Interest Rates

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Sally Limantour
February 20, 2007

We had a long weekend to digest Mr. Bernanke’s statements and his views on unemployment and inflation were telling. The Fed’s forecast for unemployment for the next two years is for the rate to remain between 4.5-4.75 per cent –right where it is. My interpretation is that he feels the economy is in a sweet spot and employment is good enough to keep the politicians at bay while foreign wage competition is dampening inflation potential of strong employment.

While Bernanke spoke of the downside risks of housing, he also said, “To the upside output may expand more quickly than expected.” This translates to mean that there is a chance for a stronger economy. Had he left this statement out, Treasury Bond Futures (US H7) may have closed the week closer to or above the 11200 level.

We have a slew of Fed speeches this week (this could restore rate hike fears) and CPI due out on Tuesday. While the Fed will focus on the core PCE Index, it is interesting to look at expected CPI as a general guide. The difference between the yield on a 10-year Treasury Note and the yield on an Inflation-Protected 10 year Treasury Note is basically the bond market’s forecast of the US CPI’s future rate of change. According to Ray Hanson, of the Speculative Investor, over the last 3.5 years expected CPI has been in a range of 2.25%-2.70%. “In other words, over the past 3.5 years there has been neither a deflation nor an inflation scare” hence, the Goldilocks economy and the strong stock market. Were we to break out of this range on the upside, rates would tighten and the stock market would suffer. On the downside deflationary concerns would spark interest rates to fall and commodity markets would be spooked. This brings me to the central banks and the current problems they face today in assessing “stability.”

Historically, central banks attempt to achieve stability by looking at changes in interest rates against measures of the amount of spare capacity within an economy. If interest rates can be moved to set demand at a level consistent with “supply potential”, then central banks will achieve stability.

Another more familiar approach is for central banks to monitor money supply growth in order to gauge inflation. These two models have worked well in the past but with globalization the central banks seem to be having a more difficult time measuring inflation and determining stability. In The Independent, 02/20/07, Stephen King wrote about the problems central banks are having with measuring the economy using an old paradigm in a world of increasing globalization.

The first approach has inherent problems in that countries dealing with large scale immigration are trying to figure out the size of supply potential. “The Bank of England, for example, has to fret about the scale of labour immigration. It knows the scale of recent immigration has been big, but beyond that, information is sketchy.”

The second problem is with measuring money supply. At the touch of a button and with the speed of light capital is flowing across borders while bank deposits are switching from one jurisdiction to the other making it difficult to know the “real” level of money supply. Perhaps this is one reason why the Fed stopped reporting M3? It may also explain why it has been difficult for traders to get a handle on interest rates – remember how bullish the market was towards a decrease in interest rates only to see them move higher? Market expectations have changed often over the last 12 months and the transparency the central banks are offering may in fact, be “revealing the uncertainties” they are confronting.

Readers in the Hamzei Analytics' Virtual Trading Room know I have been a seller of Treasury Bond Futures since Nov-Dec 2006– selling rallies and buying back on dips. After trading down to the low 110 area I have been flat looking to sell 11200 – 11208. In the big picture I believe we are in an upward multi-year trend in interest rates which will take years to develop.

Keep a heads up this week with regard to Fed speakers, Govenors Kohn, Bies, and regional Presidents Yellen and Fisher. Tuesday’s CPI number and the BOJ rate decision are also potential market movers. In addition, stay alert to more talk of a potential credit crunch precipitated by the housing downturn and rising default rates.

PBS Interview -- Master Traders

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Fari Hamzei
February 20, 2007

We are thankful to AJ Monte and Rick Swope, co-hosts of Wealth & Wisdom with The Market Guys , who arranged for us to receive the master DVD of this interview recently. Last Fall, James DiGeorgia of Gold & Energy Advisor sponsored the W&W series. The interview was originally aired on October 20, 2006.

Video Part 1


Video Part 2


Video Part 3

Market Timing

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Fari Hamzei
February 16, 2007

For next week, we will take our queue from the NASDAQ semiconductor space.

Keep an eye on BRCM, MRVL and QCOM.

Do not panic about Ballmer-Gates comments on MSFT's Vista -- they are in rational expectation management business --- nothing about mass behavior during new market highs is rational.

We should see NAZZ take off next week -- this week it put an outside bar reversal -- this is very noteworthy !!

SPX daily is in its +1 to +2 sigma channel and SPX weekly put in at outside bar reversal.

Many perma bears have begun to panic after Uncle Ben's Humphrey Hawkins Testimony on the Hill last Wednesday and Thursday while the Street gleefully celebrated its best Valentine's Day ever!!

STAY LONG -- add some high beta stocks to your account -- market will return some alpha back to you !!

Read more about why Market Timing matters in BusinessWeek, February 19 issue, pp 80-81: http://www.HamzeiAnalytics.com/docs/BW_TD.pdf

Equity Index Update

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Brad Sullivan
February 16, 2007

The index markets traded in a light volume narrow range as Dr. Bernanke finished his testimony on Capitol Hill. The SPH7 contract produced a range of 0.4% for the entire session as players held their bids from Wednesday’s sharp advance.

