Gee, Think.

Why is all the recent data which shows that the economy is slowing
talked about as benign? I think the logic is that a slowing economy
will cause the Federal Reserve to stop and possibly reverse their
interest rate policy. While lower short term interest rates will make
bonds less competitive to stocks in terms of yield, the fact the the
federal reserve is lowering rates is a bad sign for the economy. The
Fed tends to lower rates in an effort to stimulate economic growth and
increase the speed at which money flows through our economy. The only
reason for stimulating the economy, however, is that the economy is
already slowing.
So how can a slowing economy be a good thing for stocks? I think the
only answer is that traders believe the economic slowdown will be of
minor scale. They believe it will be a period of slowing growth for a
short period, followed by a resumption of a roaring economy. I tend to
think we are in for more of a shake-up than that.
The housing market is in really bad shape as of late. I read recently
that there is a record high number of sellers in the market. Sellers
have far out numbered the buyers and so prices are falling. Falling
prices encourage potential buyers to wait further until prices fall even
further.
Falling real estate prices are not just bad for the sellers though, they
are also bad for the overextended “owners” who have an overall negative
equity position. For these owners, the value of their home may fall,
but the size of their equity loan will remain the same. They will need
to continue making the same payments, and may even need to increase the
payments as mortage rates rise. Specifically, those with adjustable
rate mortgages may need to prepare for higher payments due to higher
interest rates.
If the economy does go through a significant slowdown, wages will fall.
If wages fall, making mortgage payments will become more difficult.
So what happens if a number of borrowers default on their home
mortgages? Banks will become less willing to lend to new borrowers. I
can’t speak from experience, but my best guess is that lender will
express an unwillingness to extend credit by offering loans at
unattractively high interest rates. What does this do to the adjustable
rate mortgage holder? It increases their interest payments. This could
in turn cause more foreclosures in a vicious cycle. We call this credit
contraction.
As mortgages defaults occur in a falling real estate market, the lender
will lose money on the sale of the home in cases where the borrower had
built little equity. For example, a borrower who had built 30% equity
in their home defaults on their payments. The bank recovers the
property and they can break even on the loan they extended if they can
sell the house for 70% of its value. It is possible for a lending
institution to profit from froeclose in a stable or rising housing
market. Falling markets however, can actaully hurt the lender. If the
price of the home has fallen to 50% of its value at the time the
mortgage was taken, the bank will only be able to secure, at best, a 20%
loss by selling the house for 50% and keeping the borrower’s 30%
equity. This returns 80% of the loan to the lender through the
foreclosure process, which is also quite time consuming.
So in summary, since we have an all time high level of credit in this
country, and a negative savings rate, I think any sign of a slowdown
could be very bad news. The last question is what will cause the real
slowdown? Will it be something obvious such as a political event? Or
perhaps the slow effects of globalization? I’m not sure, but as we say
in the northeast, I’m keeping my eyes peeled.

The FOMC voted to pause their rate hike citing a slowing economy, but
they asserted that hikes may be resumed if inflation does not moderate.
Well I’m surprised that only one governor voted against the pause. I
thought there would be another quarter point hike. All the same, it
seems like the Qs may fall.
I was just watching the Qs action shortly after the minutes release.
There was one huge sell order, something like 1.7 million shares, then a
bigger buy order for approximately 3 million shares. Whoa! I can’t
wait to see how the tug of war goes. I’m guessing that slowing economy
means poor earnings reports which means contracting multiple, which
means stocks fall.

Today was a typical pre-fed meeting day showing volume around 60% of the
average. To my delight the Qs slid a bit downward, and my QQQUJs
touched 0.75 for the third time in 5 days. I couldn’t bring myself to
take defense action by selling again. I really think the Naz is going
to suffer tomorrow, rate hike or not. If there’s a hike, cash gets more
competitve versus the stock market, which at this point in the hiking
policy could do some damage. If there is no hike then the Fed is saying
that the economy is slowing enough that they don’t have to do any more
damage themselves. Hike or not, inflation is running hot and company
earnings are going to drop next quarter. They weren’t so great this
time around anyway.

