MASTERING
THE TRADE
ORIGINAL, INTERACTIVE SEMINAR ON TRADING USING
TECHNICAL ANALYSIS 

 SEC FILINGS

Particularly ominous in yesterday's trading was the long bond.  Many of you will recall that on August 10th, with the 30-year yield at 6.27%, we said the bond market was poised to rally, a rally which we said would be "unable to penetrate below the roadblock that exists at 5.86%-5.89%".  The bond market subsequently rallied, and after hitting the lower end of that "roadblock" at 5.86% the long bond promptly reversed, with yields rising above the upper end of their resistance to 5.90%.

We would keep a close eye on the long bond over the next few days, if yields fail to move back into the 5.86-5.89% range in the next day or two, we would expect the long bond's long term slide to continue, with yields rising back to the 6% level in  short order-- a level which will once again prompt a heavy selloff in the Internet and technology sectors.

The bond market has received little support from this week's economic data which as a whole continued to show that labor markets remain tight, consumer spending remains strong, and third quarter GDP is likely to show a strong pickup from the second quarter's pace.  The stock and bond markets are likely to mark time until next week's Chicago purchasing managers report and NAPM survey, with the outcome of the reports dictating the markets next move.

We expect both reports to show continued strength as consumer demand and inventory rebuilding spur on the manufacturing sector.

So impressed were we by yesterday's rally, we decided to order up a heaping portion of Yeehaw Yahoo!  Before we were able to act upon our impulse, the cynical duo of Papa Naggingvoice and Mama Naggingvoice appeared.

Pappa N. whispered ," pssst.... with valuations already stretched, what happens to the stock market if the economy does slow and corporate profit growth slows along with it?" Now, since we had a minds set on The Portal, we quickly dismissed his archaic talk of valuations and P/E ratios.

Mamma N., however, is more forceful in her demeanor than Pappa N., and she forced us to listen to her "the economy is sill going gangbusters" spiel by whacking us over the head with a stack of post-FOMC economic releases.

Her first weapon she used in her assault upon our senses was the July Durable Goods report. Now, even we had to admit, it was a pretty impressive report, with durable goods orders rising at a much higher than expected 3.3%.  Ex-transportation, it looked even better, with orders rising 3.7%, their fastest pace in 30 months.  Then she pointed to non defense capital goods (ex. those planes that Boeing makes): up 8.4%, their largest gain in nearly 5 years, and shipments up 3.5%.

"Hmmm, it looks like business is stepping up their investment in equipment so it can ship more during the 3rd quarter, does that mean GDP will return to the lofty 4% level?".  But then a light bulb went on and we blurted out, "what about that 3.9% drop in existing home sales?". "They remain near record levels despite 2 Fed moves", Mrs. Naggingvoice quickly retorted.

This morning, the Naggingvoices continued their assault on the senses with more economic data: first up were initial jobless claims, which showed a drop to 283,000, their four week moving average remaining near a quarter century low.  Quickly catching on, and anxious to end our ordeal at the hand of the Naggingvoices, we said, "Looks like the August employment numbers will be strong."

The rest of the morning's data added to the picture of an economy galloping along, unharmed by the two darts the Fed had fired.  The APICS business outlook survey jumped to 56.7, a four month high, and the future component rose to a 5 1/2 year high of 57.2.  "See this, more evidence of a pickup in manufacturing activity during the second half", Mamma N. hissed.

The revised GDP figures, despite the damage the trade deficit did to the headline figure, also hinted at a pickup in third quarter growth: inventories were revised down, consumer spending was revised up.

What we saw on those bits of paper she dangled before us made our newly found conviction that a slowdown was at hand waver.  Soon, we were asking ourselves, "Where's the slowdown, if two rate hikes have been for naught is the consensus wrong, are there more hikes over the horizon?"

As predicted, yesterday's hike in the discount rate stopped the growth of euphoria dead in its tracks, but did little to arrest the spread of the belief that the Fed's work is now done--a belief that we continue to believe is premature. The recent underlying signs of potential inflationary pressures that have begun to emerge in recent economic data remain, and until they show signs of abating, the current Fed rate hike cycle cannot be considered to be complete.

We would also not read anything into yesterday's continuation of a neutral policy bias.  As we stated following the June 30th FOMC meeting, a historical precedence exists for the Fed to adopt a neutral bias following a rate hike.  Yesterday's Fed action only strengthens that precedence.

After the market breathes a sigh of relief that the much anticipated Fed meeting is now in the past, we expect the focus to quickly return to interest rates, as the market returns to its recent ways of living economic report to economic report, with jitter led selloffs alternating with rapid relief rallies in quick succession.

Going forward, in the post-FOMC environment we now find ourselves in, there are several factors that bear watching: the aforementioned economic data for any signs of building pressures, the dollar, bad breadth, and deflation (more on this in a moment).

