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.

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

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.

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

I mean seriously, have a beer with the trend. Talk with the trend. Don’t try and punch it in the face. The trend is stronger than you are. And it WILL smash your face in if you’re not careful.

While bears were out celebrating a stronger dollar and trying to spit in the trend’s face, the trend came back and hunted them down with a machine gun from a helicopter flying overhead.

If I recall correctly (and I do, because my blog tells me so) two days ago I told you to be careful about calling the recent 3-day rout another bear market.

And today, just like that, the Dow popped right back above its 20-day moving average.

Not only that, but the RSI is heading higher (forming an uptrend even) and the Slow Stochastic is nearly crossing over and heading higher as well.

That’s not all though. If you look at the dollar index, the buck is clearly overbought. And today, it was practically unchanged. I wouldn’t be shocked to see the dollar decline over the next few days.

If you’re bold, you might want to start buying.

If you’re a little more on the safe side, then wait for the dollar index to get back under its 50-day moving average before jumping into the market. At the very least, pay attention to the S&P 500 and make sure it gets above its 20-day moving average.

Oh what the hell. I’ll probably tell you as soon as it happens anyways.

The Dow Jones, Nasdaq, and S&P all broke under the 20-day moving average. The 50-day is in the line of sight. Will all three indexes plunge below the 50-day? I may not have a crystal ball, but I do have technical analysis.

Dow Jones Industrial Average

This is what the chart is telling me right now

• The Dow Jones saw significant resistance at 10,500. It even tried six times to break above 10,500 with no success.
• Huge spike in buying volume followed by selling might indicate a blow-off top.
• The RSI and Slow Stochastic are both in neutral territory. This signals more downside left (I’d like to see these two oversold before buying).
• The Dow broke under its 20-day average but is still above its 50-day.

It looks like we might have a few more days of selling. But I expect buyers to come back in as soon as the major averages hit their 50-day moving averages. If we see a decisive break UNDER this average, it could signal a change in trend.

In other words, buying now might be a bit silly. But getting heavily short right now is equally as silly. It’s kind of like betting against the Yankee’s in the first inning because the Red Sox barely hit a home run. It’s just too soon to make that bet.

In times like these, you want to use these small downturns to hedge your portfolio.

Yesterday I recommended you get into January VIX out of the money call options to hedge your portfolio. If you had done what I said, you would probably be in the green (the VIX is up over 6% today!).

Until the trend becomes bearish, I simply won’t get heavily short this market. And that won’t happen until the 50-day is breached on all three indexes.

In a speech Ben gave today, he told us what we already knew: that the US expansion would be slow and that there were significant headwinds ahead. Why this shocked the market into a decline is anyone’s guess. After all, the market is supposed to be efficient. And it should have priced this in already.

It obviously didn’t (another loss for the efficient market corner).

You can get a transcript of Ben’s talk here: http://www.ritholtz.com/blog/2009/12/chairman-ben-s-bernankes-frequently-asked-questions/

In the meantime, we have to determine what this means to the stock market and most importantly, to our own portfolio.

With Ben saying that inflation will drop, investors got out of risk (commodities, emerging markets, and US stocks) and into treasuries and the dollar. The yield on two-year treasuries alone dropped 7 basis points today (0.07%) and the buck rose 0.3% against the Euro.

This, of course, is the second straight day of dollar gains (Read Friday’s post to see what I said about it then). And if you’ve followed my writing for some time, you know that I’m expecting a dollar rally in the next few months. But whether what we’re seeing today will transpire into the dollar rally I’m looking for isn’t clear.

The Dow, S&P, and Nasdaq are all above the 20-day moving average. If that support line fails, I expect to see support at the 50-day averages. If we see the markets penetrate the 50-day, then i’ll take my ramming bull horns off and put on a stinky bear outfit and go hibernate.

If you’re heavily long, you should probably put on a little hedge by buying an out of the money January call option on the VIX.

It didn’t even matter that the unemployment count for November was far better then expected (a 11,000 drop). After starting the day up over 1%, the Dow Jones and the other two indexes both ended the day barely in the green.

The funny thing is that the good economic news actually contributed to the markets rough going. It all has to do with the complex and far reaching implications of an improving labor market and its effect on the dollar.

You see, most currency traders like to see an economy producing jobs. It makes them want to buy more of that currency, pushing the price higher.

The problem is, the dollar is being used to fuel a huge carry trade. If the value of the dollar  increases,  the carry trade becomes more expensive. Eventually any fund that is short dollars (borrowing) will have to unwind its carry trade (close out the loan and take a loss). And the dollar moves up, up, up.

This scenario is pretty much what happened today, albeit on a small scale. The November unemployment report came in strong, and some currency traders took that as a sign of strength for the buck. At the same time, the increase in the dollars value spooked carry traders into closing out their positions.

This drained liquidity from the global markets and resulted in all three major indexes closing at the lows of the day. Frankly, i’m shocked we didn’t close out deeply in the red.

Here’s the kicker…

If the market is weakening over employment numbers, how badly will it weaken once the Fed announces an end to its MBS purchases in the first quarter of 2010? How will the market react if the Fed raises rates by June 2010?Or the passage of FAS 167 in January 2010? All of these things are dollar bullish and should add downside pressure to the stock market throughout the year.

And on a finally note, let me show you a chat of the Dow Jones. It shows the important inflection point we now sit at.

Most of what I saw was ridiculous crap. Stuff not even worth mentioning (expect to say that they sucked)

But then this GEM popped out at me…

Dow Jones Chart

This is a 15-minute chart of the Dow Jones.

Notice that 200-unit resistance that has proved quite resiliant. Well, if the Dow can hold its 8,000 support and break above this 200-unit average, then the Dow is rallying.

I really like the fact that neither the RSI or Slow Stochastic are anywhere near overbought. That means the fuel is there for a move much higher…

Hmm… There’s a great credit-spread one can do : )