 percent.

Then came news that Google will stop censoring results in China and might even abandon its China offices in response to a highly complex hacking attack on its servers. Apparently some hackers out of Taiwan hacked into a few Gmail accounts of suspected human rights leaders. While Google didn’t outright say that these attacks came from the Chinese government, it sure as hell implied it.

As you can imagine, Google stock is down. It’s not that Google makes that much money off of China. It’s just the prospect of losing the biggest customer base ever that’s hurting its share price.

The selloff will probably continue early in the morning but things could change around 2:00 PM. That’s when the Fed Beige Book of economic activity hits. This is what the Fed uses during its interest rate deliberations. If this report shows a strengthening economy, the market could move higher.

I think the power of the Federal Reserve printing press combined with holiday shopping and an inventory rebuild will ensure that numbers come in at the top of their ranges or better than expected.

Will this be enough to push the market to new highs? It’s hard to tell. The market is starting to turn more bearish according to an Investors Intelligence report on January 4^th. But, it still remains at historic lows.

The market has also struggled to climb to new highs, even while volume is climbing. Seems that buyers are getting a little more exhausted and even overwhelmed by sellers.

Fundamentally, consumer credit is contracting at an alarming rate. The number of workers who have given up looking for a job is at all time highs. And there is no evidence that consumer demand can sustain the economy after the inventory rebuild and stimulus run its course by the second half of 2010.

Since the stock market is forward looking,  the stock market should start a downtrend sometime in the next few months.

Stuff to Read…

Google to end China censorship after e-mail breach

Weaker Alcoa results, China news drag stocks lower

NY Fed to be subpoenaed on AIG pass thru payments

What a Sector Rotation Chart Says About the US Economy

What sectors rise when the economy begins to emerge from an economic downturn? The answer may surprise you.

Source - http://www.onlineinvestingai.com

The chart to the left is of the economic investment cycle. The blue shaded area represents  the stock market and the yellow the economy.

The first thing you’ll notice is that the stock market  typically bottoms and peaks 6 months to a year before the economy does. This chart also shows that bull markets are formed on the back of a healthy financial and transportation sector.

You’ve probably noticed that the financial sector began to recover thanks to the billions of dollars in backdoor handouts that the Fed has given it. The transportation sector seems to have found a bottom as well as imports and exports rise.

But the problem is that banks still aren’t lending. Consumer credit has dropped for 11 straight months. That’s a record. And with contracting credit comes contracting purchasing power.  Prices inevitably go down (I love cheap milk!).That’s deflation.

Another nagging question is exactly how the banks will do once interest rates rise and the Fed shuts down the printing press. If banks aren’t lending now, I doubt they’ll lend in a tight-money environment.

My prediction: Second half of the year, when the stimulus and quantitative easing wear off, we’ll run into some “rough patches”.

As an investor, you have to realize that the market will start to price in weakness as soon as the data starts coming in weaker. The big clue for you will be if the market sells off because economic data has come in under expectations. If you see that “under expectations” phrase one too many times, you’ll know the repricing is coming.

The Dollar is Falling!

The dollar is falling… the dollar is falling!

That’s what I noticed today as the dollar index fell 0.59% (that’s big in the currency world).

It’s a big deal because a falling dollar has usually led to gains in equities. But this time the market ended the day mixed. The Dow Jones was up 0.43% and the S&P climbed 0.23%. The Nasdaq stuck out like a sore thumb, falling 0.21%. It seems that the old dollar/stock market pattern isn’t holding up as well as it used to.

This indicates to me that the dollar carry trade is losing some of its luster. In the end, these ultra-low interest rates probably won’t last forever.  I expect the dollar carry trade to be replaced with the Yen carry trade (since Japan apparently doesn’t believe in higher interest rates). The new Bank of Japan governor has also shown a preference for a weaker currency. So moving forward, we should see a big correlation between the Yen and the US stock market.

As you can expect from a falling buck, gold was on the up and up, gaining $14 to close at $1,151 an ounce.

Honestly, though, I wouldn’t read too much into a falling dollar. The market has been data driven as of late. Investors are all looking for signs that the recession is truly over. And as long as this week’s reports show an improving economy, the market could head higher, taking the US dollar along for the ride.

The report I’m most interested in is the December Consumer Price Index report this Friday. This report measures inflation at the consumer level. If this report shows a big bump in consumer prices, the market could easily sell-off. That’s because higher inflation means the Fed is more likely to boost interest rates.

