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

 SEC FILINGS

***AUGUST PPI ROSE A LARGER THAN EXPECTED 0.5%.  CORE CPI FELL 0.1%, COMPARED TO EXPECTATIONS OF A RISE OF 0.1%.  See Complete PPI Release ***

A currency intervention by the Japanese government, and a lower than expected Core PPI reading combined to send the S&P 500 Futures market soaring into orbit this morning, with the September contract soaring 14 points.

Unfortunately, what looked like a sizzler, is turning into a fizzler, and perhaps with good reason.

The currency intervention by the Bank Of Japan, while producing a momentary halt to the yen's rise, is likely to prove futile in the end.  The BOJ took action during a dead period in the market, and with few around to step in its way, the intervention initially drove the yen from the sub 108 (to the dollar) level

 Currency interventions, while done with good interventions, are ultimately powerless against prevailing market forces.  We expect the yen to continue to climb until its rise faces its real test around the 105 level.  The dollar's weakness against the yen will continue to have a limiting effect on any upward movement by the stock market.  A failure to hold the 105 level, an event which we view as unlikely, could have a potentially devastating effect on both the U.S. and Japanese stock markets.

The lower than expected Core PPI reading (a drop of 0.1% compared to estimates of a 0.1% rise), while at first glance favorable, is unlikely to sway the Fed's decision making one way or the other.

A drop of 0.1% sounds nice, but it must be remembered that this figure merely mirrored the 12 month average for Core PPI, thus, nothing changed with today's release.  The Core PPI reading must also be counterbalanced by the headline figure, which rose a stronger than expected 0.5%.  While the 12 month moving average of Core PPI has remained remarkably stable, the trend for the headline figure has shown a steady rise this year.  This month's data did show that commodity prices have reduced their long slide and their rise in price has begun to feed through the supply chain, with crude goods registering their first price rise in nearly two years.

Now, it is possible that this month's strong rise in commodity prices will never make it all the way through the chain to the consumer, but in this case, it is corporate profit margins which will suffer, a no win situation for the stock market.

While today's figures did show that inflation remains at bay in the current environment, they also showed that those underlying inflationary pressures of which we have spoken of ad nauseum, and of which the Fed has already acted on twice, remain all too alive and well, and are gaining momentum.

At this point, as we said last Friday, the jury is out on the Fed's next move pending further data, which the market will receive next week with the release of August Retail Sales and CPI numbers.

Economic data, and the Fed, aside, we continue to question whether the stock market has the ability to mount a sustainable rally.  The reason is (aside from historically high valuation levels in an unfavorable interest rate environment), of course, those words that technicians like us enjoy throwing around to the consternation of others: Divergence and Narrow Breadth.  As today's market chart shows, the present stock market rally has not been an equal opportunity share price riser.

The consumer's love affair with plastic grew stronger in July, as consumer credit galloped ahead at an 8% pace, with another $8.8 billion of installment debt being added to an already overflowing platter.  The lowdown on yesterday's data: the consumer's urge to splurge has yet to be reined in by higher rates, and the high debt level of many consumers could spell trouble for many of today's plastic aficionados if Greenspan & Co. are successful in slowing economic growth.

The latest saga of the consumer debt merry-go-round was but a minor blip on the news radar screen yesterday, however, as all eyes remained focused on the gabbing Fed members, who failed to utter the magic phrase, "read my lips, no more rate hikes" .

 One news worthy note that was uttered yesterday, but went largely unnoticed because its utterance occurred after the menagerie of talking head financial media had long since departed, came out of the lips of NY Fed president William McDonough, who opined that the Fed expected Y2K problems to be minimal. The significance of McDonough's statement for the stock market (along with the prep work the Fed did yesterday to insure the banking system remains shipshape when the millennium dawns) is a two edged sword: the Fed's relative calm on the Y2K issue means they will not feel pressured by Y2K concerns to hike at the October meeting in order to avoid end of year problems, the flip side is they also will not feel pressured by Y2K concerns not to hike in November or December.  In short, a rate hike will come when deemed necessary.

In today's trading, however, it is not Y2K that eyes will be focused on, but rather it is the dollar in the wake of GDP Thursday. For the second straight morning , events overseas have put pressure on the greenback.  Today's buck buster: a surprise 0.2% rise in April-June Japanese GDP, a 0.2% rise that was driven largely by a 0.8% rise in consumer spending, signifying that the recovery in Japan could have legs.  The GDP number has sent the yen soaring to 108.77 to the dollar from yesterday's close of 111.1, and the U.S. Dollar Index sinking uncomfortably close to support.

While the bond market is feeling the heat from the dollar's plunge against the yen, the stock market is more sanguine as the market prepares to open, with S&P Futures closing up 0.30.  The stock market's ability to remain unaffected thus far this morning is largely a result of investors becoming acclimated to their new surroundings, the land of  rates over 6%, a level which only recently shocked, has now become accepted as each return trip increases the pain threshold (bond yield tolerance) of investors. The result is complacency at levels which once excited, and the danger is that when this new found bond yield tolerance has been stretched to its limits, the complacency will quickly turn to a panicked stampede for the exits.