Hey it’s Monday! Back to business!
Getiing right to it, I’m still looking for a drop in the Naz. I was
just perusing Robert Holmes’ daily pre-market update as I ride into
Newark. He reports what “seems” to be a consensus on the rate hike
pause. He also quotes a Cantor Fitzgerald u.s. Market strategist as
saying that the market has discounted the Fed’s move already. All
right, is suppose it’s possible that the market has already moved down
enough to prevent a huge sell off if the rates go up, but I believe that
there will be some sharp short term movement in the intraday chart
tomorrow based on what the Fed says accompanying its move. If they are
still hawkish they’ll scare the markets for at least a day. If they are
dovish we should see a rise.
The most interesting part of the pre-market summary was the updat on
international markets. The Hang Seng gained 0.4%, but London’s FTSE,
Japan’s Nikkei, and Germany’s DAX were all lower. I think that means
we’re headed down.

Today the non farm payroll numbers came out. We had only 114,000 new
jobs created last month. This was about 30,000 lower than the
estimates. This information was released around 830 am today. As would
be expected, the market gapped up. It continued to rally until around
1230. Then it started a serious downtrend into negative territory. The
Qs covered 60 cents of movement from plus 30 to minus 30 intraday.
I had opened a position in QQQUJ. That’s the september 36 put. I got
into this postion on the monday and tuesday before last. That’s
somewhere around the 24th. My cost basis for 16 contracts was 0.98.
When I checked the position after vacation, it was worth around 0.55.
Wowza! That really hurt! I saw it move up to 0.75 earlier this week on
movement around the time of inflation data coming out. I did not sell
out at that point though.
Earlier today the position was worth 0.45. When the market was
sufficiently dipped, I sold 6 of the contracts for a 120 dollar loss.
At this point though, I’m trying to reduce the amount of capital I have
working in this trade. If it goes further against me, I certainly
don’t want to lose more than 23 cents per contract. I should never have
lost more than 10.
So I still have 10 contracts out there. I’m pulling for inflation fears
to kick in big time on monday. Then hopefully I can exit at break even
before tuesday.

The Kondratieff cycle is a long cycle, typically lasting 55 to 60
years. It was discovered in the 1800s by Nikolai Kondratieff. I’ve
been reading about it in John Murphy’s “Intermarket Analysis” lately.
Today I reread part of his discription on it.
Part of me thinks that these cycles can’t really be correct. It seems
unlikely for there to be such recognizable and repeatable pattterns.
However, this particular pattern has proved correct over the last 250
years. If the data supports it, I should have a hard time refuting it.
I have heard that there are issues with whether these long term models
use an inflation adjusted stock index. When I was reading Frost and
Prechter’s “Elliot Wave Principle” they mentioned that some of the
elliot patterns were more recognizable under the inflation adjusted
Dow.
Doubts aside, the Kondratieff cycle calls for a “winter” declining
period starting in 2000 and lasting upwards of 10 years. One of the key
markers of winter is deflation, which I’ve read was experienced in
2000. The next marker is falling commodities prices. I’m not sure if
we have those yet, but I’m going to keep this theory in the back of my
mind.

I’ve been reading more of John Murphy’s “Intermarket Analysis” book
lately. He has a couple chapters that discuss various business cycle
theorys and what they mean for the financial markets. As I understand
it, the idealized behavior is this:
1. Bond prices rise
2. Stock prices rise
3. Commodity prices rise
4. Bond prices fall
5. Stock prices fall
6. Commodity prices fall
Steps 1, 2, and 3 are part of an economic expansion. Steps 4, 5, and 6
are part of an economic contraction. The expansion is positive growth
and the contraction is negative growth. The time between steps 3 and 4
is when the economic growth actually turns negative, but it is decling
from the middle of step two to the midlle of step 5.
So, having read this theory on the business cycle and it’s relation to
financial markets, I’m going to try and plot our position in the steps.
Everyone who’s paying attention to the stock markets can see that we’ve
just experienced a major downturn. We also know that commodity prices
were soaring during this downturn. The commodities were corrected as
well if I remember correctly but I think they are still heading up.
This last week was a great week for the Dow, Naz, and S&P, but are
stocks done falling?
I think bond prices have been falling because yields have been
increasing. I think this means we are somewhere around step 4, which
would nake this an early recession. If that’s true we should see stocks
and bonds continue to fall over the next months. Commodities should
join the fall eventually as well.