The dollar, while not possessing the glamour (or financial press coverage) of a money losing .COM, is one factor that could quickly reignite fears of further Fed moves.  While we expect the greenback to enjoy a momentary post-FOMC relapse from its recent downward path, we expect the pressure on the greenback to quickly return as the global economy continues to show signs of a return to health.  As we have stated in the past, the recent uptick in global growth has made the risk/reward ratio far more favorable in several overseas markets that are at the beginning of their economic cycle than it is in the U.S. market.  The repatriation of foreign funds is thus likely to continue, and accelerate as investors seek out markets where the odds are more favorable.

Bad breadth, some might say horrendous breadth, is another factor that cannot be ignored going forward.  While the present bounce by the major averages continues to present opportunities for the short term trader to profit, those with an intermediate to long term time frame should heed the warnings being sounded and use any rallies as an opportunity to lighten positions.

While the Dow's high on Monday once again brought the "Dow 12,000 or more" brigade out from the woodwork, we saw little to be excited.  It was a high that occurred without any confirmation from other averages--it was a high that occurred while the Dow Transports are entrenched in a long term downtrend. 

The recent rally from the August lows as a whole has failed to provide anything other than warning bells, for it is a rally that for the broader market has been illusory.  The numbers point out the narrowness of the present rally, with 52% of stocks below their 20 day moving average, 61% below their 50 day moving average, and 49% below their 200 day moving average.  It is a market where, for all but short term traders, buyer beware.

The economy is strong, the Dow is at an all time high, inflation is low, technology is changing both the economy and the way people communicate .... leverage is at record levels, playing the market is seen as the surefire path to riches, new methods have been invented to justify valuations, and complacency is leading the way higher ....

...but that was 70 years ago.  While the similarities between today and that fabled year of lore are striking, we are not of the camp that thinks that the aftermath of the present era of "irrational exuberance" will be a replay of the 1930's.  No, rather we see the market setting itself up to relive 1987 in the best case scenario if Mr. Greenspan continues to favor his Pre-emptive Crusader costume , and 1989 Japan in the worst case scenario--a scenario that would be made more likely if the Fed were to decide that two is more than enough.

The market entered today's countdown to the 2:15 statement prepared for only the best of all possible outcomes: perfection.  Now, outside of the rare baseball perfectly pitched baseball game or 300 score in bowling, perfection is a condition seldom seen in the land outside of children's fairy tales--and it is a condition that has yet to be achieved in the financial world.

Rather than living in a perfect world, the market at this point is living in an environment where complacency has sandwiched it between a rock and a hard place, a world where the market itself is its worst enemy, a world where the hoped for is likely to be the bringer of nightmares.  In short, a world where the psychologically buoyant effect on the consumer that a new high in the crown jewel of the stock market, the Dow Industrials, produces is something that should be feared by those who are hoping that the rate hike cycle ends today.

With complacency in the driver's seat, the market is setting itself up for trouble, whether that trouble occurs today or in the coming months is up for grabs, but whether history will repeat its path of 12 years ago or 10 is up to the Fed.

The market enters the week in somewhat better cheer, knee-buckling jitters replaced by an anticipatory tentativeness, the Dow seemingly poised to leapfrog its old high as the belief that "two, but not three" rapidly permeates the marketplace.

With a quarter point hike tomorrow factored in by one and all, the only unanswered question remains the trimmings that will accompany the FOMC's widely anticipated hike in the Fed Funds rate. The market is currently pricing in a 1/4% rise in the Fed Funds and no change in bias. While we concur with the current consensus opinion regarding Fed Funds and a neutral bias, we believe that there is a third part of the equation which is not yet fully factored into the market: a 1/4 point hike in the discount rate.

We believe that the Fed learned from their ill advised change to a neutral bias at the June meeting, and is unlikely to offer euphoria a second straight opportunity to blossom. A hike in the discount rate would prevent the transformation of relief into mass exuberance, and at the same time it would send the market a message--a message that while largely unexpected, would be unlikely to produce the broad based panic that the choice of a different messenger (a 1/2 point hike, or a change in bias) would likely cause.

The added move of a discount rate hike, however, is unlikely to change the widely held belief that the rate hike cycle ends at two, a belief that we have made clear before that we differ strongly with. Despite two rate hikes now being factored into the market, the prime driver of the economy has yet to be reigned in: the consumer's buying spree fed by a rapidly rising stock market. It will take further Fed action beyond tomorrow's expected move before consumer confidence retreats from current high levels and the economy begins to slow.

That drop in consumer confidence will only occur after the stock market's ascent is arrested. The further the stock market rises in the interim before Fed moves begin to have an effect, the longer will be the time required before the current rate hike cycle ends.

With recent economic data showing signs of an underlying current of potential inflationary pressures beginning to build, from wage pressures induced by labor market tightness to rising commodities, from a resurgence of global growth and the resultant inflationary implications of a sliding dollar, the Fed's job is far from done, and the market's current relief could be short lived.

After the FOMC meeting, the stock and bond markets may enjoy a brief respite from their recent jitters, but we expect this respite to be brief, and to be followed in short order by a return to the uncertainty of living economic report to economic report.