CAPITAL MARKET COMMENTARY
ALL THE MAJOR EQUITY MARKETS ARE “HIGHER” THIS MORNING:
From Asia’s close to Europe’s opening – all the major bourses are trading higher this morning. Earnings announcements continue to dominate the news with the Chinese change in currency regime now considered stuff for reading later with no discernible impact upon current capital markets. In fact, the US dollar is trading back to about
where it was prior to the Chinese announcement. The change was bullish for the Japanese Yen…yet prices have fallen quite sharply since the sharp one day higher adjustment. Bonds too are a bit lower after Friday’s rally and crude oil is taking a ‘breather’…a very modest one indeed. This latter circumstance is where we want to hone our focus upon, for the chart at the bottom of this page shows prices rising from the ‘lower left to the upper right’ – the definition of a bull market. Too, we see the recent decline in prices was relatively ‘minimal’ at best and did in fact hold support. To us this would suggest crude oil breaking out to new highs in the weeks ahead…and perhaps even days ahead. Our focustherefore turns to oil-related shares; the oil service sector did rise rather sharply on the back of good earnings reports, and this is not likely to change given the trade is still underweight oil shares given many expect lower prices. We were in that camp as well – but we have erred in our thinking and are returning once again to ‘the patch’ this morning.
THE FOMC WILL CONTINUE RAISING RATES:
continue to read and reread report after report that says the FOMC is nearly ‘done’ in their efforts to raise borrowing costs via the o/n fed funds rate. We think they are ‘wrong-headed’ as they generally are when the FOMC embarks upon a campaign of doing so; the FOMC always goes further and farther than anyone expects until they ‘choke’ off the recovery and some ‘bad happens’.
Last week’s final Humphrey-Hawkins testimony by Fed Chairman Greenspan reiterated this stance we believe; he noted the economy was coming out of a ‘soft patch’ and the labor market was improving although measures of inflation were quiet. The Fed always is out in front of the curve in terms of tightening before inflation is seen – and while we have very large problems with the calculation of government inflation figures – we do know that many are saying that the Fed is about to stop because inflation is quiescent.
As the chart atop this page courtesy of BNA demonstrates – labor pay increases should soon begin rearing their ‘pretty heads’. This is great for workers as pay increases have been abysmal for the past 5-years; however, they will push the FOMC to continue raising rates until the economy falters. We suspect a material
slowdown by year-end; with an increasing probability of a recession next year. Remember, recessions begin with strong economic activity declining. That
said, an August high in the major indices may develop in seasonal fashion that begins to discount this very real and increasing probability.
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ETF : CHART COMMENTS OUTLOOK: We remain long-term fundamentally and technically bearish given reward-reward parameters are skewed towards ‘risk’. Our
S&P 500 rally target range is 1230-1265...with downside projections near 1050.
GENERAL TRADING COMMENTS:
The overall bullish tencor continues unabated; but the underlying technicals are showing some signs of deterioration. Specially, bullish sentiment remains very very high, although the percetange of stocks above their 10-day and 200-day moving averages are ‘off their highs’. This suggests downside risk is present, but not sufficiently so to warrant an aggressive short stance.
If we were to consider long positions, it would obviously be in DIA and QQQQ – the recent laggards; both have relatively bullish patterns and we think better risk-reward parameters than either the mid or small cap indices. Many are becoming uncomfortable with the relative outperformance in these indices and are now moving to adjust their relative risk profiles accordingly.
That said, if we were to become short in the very near future if our short-term model were to turn lower – we would cast our lot with IWM to be sure. And given our previous comments...we would rather be short than long in the next several weeks.
And finally, concerning our short bond position; Friday’s rally basically retraced 50% of Thursday’s decline. We hold tight for now; we expect weakness to prevail in the days ahead. If not, then we must consider exiting our position.
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About Richard Rhodes