This morning the indices are marked slightly lower on news that MSFT’s Vista software projections are a bit too optimistic. After trading through yesterday’s low in the SPH7 contract, buyers bid the pre-market higher on a rumor that AMR would be taken private in a deal led by GS. The morning’s economic data was right in line on the PPI with a headline reading of -0.6% and a core reading of +0.2%. Housing Starts came in a bit weaker than anticipated. Since that news, the indices have lost their slight bid and now rest around -1.00 pre-open.

We are focusing on an early close in the treasury market, option expiration in the equity markets and a pretty aggressive back and forth trade in the dollar. The Yen carry trade and its potential unwinding is in the back of everybody’s mind. However, I still hold that only a move below 115 in the Yen/Dollar would get the carriers frightened. And if that were to happen, it would be a short term detriment to the equity markets.

Keep a close eye on the “normal” expiration trade, which consists of a sharp mark higher just prior to and through the first minute of the open. Afterwards, look for a break around -0.3% in the SP before sideways action hits.

S&P, Yen and Gold

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Sally Limantour
February 16, 2007

The risk appetite is increasing in the financial markets and the shortest term indicators are now back at high levels. Consequently, my short term model is back to a sell signal. There was a notable short covering of put options yesterday and the 3 day put to call ratio is also moving back towards a sell. Closing long positions today ahead of the 3 day weekend and will execute short positions with a stop loss of about 1% above current levels between today and Tuesday.

The monthly capital flow report from the Treasury yesterday showed a net portfolio inflow of only $15.6 billion in December versus the “norm of $50-80 billion (Nov. was 84 billion). This is due to record net outflow of foreign investment from US equities and record US investment in foreign securities, according to Bank of NY economist, Woolfolk.

The Yen moved higher against every currency and the probability a rate hike at next week’s BoJ policy meeting is growing. The question is if the BoJ yields to foreign pressure, thereby raising rates, will the whole carry trade unwind and if so, will it be orderly? The Carry Trade was covered here on my February 4th post. The last time we saw an unwind was the summer of ’98 when the carry trade ended violently and some are concerned given the size of the short position today we could witness a protracted and painful event. This must be monitored closely. The BoJ members are in a “blackout” mode ahead of the policy meeting next Tues/Wed., so we will not hear policy statements until after this time.

Gold has formidable resistance between $668-674. Gold is trading lower this morning and next support for April gold is 663. Many cycle folks are writing about a cycle high due at the end of February. Perhaps if the market continues to reject closes over the 672 area we will go back and test the low 650’s. The real action of late is in the base metals, particularly nickel which rose 5.4% yesterday due to tight supplies. Nickel is up 22.3% for the year, versus copper which is down 7.2% year-to-date. There are a number of attractive companies to look at in the base metals sector.

Equity Index Update

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Brad Sullivan
February 15, 2007

The index markets caught a strong bid on the heels of Fed Chair Bernanke’s testimony on Capitol Hill. Dr. Bernanke gave a rather stunning assessment of the current domestic economy as he came across quite “dovish” versus his global counterparts (Trichet anyone?) on the future direction of interest rates, inflation and employment. On the inflation front …“while we have not had much new information, the recent readings on inflation are encouraging.” Perhaps his key catch phrase was “sustainable and not overheated” when discussing the current economic situation --- Golidlocks is alive.

The index markets did not wait for another utterance from the esteemed Fed Chair as buyers took in 95,000 SP mini contracts from 9:00 to 9:05 cst. An aggressive stance to be certain, and when the dust had cleared new trading highs for the move were established in both the SPX and DJIA. Interestingly, the Russell 2000 felt the brunt of rotational selling and finished the session with slight gains. This highlights the internal strength of the current marketplace. The Russell 2000 broke to new highs after nearly two months of a 3% trading range…in doing so the index rallied around 2.5% from its previous closing high. The SPX remains about -5% below its all-time highs established in the spring of 2000 and retested later that fall. Could we be in a position where the small and mid-cap indices mark time while the SPX makes a run at 1515?

Today is chalk full of data for the markets…and so far it has been generally favorable to “goldilocks.” The Philly Fed data at 11:00 cst always smacks of lunchtime desperation trading, so be cautious.

S&P, Currencies & Gold

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Sally Limantour
February 15, 2007

Yesterday we saw Retail Sales come in weak and Bernanke state that inflation risk is declining as the economy transcends from rapid growth to a more sustainable pace. This “cooling” was led primarily by the housing sector. Bonds rallied, the dollar tanked and stocks soared.

The S&P 500 reached its highest level in over 6 years and the Dow hit a new all-time high. Both markets took out the previous week’s low on Monday and reversed and have now created an outside bar on the weekly charts with a reversal higher – this is very bullish action. The Dow Industrials and cash S&P have now made higher weekly highs for 10 of the last 11 weeks and higher monthly highs for 7 consecutive months.

