Up, Up and Away

No, not stocks, at least not today. That dirty little word "distribution" jumped up front today. Not the greatest of distribution days, but clearly one, nonetheless. It seems to me that aggressive traders can start to take some short positions, with tight stops, and look to double down on a break of NDX 1564. Long positions should have been trimmed on Monday's strength, if not, now is the time to start doing some selling. There will probably only be one or two more decent selling opportunities in the next few months. The housebuilding stocks have taken it on the chin and will probably do so some more now that rates are on the rise in earnest. So long BZH and RYL! 3%+ percentage losses on larger and above average volume point out another case of distribution. There is that word again!

Bonds have cooperated beautifully with the script outlined last week. Look out for 4.9% on the ten-year note in the next two months and look out for the Fed as the realization that they are behind the curve (again!) dawns on them and the restraint of the Presidential election is behind them. Look for them to continue doing what they have been doing for the last ten years: driving monetary policy like a drunk on an icy, winter road. Only at this point, there may some dangerous curves ahead. Whatever happens, it will be exciting! (I don't think excitement is good, when I refer to the economy. And anything that is exciting with respect to the "undertaker" of our Federal Reserve cannot be good.)

Uninspired

Friday's uninspired action leaves a lot to be desired and I will selling into strength first thing on Monday. I expect things to get much more choppy from here.

Bonds are cooperating nicely with the scenario I have recently laid out for higher rates directly ahead. A holiday trading day should not have too much read into it, but expect the surprises to occur on the upside in yield. This is probably just the beginning of higher yields. Will this coincide with a rise in the Euro? So far it has, but the front page bullishness would seem to be a contrary indicator, but the crowds are not always wrong.

Low volume rally

Today was another low-volume rally. Not surprising since the path of least resistance is up and it was holiday. Look for a positive move on Friday's shortened trading day. But next week, be on the watch for another distribution day. If one occurs next week, then this rally is doomed. Resistance is now just above 1600 on the NDX, with support at 1564. Any breaks of these levels must be respected.

Bonds continue to work higher and are putting the finishing touches on a short-term base which will likely lead to an upside breakout in yields next week. No reason to be long the bonds at this juncture.

Distribution, distribution...

The second distribution day to hit the NDX in a week occurred today. Now the bulls would say, correctly, that Tuesday was a modest distribution and that the market was mixed with a small gain for the Dow and small losses for the other major indices. But distribution it was all the same. This following a strong market on Monday on lower volume. The armor in the bulls case is that the market is still in an uptrend and that the NDX actually recovered from larger losses, earlier in the day to trim the damage. This action suggests that the bulls have not given up yet and that another attempt to push convincingly through resistance around 1564 on the NDX should be expected. So look for a breakout to new highs for the move, but use any such move to lighten up. Those who are aggressive should wait for a breakout failure to go short using 1564 as a trigger for initiating shorts after a failed breakout attempt. Volatility remains historically low suggesting that an increase is inevitable. Patience and diligence are the keys here, because if a top is being put in place it will likely take a while to develop.

The bond market is giving much clearer signals, thankfully. Since these signals point to higher rates directly ahead, I am glad that I sold my bond position in October. Look for the ten-year to break above 4.25% in yield and head toward 4.90%, most likely in January. The next resistance level after that is 5.5%, a key level that would indicate an end to the multi-decade bond bull market. I am not so sure that such a level would be breached and at the present would lean toward repurchasing bonds with yields above 5.0%. But that can be dealt with when the time comes, until then stay short in duration and wait for better yields which are surely coming, almost surely in December with another quarter point bump likely from our good friend Al.

Moronic Hedonics

Well, today the markets are moving in a snap-back fashion to the post-Fed "head fake" that is not unusual. The problem is that in the process, volatility measurements are moving to new lows. This implies that volatility will also "snap back" to its normal range. So, either the market is about to surge higher and faster or it is due for a sharp correction. Since we have reached the 1540 to 1560 range of resistance mentioned yesterday for NDX, I am voting for the latter as the likely scenario. Also, yesterday's drop, although modest, technically qualified as a distribution day. Followed up by a sharp, holiday-assisted rise on lower volume, the reasonable interpretation is that upside is limited, at least in the short term.

