NOTE: This Maarket Commentary alert was originally emailed to subscribers at Ritholtz Research & Analytics on Tue 10/06/2006 3:28 PM EDT;
This is posted here not as investing advice, but
rather as an example of a trading call for potential subscribers. We
expect to post future advisories in a similar manner — after the call,
but in the correct chronological location on the blog.
Given the new Dow highs hit this week, we thought we would take a look at some of our favorite technical and monetary indicators to see where we are in the current cycle.
Despite all the recent CNBC hoopla, it must be pointed out that 1) the Dow has still underperformed cash since the 2000 highs; and B) The much broader Wilshire 5000 Index remains a full $1.2 Trillion below its 2000 first quarter value.
Our review of the technical and monetary components strongly suggest that caution is well warranted. Further, our advice that it is too early too early to short continues to remain in effect. Patience is the key in placing shorts, and we know far too many who trade from that side of the desk who have been carried out on their shields. Our favorite example is Jonathan Cohen, the Merrill Lynch analyst who correctly stated that Amazon.com — then priced at $80 — should be a single digit stock. He was eventually correct, but only after Amazon went to $400+ (and after Henry Blodget took his job).
However, we are considerably bit closer to being ready to start to putting on short positions than we were a month or even a week ago.
Let’s get into the details:
Monetary Policy: A large portion of the present rally rests on the probability of the Fed cutting rates in 2007; We went back and looked for when in the past the Fed has cut rates when the Dow was near 52 week highs — or all time highs. While it has happened on occasion, its not common Fed practice, with July 1995 as the most recent Fed easing when the Dow was near a 52 week high.
Our assumption for this is that the Fed doesn’t cut when stocks are near highs, because stocks don’t get near highs without some degree of underlying economic strength that translates into revenue and earnings. However, stocks can and do overshoot to the upside — but the market should catch itself and correct the excess long before the Fed is cutting rates again.
Another thesis has been that "we are slowing to a Goldilocks economy" — not hot enough to cause inflation and Fed tightening, and not cool enough to cause a recesssion.
We remain unconvinced.
Another thesis has been we are slowing to a "Goldilocks economy" — not hot enough to cause inflation and Fed tightening, and not cool enough to cause a recession. We remain unconvinced. The only true soft landing was 1994; As rust belt industries went south, it nearly caused a recession. But the underlying strength in several new industries — the Wireless build-out, the PC upgrade cycle, and the early expansion of the Internet — was more than enough to make up the slack. That is missing in the present environment as housing cools.
Goldilocks proponents keep suggesting that commercial real estate can take its place, but we are doubtful; Last year, Residential Real Estate was an over $700 Billion dollar sector; Commercial was a little more than one third of that. Additionally, commercial construction does not generate the same equity withdrawal that has powered so much of consumer spending over the past few years.
Technical Underpinnings: Anyway, several technical indicators are suggesting that our caution is well warranted:
- Market Breadth remains poor, with only the biggest stocks participating (see chart below); This is not how healthy markets behave, and is more typical of what we see near market tops.
- Despite the drop in Oil prices, the Transports are not participating in the rally — this suggests the economy is significantly slowing;
- The number of stocks making new highs on the NYSE is barely positive; Its hard to reconcile this with the Dow at new highs;
- Sentiment has been very bullish, with the finacial media bordering on giddy.
The bottom line: The price action has been good, the volume okay, and the internals weak. This is not what is typically observed at the beginning of a new Bull cycle.
Bullish Percent (red and black) ; S&P500 (green)
Upside Targets: One of our subscribers pointed out to us
that our upside targets had been hit this week. In the beginning of the
year, we participate in several market forecasts by major media. We do this despite our longstanding believe that "Forecasting is Folly."
Through what can only be referred to as Dumb Luck, two of our upside
targets have been reached. In December of 2005, we forecast the Dow
hitting 11,800 before reversing, the S&P500 hitting 1350, and the
Nasdaq reaching 2,600. This took longer than "mid-year" we
So too has the reversal. That’s part of the reason why predictions
are so perilous — no one consistently anticipates exactly when markets
top or bottom and reverse; (there are simply too many variables to
control for). Its also why investors should not rely on these long term
guesses. Sure, they make for a good double issue filled with lots
advertising — but they are not a basis for intelligent portfolio
October 6, 2006
Another edition of our new series: Blog Spotlight.