And higher interest rates signal an end to cheap money.

Will the CPI come in very high? I doubt it. Gas prices were close to flat in December. And at the same time, retailers were discounting everything. So I wouldn’t be shocked if CPI came in at or under consensus (0.0%-0.1% gain).

At this point I’m cautiously bullish, especially on the commodity complex.

My Love for Android Knows No Bounds

This has been one of the laziest market weeks I’ve ever gone through. As a result, I’ve had more coffee this week than I’ve had in a long time.

I tell you, the girls over at Dutch Brothers (a drive-thru coffee joint here in Oregon, which hires shockingly good looking people) not only know my name by this point, but they’ve also figured out exactly what I love to drink, and what car I drive.

They have my coffee ready for me by the time I drive up to them! It’s fantastic. But it goes to show you how much time I’ve spent getting coffee this week in order to cope with this flat market.

After all the excitement of Monday’s rally, the rest of the week was flat, flat, flat.

Dow Jones Industrial Average

Just look at that. The Dow Jones stayed in a 33 point range for most of the week.

A big reason why the market was so flat is that investors were posturing for today’s Bureau of Labor Statistics employment report. At the start of the week people were throwing around all sorts of optimistic jobs numbers. I even saw Zero Hedge –- the most bearish blog I’ve ever read in my life — point out analysis calling for a jobs number surpassing 300,000 due to seasonal fudge factors.

From ZH…

An analysis out of Stifel Nicolaus points out that due to various seasonal adjustments, an NFP print of up to +100,000 could be expected (which incidentally does not reflect anything favorable at all about the actual employment picture as it is due exclusively to seasonal fudge factors). In fact, Stifel argues, a print of +316,000 is theoretically possible

Alas, the positive number never came. Instead the employment report showed an 86,000 job drop.

A couple things you should be aware of regarding the employment report…

• Bernanke said himself that it would take 100,000 new jobs a month for the unemployment rate to start dropping.
• When trying to look for a bottom, it’s best to look at how many hours the average work week is. Right now it’s at 33.2. Once employers start feeling better about the economy, we’ll see this number increase. That’s because an employer would rather give an existing employee more hours rather than hiring a new employee.
• There are 2.5 million people that have no job and want one… yet are still not counted in the unemployment report.
• In February the BLS will make revisions to the 2009 unemployment numbers. Analysts are expecting a HUGE decline as the BLS accounts for fewer jobs created at small businesses. Calculated Risk, who is very good when it comes to predicting economic numbers, has calculated that revision to lead to 824,000 more jobs lost. This would most certainly shock the market and lead to a higher unemployment rate.

So while the jobs report has certainly been improving, we’re not out of the woods yet.

As for the market…

The three major US indexes are at or near 52-week highs and overbought. Investor sentiment is at extremely bullish readings. And the VIX is at a 52-week low.

Even the commodity companies I love so much are sitting at 52-week highs. So what does that leave for us, the guys who profit off of short-term market swings?

One rout we could take is getting into some bearish credit spreads. In other words we sell call options in hopes that they are never profitable for the buyer. But honestly I just don’t feel comfortable going against the dominant uptrend right now.  Nearly ten years of playing the stock market has shown that type of play to be a painful one.

What it comes down to is good old fashioned stock picking.

One stock I’ve recently loved up is Google, mainly because of the Android operating system for mobile phones. It’s really started picking up market share after Motorola’s recent release of the Droid for Verizon.

Admittedly I think the Droid is a hideous excuse for a phone. But everyone seems to be eating it up. Most of that love is because it runs on Google’s OS.

In just the last year the Android operating system has picked up 12.4% market share in the smartphone sector, mainly at the expense of the iPhone and the Blackberry.

And with a slew of new Android devices hitting in the first quarter of 2010, I fully expect that market share to hit 20% or more by the end of the year.

This is great news for Google, and so I expect GOOG to be a low risk way of riding the Android OS higher. Another way to take part is to get into Motorola itself. The company has picked up pace ever since the release of the Droid. Analysts expect 1.4 million Android devices sold for Motorola in the 4^th quarter alone. In all, Motorola sold 12.5 million handsets for the year. For a company everyone expected to vanish by 2010, that’s remarkable.

Motorola isn’t sitting on its ass either. It’s gone ahead and released another phone, the backflip, for AT&T. It also plans on introducing more new Android based models this year.

