Double Jeopardy

What you are looking at in the chart below is the 50 and 200 day moving averages of the very same S&P over two different cycles or time horizons. Focus especially on the relationship of the 50-day MA to the 200-day MA along with the directional movement of the 200-day MA. Does this chart along with the moving averages provide you with any clues about the direction of the market? Tomorrow, we will identify the time horizons.

Source: Contrary Investor

Çredit Crisis: Precursor of Great Inflation

An excellent article on the causes of economic "booms and busts" is not only thought provoking but just might make you mad. After you read the article, ponder the following questions: What is the Fed's explanation for economic booms and busts? Who is the Fed accountable to? Why does the Fed appear to get a "free pass" from the media and politicians?

Bear Market Rallies

Alan Abelson, who writes a column for Barron’s, states in last week’s edition that during the 2000-02 bear market, there were no fewer than 16 rallies of at least 5% in the S&P 500, each lasting on average about a month, and no fewer than 35 bounces of 5% or more in the NASDAQ, which still managed to wind up losing nearly 80% of its value. In other words, this bear market is not over yet. Therefore, your investment mentality should be the mirror image of what it was during the bull ride from 2003-08. That is, sell the rallies.

Dollar as the International Reserve Asset

What are the implications for the value of the dollar, given the following chart?

The Great Fiscal Stimulus Package of 1929

Does the title sound familiar, with the exception of 1929? Read the article and see if you can substitute 2008 into the title. Article is located at Mises.org. Make sure that you follow the link to the original article that was published in Times Magazine.

Need One Say More

The Market Has Spoken!

The weekly 1387 level on the S&P 500 was taken out this week (See chart below). Given this penetration, we are now either in a "major correction or bear market." Therefore, our focus will be on sell signals rather than buy signals. Sell signals are the mirror image of buy signals. Our primary bear market instrument is the SDS, which is an inverse ETS of the S&P 500. As an inverse ETS, its price rises when the market (S&P 500) sells off.

Since the market is extremely oversold, we should expect the market to rally short-term. Keep-in-mind that this is not a time to me looking for a major bottom. Don't get sucked in by those pundits who will be screaming that this is a golden opportunity to buy. Prepare yourself mentally to either short the market or purchase inverse ETFs, like SDS. The best chance for the market to make some kind of a bottom, based on market cycles, is around March 27, 2008.

Source: Jack Chan's "Simply Profits"

Inflation Jumps in 2007

Inflation rose to 4.1% in 2007 from 2.5% in 2006, which is the largest increase in 17 years! Take a look at the following chart of the growth of money. That just might help explain a good part of the reason for the increase in inflation.

Market: Critical Junction

As indicated in my post of January 15, 2008, all four long-term indicators have now turned "bearish." From a short-term perspective, this market is very "over sold," which should generate a price reaction back to resistance near term. If this is a start of a new bear market, similar to 2001-2002, the SPX must take out 1387 on a weekly basis. See the following chart from Jack Chan at Simply Profits. I will monitor very closely this critical level.

Investment Trend

As we head into 2008, the market is giving very negative (bearish) signals. If you have followed this blog over the course of the past semester, you would have been keep abreast of the key turning points to the market trend, especially the SPX's weekly 17-and 43-EMA's, which has been refined to a weekly 15 and 40 EMA's. Over this semester, I will continue monitor this long-term indicator along with three others, which are from the "Contrary Investor." These three indicators are the SPX Trend Line from 2000, SPX's 80-week MA, and SPX's 10- and 40-week MA. All four indicators are currently negative.

S&P 500 Index: Home Building vs. Department Stores

The following chart does not bode well for overall consumer confidence and the economy, especially for retail sales as we enter the Christmas shopping season. Keep-in-mind that consumers constitute approximately 71% of GDP.

Source: The Big Picture

Today's FOMC Meeting

On September 17, the Fed cut the Fed Funds rate by 50 basis points to 4.75%. This was the first rate cut by the Fed in 18 months. The rationale given by the Fed was because of the precarious situation of the credit markets, which really means the subprime mortgage mess.

Today, the Fed will cut the Fed Funds rate by 25 basis points. At least this is the betting line over at the Chicago Board of Trade. 98% of the traders are pricing in a 25 basis point cut, while only 8% are pricing in a 50 basis point cut. I am firmly in the camp of another rate cut, because our credit problems (subprime mortgages and SIV's) are still with us.