We put together a short list of excellent but somewhat overlooked
blog that deserves a greater audience. Expect to see a post from a
different featured blogger here every Tuesday and Thursday evening,
Second up in our Blogger Spotlight: Michael Shedlock and Mish’s Global Economic Trend Analysis. Mike is one of the editors of The Survival Report, covering stocks and the economy. He also writes for the Daily Reckoning, and co-edits Whiskey & Gunpowder. He also runs stock boards on the Motley Fool, Silicon Investor, and TheMarketTraders. He is an avid photographer, when not writing about stocks or the economy, with over 80 magazine and book covers to his credit.
Today’s focus commentary is called Falling Dominoes and addresses the impact of Housing’s decline on the economy:
The Sentinel is reporting State targeting abusive lenders.
The [Massachusetts] state Division of Banks is cracking down this month on what it sees as abusive business practices by mortgage lenders and brokers.
The agency issued a series of new emergency regulations earlier this month, requiring better documentation from lenders and prohibiting them from pressuring consumers into taking out mortgages they can’t afford or working without their own independent lawyers. It also forced four companies — two of them located Worcester — to close immediately and place all pending mortgages with another, more established lender.
Commissioner of Banks Steven L. Antonakes said in a recent interview that division examiners found a pattern of deceptive business practices by some lenders during their most recent round of company inspections.
"We want to spell out in very plain English to send a message to lenders and brokers that these specific acts, whether they’re very obviously unfair or deceptive, or more subtle, they weren’t going to be tolerated," he said. "And you would put your license at risk by engaging in this kind of activity."
Abusive lending practices can destabilize the entire real-estate market. As an example, he described a hypothetical street containing 10 homes, each worth a certain amount of money.
"If loans were originated for two of those homes, in which the loan was made that the broker knows the consumer has no hope of repaying those loans, very likely the borrower will become delinquent," he said. "In the worst case, the home will be foreclosed upon, and that kind of activity could result in the home being sold for less than its value and before you know it, you have a domino effect."
But the slowdown has also put lenders in a tough position, said Christopher J. Iosua, president of the Mortgage Connection Inc. "When business slows down the way it has in the past six to nine months, new loan originators and those without a strong base of customers do things they probably wouldn’t normally do," he said.
The idea that lenders are doing things they may not have done in "normal conditions" may have some merit for some lenders but when 40% of the loans sold in California before the bust were either stated income loans or pay option arms, I think the idea if more fiction than fact. Anything and everything was done to keep the bubble booming, and that was as I said happening well before the bust.
With every bubble comes fraud. The two go hand in hand and housing is not unique in this respect. We are only beginning to scratch the surface of the fraud that supported this bubble. Lending standards are going to tighten as a result, and will continue to tighten as more and more of the fraudulent activity is exposed. I consider fraud and tightening of lending standards to be two big dominoes that are now falling. Tightening of lending standards was previously discussed in Lending Guidelines / Credit Squeeze and The Blame Game.
Due to a very thoughtful birthday present from Mrs. Big Picture, there will be somewhat lighter posting the today and tomorrow due to travel — mostly in broad and curvy circles: > Lime Rock CT / Skip Barber UPDATE: October 5th, 11:14pm This was an awesome trip — I’ll try to do a full update…Read More
Today we start a new series: Blog Spotlight.
We put together a short list of excellent but somewhat overlooked blog that deserves a greater audience. Expect to see a post from a different featured blogger here every Tuesday and Thursday evening, around 7pm.
First up in our Blogger Spotlight: Tim Iacono and The Mess That Greenspan Made. Tim is a software engineer in his mid-forties, living in Southern California. He calls his blog is a "vain attempt to stave off a mid-life crisis, and here’s hoping that it’s going to work."
Today’s focus commentary is called Friends in High Places? and it address the controversey we discussed last week.
Friends in High Places?
Life is always much more fun when there’s a good
conspiracy theory to kick around. When the New York Times starts kicking it
around too, then it can really be
Such is the case with the recent plunge
in the price paid for gasoline by formerly dour consumers leading up to an
election where the party in power is clearly having difficulty wooing the
electorate. It just so happens that the newly appointed Treasury Secretary used
to run the investment bank that controls the world’s most important commodity
index, which seven weeks ago cut the weighting of unleaded gasoline by nearly 75
percent, causing all commodity investments based on this index to sell their
unleaded gasoline futures.
For the same number of buyers, a glut of
sellers means lower prices, and voila! Prices at the pump drop precipitously,
consumer confidence rebounds, and the electorate develops a new spring in their
Or at least, that’s what some would have you believe. . .