At this point Motorola has good exposure to AT&T, T-Mobile, and Verizon Wireless. That’s good in my books. All it needs to do now is charge for the European market and sales should beat expectations.

Just be aware that positions in these companies should be held over the mid to longer-term (about 6 – 12 months).

Take care,

Charles Delvalle

Will the Money Printing Ever End?

Will the Fed keep printing money?

That was the question on everyone’s mind yesterday, as the markets stayed relatively flat all day.

Investors weren’t sure what to make of the Fed Minutes that were released. In those minutes, the Fed openly debated extending the money printing program. It’s interesting that the debate is even around at this point in our so-called recovery.

After all, the Fed has already stopped buying back Treasuries. And it makes a point to tell investors that many of its emergency programs would wind down early this year. Up to this point, it seemed that the Fed was worried about not tightening soon enough.

But the minutes released today showed that this worry wasn’t the consensus. Some of the Fed governors are worried about tightening too soon.

I say rightfully so. Up to this point the “recovery” we’ve seen was led by stimulus and an inventory rebuild. For this recovery to be genuine, consumers need to start spending.

But with consumers drowning in debt, I don’t see consumer spending picking up.

So the economy will drag during the second half of the year. And if the Fed starts tightening right now, it risks pushing the economy into a double-dip recession.

Of course, the temptation to tighten will always be there.

For instance, the Bureau of Labor Statistics’ December Employment Report is expected to show a gain when it gets released on Friday. The Fed might read too much into it… maybe even forget that it was the stimulus and inventory rebuild that helped create these temporary jobs… and decide to quickly tighten rates in order to avoid an inflationary onslaught of epic proportions.

Of course, we in a deflationary time. Debt deflation is still running rampant. Credit is tight. And banks are still going bankrupt everyday.

This isn’t an inflationary environment.

Too bad everyday investors don’t ever think of that stuff. If employment surprises to the upside on Friday, this market could easily make new highs. Dow could hit 11,000 +.

Take your risk money and buy some calls.

Take care,

Charlie

Stuff to Read…

http://www.bloomberg.com/apps/news?pid=20601087&sid=atPFbpy.GylQ&pos=5

http://www.zerohedge.com/article/316000-nfp-print-friday-bls-seasonal-fudge-factors-make-it-very-likely

http://www.reuters.com/article/idUSTRE6060VR20100107

2010 Prediction

The market didn’t move one way or the other yesterday. The Dow Jones – the lagging index – ended the day slightly down. The S&P 500 and Nasdaq closed  slightly in the green.

The reason why the indexes didn’t move much had to do with economic news. The Commerce Department reported factory orders for November that were twice as good as what had been expected. This good news was offset by data that the National Association of Realtor’s Index of Pending Home Sales dropped 16%. That was the first drop in nine months.

Plus, dollar started trending higher again, moving up almost 1%. Not only did this put pressure on the stock market, but it also helped push down the price of spot gold by 3.35%.

When you look at the technicals, the market is pretty overbought. Don’t get me wrong, if the technicals were overbought and everyone hated the market, I’d probably take it as a sign of higher prices. But right now everybody is bullish.

The American Association of Individual Investors Bullish Ratio hit its highest level since February of 2007. The market topped out later that year.

Another sentiment indicator, the Investors Intelligence Advisors’ Survey (they all sound the same), showed the lowest percentage of bears since March of 1987. We all know what happened a few months later…

So, while investors can stay bullish for a long time, the contrarian in me says that we’ll see a drop in the next 3-6 months. But that’s not the only reason why i think we’ll see a drop in the second half of the year.

During a typical recovery, the inventory rebuild leads to more jobs, which leads to more domestic consumption, which finally starts a growth cycle. But right now, consumers are up to their ears in debt. Most have been laid off. And a good number have seen their hours cut. People out there are picking and choosing what bill to pay. And the credit card ends up being the last one.

Consumer demand can’t take off in that type of environment. Cash is tight. And the next dollar is used to pay the next bill.

To make matters worse, the Fed may end up tightening in response to this inventory rebuild and the effects of the stimulus. Could the Fed be so stupid? Sure they could!

Listen, the Fed typically begins tightening as soon as job growth begins. Over the next 12 months, the US government will hire up to 1.4 million people for the 2010 census. And even though these 1.4 million jobs will probably only last about 6 months, it could definitely push the labor market up over the next few months.

