Pork n’ Bonds

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Sally Limantour

Various commentaries over the weekend point to many reasons why interest rates rose recently. Bill Gross throwing in the towel; massive duration hedging required by portfolios; a 12.5 billion reduction in foreign holdings of US Treasury and Agency securities, and yes pork prices climbing 43 percent in the first three weeks of May from a year earlier.

Bloomberg reports: “China's inflation probably accelerated in May as pork prices soared, increasing the likelihood that interest rates will be raised”. http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aNDCG3kLYQqg

Seriously, we have pointed out here that food prices together with rising money supply (around the globe) and recent labor price increases have lead to bond yields increasing.

On a technical basis I have been charting two things – the pattern of lower highs on the weekly 30 year Treasury futures and the 50% level from the highs on 6/20/03, of 122 27/32, to the lows on, 6/18/04 of 10228. That 50% level is 11300 and we continue to reject it.

While Mr. Gross of Pimco “capitulated” last week this was something in the making as he was beginning to get uncomfortable with his bond positions the summer of 06. I quoted his discomfort at HamzeiAnalytics.com from an interview in the WSJ back on August 23, 2006:
“The Bond King, Bill Gross, of Pimco, who had bet on the economy slowing, was so stressed from positions going against him that he took an unplanned vacation. “I just had to leave for 9 days, I couldn’t turn on business television, I couldn’t pick up the paper, and it was just devastating.”

So what now? My guess is we continue this pattern of lower highs and I will continue to sell decent rallies. Bond yields are not high by historical standards and typically once a trend change in bonds is started it continues for years.

Higher rates remain a long-term theme.

Food accounts for a third of the consumer price index and meat alone for 7 percent. ``The size of gains on stock markets, as well as the likelihood that food prices will keep consumer price inflation high in coming months has depressed bond prices in anticipation of rate hikes,'' M2, the broadest measure of money supply in China, probably jumped 16.9 percent in May from a year earlier, exceeding the government target for a fourth month, according to the Bloomberg News survey. The central bank may release the figures as early as today.
China's producer prices may climb 3 percent in May from a year earlier after increasing 2.9 percent in April, the survey showed. The statistics bureau will release the figures today.

Outlook on Gold, US & Global Equities

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Frank Barbera

Our medium term Outlook on Gold is now bearish, and we are bearish on Gold Stocks. Over the next few months, we expect Gold to fall below $550 to the low $500 area, where another long term bottom should develop.





The US and Global Equity markets are also completing major topping patterns, but should manage to hold up on the current rally for another 5 to 7 days. The S&P has a near term target of 1525-1530, and massive resistance at 1540-1550. We believe that within a few short weeks, the Chinese Shanghai Composite Index will begin an extended, multi-week collapse on the order of 40% or more. That decline, when it unfolds should trigger heavy selling in US Cyclical stocks, and in stock markets around the world, with Brazil, Mexico and Germany especially over-extended. The S&P could tumble initally on the order of 10 to 12%, bringing the index back down to the vicinity of the mid-March lows near 1360, possibly somewhat lower. Readers are advised to assume maximum defensive positions and seek the safety of cash.

HOTS Weekly Options Commentary

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Peter Stolcers

This has been a bloody week and I suspected that we were in trouble Monday when the market completely discounted the 10% drop in the Shanghai Index. After the muted reaction to that decline, our market finished a little higher. It wasn't until Tuesday that the real fireworks started. Concerns over higher interest rates were fueled by Chairman Bernanke's comments and England's quarter point rate hike. England's increase was largely expected and it should not have caught anyone off guard. Some analysts blamed the sell off on the surprise rate increase by New Zealand. I find that rather amusing given their small GDP and high 8% rate. The true culprit was a lack of news and a round of profit taking after a recent run-up to an all-time high. It took the market seven years to get to this point and heavy resistance should be expected.

Interest rates might be creeping up, but they are still near the low end of the 50-year range. Rates are not increasing because of inflation; they are rising because of global economic expansion. A positively sloped yield curve is good for the market and this rise will correct the current inversion. Corporate earnings have seen double-digit growth for 14 consecutive quarters. As a result, their balance sheets are strong and they are using cash to buy back shares or acquire companies. Last quarter was considered to be weak and earnings rose a healthy 6%. As you can see in the chart, over the last year the market has established a pattern of sharp declines that follow relative highs. The corrections are very short and steep and the recoveries are brisk. I do not see any evidence that the macro environment is changing. I do feel that many analysts have had to raise their interest rate expectations. None are more significant than Pimco's Bill Gross. He has been leading the charge for lower rates and he manages the largest bond fund in the world. This adjustment process creates chaos. I believe the market will get accustom to the "tight light" bias and it will put the relatively low interest rate picture back into perspective. Employment is strong and wages are increasing due to a tight labor market. Companies are profitable and the P/E ratios are reasonable. Inflation is relatively contained. Given these factors I do not see a doomsday scenario unfolding. I do see a market that needs to work off some excess and this is not something to stand in front of.






Next week's big economic numbers are the PPI and CPI. If they continue to show contained inflation, the market will rally. On the earnings front the only stock worth mention is ADBE. Overseas trading and M&A will have a bearing on Monday's open. If the market can get off to a good start and the PPI comes in on target, we could build on Friday's bounce. Option expiration weeks have been bullish and if the market starts grinding higher, buy programs could "goose" it even higher. Conversely, if the market can't sustain a rally next week, there is a chance that the lower support level of SPY 146 will be tested. I expect that level to hold. As long as it does, I will have a "buy the dip" mentality. This is a time to look for stocks with support and to wait for the market to show us that the 'bid' is back.