The importance today is not the Fed's action but the reaction of the markets, currency and equity. Rates cuts are generally considered bullish for the equity market, except when a recession is looming on the economic horizon. Thanks to the Contrary Investor for providing the following insight on the rates cuts that preceded the previous recession.

On January 3, 2001, the Fed cut the Fed Funds rate by 50 basis points; and the S&P 500 responded with a gain of 5%. Interesting the rate cut a month ago resulted in a 2.9% increase in the S&P 500.

Learning point is that not all rate cuts are bullish, but rather the key is the reaction of the financial markets to any change in monetary policy.

Washington Mutual's Earnings To Suffer From Mortgage Woes

The "Wall Street Journal" has just reported that Washington Mutual, one of the nation's largest mortgage originators, expects to set aside nearly $1 billion on a pretax basis in the third quarter to cover potential future mortgage losses and record a $150 million writedown on mortgage loans it planned to sell. Chairman and Chief Executive Kerry Killinger said, "While we're disappointed with our anticipated third-quarter results, we look forward to an improved fourth quarter as we continue to see good operating performance in our retail banking, card services and commercial group businesses." Did you noticed that he did not mention any improved performance for the mortgage side of the business for the fourth quarter.

Technical Analysis: Would You Purchase this Stock?

Question: Refer to the following "Point & Figure Chart" that goes back to 2003 and decide if you would purchase this stock. Point & Figure Charts provide a long-term perspective of price action. The X's indicate the price is rising and O's indicate the price is declining.

Answer: In your response, indicate the reason for your decision. [There is neither a right or wrong answer.]

Dollar Strategy

Yesterday was a great day on Wall Street. DJIA up 192 points or 1.38%, which puts the market back above 14,000. This surge in the market came despite Citigroup announcing that its profits may decline by 60% for the current quarter because of its subprime credit problems. Therefore, why did the market go up? Because the dollar is weak! That is the current conventional wisdom on Wall Street. A gradual dollar decline will help exports, which will be good for the economy. However, the optimal word is "gradual." If the dollar falls too fast, it could cause interest rates and inflation to rise, stock market to plummet, and foreigners to sell Treasury debt securities. Not a good scenario. However, take heart in that most economists believe that the dollar decline will be gradual and will not cause any major dislocations to the economy. In fact, the majority of economists, inclusive of the Fed, are saying that a weak dollar will help cushion the subprime real estate correction and be a real plus for the U.S. economy. In other words, the dollar decline will be contained. I believe we have heard all this before in which the containment crowd said that the subprime problems is not a cause for concern. I don't know about you, but I am not buying it. Then again, you be the judge and look at the following link that illustrates the dollar's performance: Trade-weighted value of the dollar.

What is the Dollar Worth?

The answer to the question in the title is "not much!" But then again, it depends on one's time horizon. However, if we go back to 1913, which by the way was the year that the Federal Reserve System was established, a dollar in 1913 would be worth only a "five cents" today. This is very interesting, because one of the Fed's main objectives is to maintain a stable currency as the protector of our economy's stability. Then again, in this day and age, who wants to be accountable for one's action.

Since the Fed cut the Fed Funds rate, it seems every currency, inclusive of Third World currencies, in the world has rallied against the dollar. The Euro is at an all time high, recently the dollar was trading at $1.412 to the Euro. Even the Canadian dollar (loonie) is now at par against the dollar, which is the first time in three decades. However, take solace, the dollar did hold its own against the Zimbabwean dollar where inflation in that country is only running at 15,000% a year.

In addition to the dollar's weakness against currencies in general, the price of oil exceeded $84 a barrel; and with the prospects of reflation, the price of gold went to $740.

Don't worry. The Fed has everything under control. Just look at how well they have protected the value of the dollar.

August Wholesale Prices Fall Sharply (What about core inflation?)

"The 1.4 percent decrease, the biggest since October 2006, followed a 0.6 percent increase in July, the Labor Department said today in Washington. So-called core prices, which exclude fuel and food costs, rose 0.2 percent after a 0.1 percent gain the month before."