It’s enough to make you go “hmmm”.

An overbought market with record bullishness… poor consumers… and tighter money, spells a recipe for a nasty second half.

A Thought on the Dollar Carry Trade…

Why is the stock market not plummeting while the US dollar index gets stronger?

Well, maybe it’s because the dollar carry trade is being replaced by the Yen carry trade?

Since November 30 the Yen rose from 86.28 to 89.86 to the dollar. At the same time, the US dollar index jumped from 74.50 to 77.09.

So the charts confirm my suspicion. It also means that the dollar can move higher without affecting the stock market much.

The move to the Yen is justified since Japan is suffering deflation and will keep interest rates low for a really, really long time. And by this time next year, US rates will probably be higher.

Is 10,500 STILL a No Go?

Last week I wrote about how the Dow Jones couldn’t stick at 10,500.

Well, nothing has changed this week.

This is what I think is going on…

This is a 3-year weekly chart of the Dow Jones. And it shows that since October of 2007, the Dow Jones has been in a pretty nasty bear market.

More importantly,  the Dow Jones is now at that bear market trend line. Will it break above it? That’s hard to say. But there are some other interesting things going on.

For example, the US Dollar Index is trending higher. I mentioned last week how the buck had broken above its 50-day moving average. Interestingly enough, even though the dollar is trending higher, the stock market has maintained its highs.

Sure, it’s not making new highs. But I expected to see more of a correction by now. Maybe a plunge under 10,000?

Of course, a strengthening dollar could actually lead a falling stock market. But why is it taking this long? After all, the dollar/stock relationship had been pretty tight over the last year.

It’s one of those questions I can only guess on. Maybe funds are moving to cash at the end of the year? (My main thought.) Or maybe the dollar carry trade isn’t as big as everyone thinks? Or possibly the dollar hasn’t strengthened enough to cause carry traders to sell?

It’s all just guesses at this point.

Taking a look at the US indexes on a shorter-term time frame, they are all pretty much overbought. I’d put my money on a reversal; with a tight stop set at around 10,550 on the Dow Jones.

This would strictly be a small money bet. None of the major indexes have broken under their 20 or 50-day moving averages. This would be more like insurance.

Fundamentally, there are still some things this recovery hasn’t proven yet. Like, will there be follow through? Consumers are up to their neck in debt. Credit lines are being shut. And a lot of money is spent on servicing debt.

I also think that people are beginning to shun debt. In a credit driven economy, debt is money. So less debt means less money. That’s deflation my friend.

I’m not sure how consumers could keep this economy humming along. If they do, it will be what John Mauldin likes to call a “statistical recovery” and nothing more.

With that in mind I think next year will be a flat year in the market. I mean, do you really expect this year’s momentum to continue? Stimulus is going to fade slowly. Tax credits are going to expire. And the government is going to tighten its budget.

That’s not exactly a good environment for growth.

Now you understand why I feel placing a little bit of insurance on the portfolio would be a good thing to do. Get into a put option, or short something. Just make sure it’s a small percentage of your overall portfolio.

Don’t go off and use 95% of your funds to insure your portfolio. That’s just stupid.

If the market falls, well, your portfolio is buffered somewhat until you can change things up. If the market doesn’t fall, just be glad you didn’t have to use your insurance.

Get it?

Good

American Credit Crisis Returns January 1, 2010

Ever heard of FAS 167?

Most investor’s haven’t. Which means they aren’t aware that it could cause another credit collapse come January 1, 2010.

FAS 167 is a rule from the Financial Standards Accounting Board (FASB) that forces banks to put securitized off-balance assets back onto the balance sheet.

In other words, all of those failing mortgages and credit card assets that banks hold will be out in the open, for everyone to see the true value of. And banks will have to put more cash in loss reserves for these assets (some of which are deteriorating rapidly in value).

As you can imagine, banks are scared shitless.

From Fincriadvisor.com…

The American Bankers Association declared the NPR a disaster-in-the-making, noting that the effect of the proposal would be to require higher levels of risk-based capital against assets that pose minimal risk, diminishing the “resurgence of bank lending that is so critical to the restoration of a vital U.S. economy.” The ABA also noted that FAS 167 could force banks to account for billions in assets in investment funds managed for third parties.