With the volatility levels remaining low the focus for most money managers has been to purchase puts to protect against a correction. Yesterday in our Virtual Trading Room we discussed this and Brad Sullivan was saying how the market could potentially have a “melt-up” which would cause all the folks on the sidelines to rush in. Should we, perhaps be buying calls in this low volatility environment? My short term model remains long, and stops are moved to 1445 basis the S&P 500 cash.

In Japan yesterday the GDP growth rate for 4th quarter was 4.8% which surpassed expectations of 3.7%. The yen rallied as did the Nikkei which was up .81% and closed the highest since May 8, 2000. The yen is continuing its rally this morning as are most currencies and the dollar is taking the heat. The perception seems to be with the dollar falling, gold will break out and make fresh highs as hedge funds and others raise their stake in gold as a commodity (rather than an inflation/dollar play). This coupled with the fact that the legacy banks are selling less gold is a hot story, but gold needs to break out above 684 to get the momentum going.

Also, a story out of China’s National Development and Reform Commission yesterday stated they had raised their exploration target for new gold reserves where they plan to produce 260 tons of gold which is a historical high for the country. This would basically mean an increase in supply and a drop in demand down the road. Both gold and silver are in a bull trend and until that changes, breaks are to be bought.

Market Timing

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Fari Hamzei
February 14, 2007

"first [two] one-hundred-point day[s] for DJIA in 2007" is not the issue.

what matters is where the SPX, DJ Trans, NDX and RUT Indices are trading at.

for a healthy market we need to see active participation by risk takers as evidenced by Russell 2000 (RUT) and see a healthy DJ Transportation Index (Trans is a fwd discounter of Economy as a whole) in ADDITION to SPX and NDX

Video Part 1



RUT weekly has put in an outside bar reversal this week and hit an all time high today but we did notice a big seller near the close and DJ Transportation Index closed at all time high today

Video Part 2


bottom line -- the pause we talked about last week has come and gone -- thanks to Uncle Ben

STAY LONG

Cheers and Happy Valentine's Day!

Equity Index Update

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Brad Sullivan
February 14, 2007

The index markets recaptured the majority of losses associated with Friday’s mid-session plunge. In fact, both the DJIA and Midcap 400 settled within a whisper of all-time highs. Many were explaining the rally on the AA news of a possible takeover, however, that seems a bit too simplistic. The fact remains that since the indices began their steady march higher in August of last year we have survived quite a few vicious one day declines. In each of these instances the sell-side failed to capitalize on any ground, gained both in price and market psychology. Accordingly, a spat of dip buying and short covering pushed the indices to new high territory for the move – will it occur again?

One aspect of the current environment that pushes me towards uneasiness (at least from the selling perspective) is the constant and growing chorus of those anticipating for a correction. The discussion about a -2% correction in the SPX on an intraday basis and low volatility and liquidity and selling premium and too many hedge funds and – well you get the point. These are the ingredients needed for a “melt up”… too many players on the sidelines, expecting a correction in order to get their positioning. The fact is this – if you waited to buy this rally, you would still be waiting. Strong markets do not let you in very easily. This discussion is running counter too much of my writing on Monday of this week. In that piece, I discussed liquidating long positions into Friday’s option expiration. I still believe that is a prudent move…however, at this point, given the information at hand I would liquidate only partial longs.

This morning brings testimony from FED Chairman Ben Bernanke…as he discusses the economic outlook in front congress for the next two days. In addition, we will receive Retail Sales. This morning, the dollar is sharply lower against its European counterparts. One trade that demands examination is the Euro vs. Dollar. The Euro has based for over one month in a narrow 1.5% range, well below the late 2006 contract highs. There is a potential – assuming the Euro closes over 13100 that we could see a sharp rally ensue over the next 6 to 8 weeks.

As for the index markets, all ears will be tuned to Bernanke and particular any comments about inflationary pressures in the economy. So far the new chair (with his one glaring miscue in May of last year) has hit all the correct buttons for the Street. If today is more of the same, we should move higher.

Currencies and S&P 500

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Sally Limantour
February 14, 2007

The Euro is on fire this morning and is now getting back into the value area that was rejected in that last sell off on Jan 3rd –Jan 5th. The market has gone above the resistance area of $1.3055. The European growth data yesterday was friendly and the boost this morning is from remarks by Austrian Central Bank Gov Liebscher when he said the bank is fearful that inflation is going to accelerate. There is other news out today that much of the euro’s rise this morning is due to demand from, “Russian names running into offers from an Asian account defending a $1.3110 barrier.” Market News.

The dollar rejected the 85.00 again and I thought we could see a fast move to test recent highs above 85.00 then fail, but it cannot even do that. Despite falling oil prices and rising bond yields the dollar cannot rally and this now has a feel of taking a more serious downturn.

The S&P (ESH7) opened strongly and had a range extension early on. Stops on short positions were hit at 1444. Closing above 1446.50 is short term bullish and put my short term model into a buy yesterday with stops below 1437 (1430 on cash index). Medium term model is neutral but expect to see a sell off in the next 1-3 months as the probability of a wave of risk aversion is rising.

Cupid Bernanke speaks today and I expect to hear the required inflation warning with the “on hold” theme.

Happy Valentine’s Day!