The reason that I posted this information is to inform you that the market will do anything to justify a rate cut by the Fed. The whole emphasis in today's financial press is on the decline of wholesale prices, which in effect is saying that inflation at the wholesale level is in check. Therefore, the Fed can go ahead and cut interest rates. However, what is completely ignored is the fact that just a month ago the emphasis by the financial media was on "core inflation." And, if you noticed the last sentence in the first paragraph, you read that core inflation rose .2%, which on an annual basis is 2.4%. This was double from the previous month. The Fed generally would like the core inflation to be between 1% and 2%.

Will the Fed cut the Fed Funds rate? You bet! Will the equity markets be satisfied? Probably not. That is why the old Wall Street adage will probably be true, which is "Buy the rumor and sell the news."

Root Causes of Financial Bubbles

All financial bubbles, subprime included, start when the banking system is awash with liquidity (money). Then, the question one must ask is who or what provides the liquidity to the economy in the first place? From your course in Macroeconomics, you learned the answer to that question as being the Federal Reserve System. Therefore, the Fed initiates any financial bubble through increasing reserves (money) to the banking system, which in effect will lower interest rates. Then, banks, which now find themselves with additional reserves, will do what they are in business to do; and, of course, that is to make loans, i.e., mortgages. Because of low interest rates, which is caused by the increase supply of reserves, individuals are more than happy to borrow money, in this case, for that new home or refinance their current home and draw down any home equity that is available.

Another question to ask is why and when did the Federal Reserve increase reserves to the banks? The Fed started its current monetary expansion program after the last recession, 2002. The Fed realized that since the consumer is such an important component of GDP, something like 71%, it needed a catalyst to stimulate the economy. The consumer was that catalyst. By providing and injecting reserves to the banking system, the Fed knew that the desired outcome of GDP growth would occur through the assistance of the banking system and individual borrowers. However, this contrived real estate bubble has finally burst, as all bubbles do, and the consequences are going to be felt for many years to come. The Fed's solution will be to simply reinflate the economy and create another bubble.

What I find interesting about this current subprime mess is that no one or a very small fraction of the financial world is looking at the Fed as the real culprit or villain. However, I do hear that the subprime mess is the fault of mortgage banks, credit agencies, and hedge funds. But I firmly believe that these entities are not the "root" cause of the problem. For that, simply look at the Federal Reserve and its expansionary monetary policies.

By the way, the chart from my post of September 3, which was entitled, “Picture is Worth a Thousand Words,” is that of the Money Supply. The chart can be accessed at the following URL: http://research.stlouisfed.org/fred2/series/MZMNS.

The Next Subprime Mess

Get ready for another financial debacle. This time it is going to be those nasty SIVs. No, I don't mean SUVs, which I guess the "Green Movement" would consider to be nasty. SIVs stand for "Structured Investment Vehicles. Trust me, SIVs will become as well known as those SUVs we drive.

These investment vehicles are entities that banks use to issue commercial paper, which is a money market instrument. With the proceeds, banks purchase corporate receivables, auto loans, credit card debt, and, yes, mortgages. Why is this so alarming? Take Citigroup, for example. Citigroup owns about 25% of the market for SIVs, which is approximately $100 billion according to the "Wall Street Journal" in its September 5, 2007 edition. Yet, in its 2006 filing with the SEC, there is no mention of it. What? How can this be? Well, accounting rules don't require banks to separately record these type of off-balance sheet investment vehicle on their main financial statements. One would have thought that the accounting profession would have learned something from Enron, World Com, and Global Crossing. The demise of each of these companies was directly tied to off-balance sheet vehicles.

The Federal Reserve System has a major challenge ahead of itself in trying to bring stability and trust back to the financial markets. In my opinion, these challenges are a direct result of their own polices instituted during the past five years. The banks and financial markets did not create this subprime mess or pending SIV mess. The Fed did that all by themselves. The banks and financial markets were just reacting to what the Fed was doing. That is, when the Fed reinflated the banking system with reserves (money), banks made loans. Because interest rates were low, which was caused by the Fed reinflating the banking system, individuals were more than happy to refinance their homes and draw down their home equity. This resulted in real GDP growth. However, the consequence of all this liquidity has been the inflation of all financial assets. Like all bubbles, they do burst; and we have already seen the subprime bubble burst. The next one just could be those nasty SIVs.

Picture is Worth a Thousand Words

A picture is worth a thousand words is a proverb that refers to the idea that complex stories can be told with just a single still image.

What is the name the above chart?