No stampede is likely to occur today.  Instead, today there will be a little more Fed speak, and tomorrow there will be the PPI, but we would keep in mind that tomorrow's PPI is yesterday's inflation data, while today's weak dollar and surge in oil prices is tomorrow's inflation data. 

While the failure of the CBS/Viacom merger to spark a rally yesterday was a mild concern, we did not lose any sleep over it, the announcement coming as it did on a day when profit taking in the wake of Friday's relief explosion was inevitable.

That's not to say we didn't lose sleep over yesterday's market action, for we did, our night of twisting and turning a result of the bond market's failure to follow through on Friday's rally.

While a portion of the bond market's dismal performance yesterday can be traced to worries about this month's looming abundance of corporate supply coming to market, the remainder of the bond market's woes yesterday could be traced to a familiar source: Fed rate hike jitters, this time caused by a breakout in the CRB Index.

The CRB Index's surge yesterday, largely a result of a strong rise in oil prices (although we must say soybeans also joined in the upward romp), is a reason for concern.  A bottom is firmly in place in commodity prices, as today's market chart shows, and the CRB Index looks set to continue its upward path.  With the inflation reducing downward spiral of commodity prices now transformed into an inflationary uptrend, one of the main ingredients that has allowed the U.S. economy to enjoy strong growth and low inflation has now been removed from the mix.

An upward revision to global growth estimates by the IMF yesterday, from 2.3% to 2.8%, served as further notice that the circumstances that allowed the U.S. to enjoy its high growth/ low inflation Goldilocks period have now changed.

In the face of strong global growth, rising commodity prices, and a tight labor market, the mixture of the stew has changed, and the threat of inflation developing continues to loom, despite last Friday's benign employment report.

The bond market's realization that the problems that prompted the Fed's first two rate hikes remain, and with their continuation, the threat of further moves by the Fed cannot be ruled out, was largely responsible for yesterday's poor showing by bonds, and the accompanying reappearance of the jitters.

While sentiment in the bond market remains cautious, the stock market is a different story, with many stock investors convinced that last Friday's data spelled the death knoll for the current rate hike cycle, and cries of "The data shows no inflation, the Fed won't hike", rampant once again.

For a day at least, they will.  Beyond today, the picture becomes murkier, with the same old questions remaining, unanswered despite Friday's employment report driven euphoria booster shot.

The dollar, and its fate, tops the list of problematic question marks that continue to overhang the U.S. stock market.  The U.S. Dollar Index has momentarily escaped a near fatal brush with support at 99.1, climbing back above 100 this morning, its rise aided by a trio of factors: a surge in the sightings of complacency-filled clouds floating over Wall Street, an unexpected rise of 4,000 in the number of Germans who count themselves among the jobless, and a surprising 13.4% drop in second quarter Japanese capital spending. 

The dollar could receive an added boost on Thursday if pivotal second quarter Japanese GDP figures meet expectations of a 0.1% decline (on the flip side, a gain of greater than 0.2% in Thursday's report would touch off a frenzy of yen buying, and the resultant sharp decline in the dollar would touch off a stock market sell-a-thon). 

While the dollar is temporarily looking a mite healthier, we continue to believe that the odds are against it making a sustainable move higher. While growth remains strong in the U.S., valuation concerns, an unfavorable interest rate environment, and an economic cycle in its latter stages will continue to drive money to markets where the valuations are lower, and the economic growth cycle is younger.   The grass continues to look greener on the other side of the fence, and the dollar is likely to remain under pressure longer term as the trickle out effect of foreign funds in search of a better risk/reward ratio continues.   The negative outlook for the dollar remains a strong roadblock in the path of sustainable higher U.S. stock prices.

Just as the questions surrounding the U.S. dollar were not resolved by last Friday's surprisingly benign employment report, the questions surrounding the Fed's next move on interest rates remain unresolved despite an overwhelming belief by many that one indicator has the power to negate all that came before it.

Last Friday's euphoric surge of "the Fed is out of our hair now" complacency is likely to die a swift death on Wednesday and Thursday, replaced once again by the debilitating malaise of rate hike uncertainty, as the Fed steps up to the podium, and speeches by Greenspan, Gramlich, Meyer, Ferguson, and McDonough (X2) dampen sentiment. 

While we do not expect any bombshells to be dropped by the Fed quintet, we also do not expect to hear a recantation of recent views on the valuation levels of the U.S. equity market, nor do we expect to hear Fed officials voice the opinion that last Friday's market-bullish economic data negated the market-negative data that immediately preceded it: productivity, unit labor costs, the NAPM's prices paid component, or the strength of consumer spending and the housing market. Despite the enthusiasm shown by armchair economists on Friday, the Fed's next move remains up in the air pending further data.

Also remaining up in the air is the fate of the U.S. bond market, where despite Friday's strong gains, the weekly chart added another down bar, and the long term trend of bond prices remains down while the trend of interest rates up.  With the trend in the bond market still negative, and rates remaining above 6%, Friday's wholesale erasure of the words "valuation levels" from memory is likely to prove to be a costly mistake, especially in a divergence laden market where 51% of stocks remain beneath their 200 day moving average.

The week begins much as many weeks in the recent path have: with uncertainty in the driver's seat.