Here’s what Freddie Mac had to say about it…

“Under these accounting standards [SFAS 166 & 167], the company will record the underlying mortgage loans in these single-family PC trusts and some of its Structured Transactions on its balance sheet. These mortgage loans have an outstanding unpaid principal balance of approximately $1.8 trillion as of Sept. 30, 2009… While Freddie Mac continues to evaluate the impacts of adoption, the company expects that the adoption could have a significant negative impact on its net worth.”

Wells Fargo isn’t happy either…

“I want to update you on our most recent analysis of the impact of the application of FAS 166 and 167, which is expected to result in the consolidation of certain off-balance sheet assets currently not included in our financial statements. We provided a preliminary analysis in our second-quarter 10-Q. Based on our continued refinement of this analysis, we now expect approximately $55 billion in incremental GAAP assets to be brought on balance sheet, representing approximately $28 billion in incremental risk-weighted assets… we continue to explore the sale of certain interests we hold in securitized residential mortgage loans, which would further reduce the amount of incremental GAAP assets and incremental risk-weighted assets.”

Up until now, banks have kept these assets off balance in special investment vehicles. As long as the assets were off balance, the banks could essentially make up a value for them, resulting in less cash going into loss reserves.

But you and I know better.

Banks in America are practically insolvent.

The only reason this hasn’t come out in the open is collusion between the banks and the government. Hell, the government even forced the FASB to lighten up on mark-to-market rules earlier this year in order to keep the banks solvent.

This collusion isn’t over, either.

From 12^th street capital…

A bit of good news for banks today. In a Bloomberg interview, FDIC Chairman Sheila Bair said that she is in favor of giving banks “some breathing room” to raise the additional capital that will be required to support the hundreds of billions of dollars of securitized assets that will be consolidated onto their balance sheets as as result of the implementation of FASB Statements 166 and 167. Bair said she hopes to have the matter voted on at the December 15 meeting of the FDIC’s board.

It’s obvious the FDIC is worried about this. And the reason is very simple: The FDIC is in charge of taking over any other banks that fail. So this rule could have a disastrous effect on the FDIC. They’d be inundated with failed banks and have too few resources to take care of them effectively.

At this point, the banks all know that FAS 167 is in the works. And to compensate for the insane amount of capital they’ll need to build to cover the losses on these new assets, banks have hoarded cash, slashed credit, and increased fees like crazy.

Banks are in survival mode. And FAS 167 is one big reason why consumer credit has dropped for 9 straight months.

We’ll find out on December 15 whether the banks will have more time or not before FAS 167 takes effect. In the meantime, it’s adding a lot of uncertainty. And even if the rule is pushed off by six months, all it does is buy the banks time – time to slash more credit and increase more fees in a vain attempt to raise more cash.

What does the dollar rally mean to investors?

When I used to date (before I got engaged), I never tried to kiss a girl unless she confirmed her interest in me.

A first date was never enough. People date all the time and it leads nowhere.

But if the girl was fiddling with her hair, touching my arms and telling me how I was a “strong and powerful Puerto Rican”, well, I would definitely kiss her by the end of the date.

Other guys I know aren’t as conservative. They try and kiss a girl whether she shows interest or not.

These are the same guys that spend money that they don’t yet have. Or that put all of their money on one big bet. And the same ones that try and predict tops and bottoms before they ever happen.

Their success in the stock market – as with the ladies – was limited.

I guess you can say I’m on the safer side of things. I like to wait for confirmation before I act. With the girls, as I explained above, I like them to show an interest in me. I don’t like to spend money I’m not holding in my hand. And I definitely don’t try and pick tops and bottoms in the market before they happen.

Rather, I ride out the trends and look for predictable buying or selling opportunities to take advantage.

In yesterday’s issue, I told you that I wouldn’t become a bear until the 50-day moving average was breached on the major indexes.

One thing I didn’t cover though was the dollar.

Careful observers have noted that the buck is now above its 50-day moving average. On Friday, I explained the relationship between the dollar and the stock market. Suffice it to say, a rallying dollar is bearish for the stock market.

But just because the buck is above its 50-day doesn’t mean I’ve become a bear. As I said before, I like to see confirmation first. In this case, confirmation would only happen if the major indexes drop under their 50-day moving averages (10,076 on the Dow Jones).

In the end, you have to stay realistic. Don’t let ideology drive your actions in the stock market. Instead let the market guide you.

Even though the dollar broke through a major resistance point, the trend is still up for the stock market.

Act accordingly.