So I’m reading TheStreet.com trying to understand the data that is
alleged to have led last weeks strong gains in the Dow, Naz, and S&P.
So far it looks shaky to me. Hourly earnings rose 0.5% when analysts
were expecting 0.2%. The analysts were more than 200% off their
estimate in the wrong direction! Further, apparently the “Feds stated
comfort zone” is 2% for core inflation. Last quarter’s core inflation
reading was 2.1% and this quarter’s was 2.9%!!! Whoa. Does that scream
inflation? Being fairly inexperienced in following these numbers I
can’t say how significant those numbers from a historical perspective.
Through my green eyes, it sounds like the core inflation number is too
high and the hourly wages are going up too fast. Meanwhile companies
are beating their earnings forecasts. Are they beating the estimates
because the dollar is falling? Is the dollar truly falling? I’d like
to take a quick look at the dollar vs. Yen and dollar vs. Euro this
morning.
So if there is still evidence of inflation, why do we think the Fed will
stop tightening? Especially if companies are still doing so well?
Beats me.
I wonder if this is a corrective wave of a bear market. Maybe it’s got
everyone all excited that we’re out of the woods. Then just when you
think the worst is over we REALLY get whacked.

This is a really interesting time to be watching the market. People are
hoping that the Fed will stop raising rates soon, but no one can say
when it will happen.
The Free Open Market Committee has sworn to be data driven and
transparaent under Ben Bernake. This new communication policy has made
for a lot of speculation. Take for instance the FOMC meeting minutes
that were released a couple weeks ago. I think they were from march
28th. There was a sentence in the minutes that expressed concern at the
Fed that raising rates too far could be bad for our economy. Raising
the rates is meant to slow growth, but the FOMC does not want to kill
growth outright. They are trying to find a balance.
Meanwhile, the economy is still doing quite well. Many companies are
beating their earnings estimates. The strange thing though, is that the
stocks of these successful companies are taking a beating. I think this
is a mix of profit taking and investors switching to hotter sectors.
The energy sector, especially oil, is really hot. The increase in the
price of crude is due to the fact that companies are having a hard time
finding new sources of oil. The cause of the price hike in gasoline
seems to come from some inefficiencies in the supply chain. Crude oil
must be refined to become gasoline. The gasoline must then be mixed
with ethanol and distributed across the nation. The ethanol mixing
process is labor intensive and is causing a real bottleneck. Also,
there have been no new refineries built in the united states in over 20
years. The demand for gasoline has certainly increased, and the method
of making it has also gotten more labor intensive. When you look at it
like that, it’s not hard to see why gasoline is expensive and getting
worse. Is there anything in the foreseeable future to ease prices by
increasing supply? Not yet.
These conditions have made both gasoline and oil stocks profitable to
investors recently.
Gold and other precious metals have also been on the rise. They’ve gone
up rather dramtically. This rise drew investment from many market
players. Perhaps this was also money that came out of the QQQQ’s.
The sentiment at the fed, the action in oil, and the action in gold were
my reasons for betting against the QQQQ’s. Today, hoiwever Ben Bernake
of the FOMC testified to congress at 10am. In his testimony he said
that the Fed may pause the rate hike campaign. A stable or easing
Federal interest rate makes stocks more attractive than cash. the
reaction to his words seemed to be celebration, and a feeling that it
was okay to get back into the market for a bit. This drove the markets
up. The QQQQ’s had a 1% gain today. We will see if this feeling
lasts. I think that if the fed pauses the rate hike at their next
meeting on May 10th, the QQQQ’s could be on the rise again.
So which forces in the market are the strongest? The price of crude?
The price of gold? The easing fedseral rate? Are we back into a bull
market mode after the last near week?