Now to the title of today's rant. For those not fluent in bureaucratic doublespeak, hedonics is the term applied by government statisicians to "quality adjustments" made to series of economic data. Two recent articles by Walter Williams and Bill Gross discuss the implications of these adjustments on the GDP numbers and inflation statistics, respectively. Walter Williams argues in his analysis that GDP figures are inflated by almost 3 percent! Obviously, this has significant implications for an economy that is purportedly growing in the 3-4% range. Ancedotally, it seems reasonable that this is more realisitc, since the economy "feels" like it is growing at a rate more like 0.5 to 1.0% a year. Job growth (whose numbers are similarly manipulated) also "feels" more in line with these more modest growth numbers. Read the full text of this excellent analysis here : GDP growth not as advertised


Bill Gross has penned a missive along the same lines, blasting the Fed's bean counters for underestimating inflation. This also seems to agree with real-world experience as anyone who has bought a gallon of gas, a cup of coffee, groceries or a house can readily attest. His guesstimate of the false reduction in the inflation figure is around one percent. This also fits the goals of our elected and appointed leaders to accomplish their economic dirty work with no one being the wiser and complaining. Namely, our President can say that the economy is strong and our Federal Reserve Chairman can say that inflation is sufficiently under control that interest rates don't need to be raised further, faster. Don't miss this one! Haute Con Job

Fed Impact

First, a few political observations. Pres. Bush is floating the idea of Social Security Reform. Good idea. But I remain a little skeptical that the powerful vested interests will sit still and allow this to happen. On one side, Wall Street would love to see this become reality. On the other, Democrats will paint this as a "cutting benefits to the elderly". My cynical guess is that nothing will happen with this, Bush will score points with the financial community and the Dems will be given another notch on their belt for scaring old folks.

Secondly, Serhan Cervik of Morgan Stanley comments in an otherwise reasonable analysis that, "A descent to anarchy in the immediate aftermath of Mr. Arafat's passing is unlikely". Some people would say there is not much further descent possible. Read this excellent article here:
http://www.morganstanley.com/GEFdata/digests/20041110-wed.html

The widely anticipated move by the Fed to raise the Funds rate to 2.00% had minimal impact on the markets Wednesday. But as the Nasdaq is approaching this year's highs, expect some resistance and choppy trading between the 1540 and 1560 levels. With volatility measures moving to match recent lows after a few strong weeks, expect increased volatility as the market deals with this resistance area. Fannie Mae is looking vulnerable as it sits below its 50 and 200 day MA. But with inflation probably running in the 2 1/2% range, after taking out the government's "hedonic adjustments", the current Fed Funds rate is still stimulative and there will likely be enough liquidity around for the near term to at least keep the markets stable. A sustained sell-off seems unlikely until after the beginning of the year. But with the first year of the Presidential term being the market's worst year of the four, 2005 may not hold much promise for the bulls.

The bond market seems to be sending a strong signal that higher rates are coming at the long end. Does this suggest that the Fed has a good deal more tightening to do? The 10 year notes recent drop below a 4.0% yield has quickly and decisively been reversed. I am guessing that the yield will eventually reach 5.5%. That is why I sold my bonds last month. 2.0% isn't a comfortable return for parked cash, but it is better than 20% or greater capital losses.

Post Election "Analysis"

There has been a lot of analysis of the Presidential election results, lately. Some are saying that it was religious conservatives who made the difference, while some claim that Bush's improvement among Hispanic voters and women is what put him over the top. I am sure that there is some truth in all of that. But first of all, this discussion is at the margin, a swing of a few hundred thousand votes in the right state and the mirror image of Election 2000 might have occurred, with John Kerry winning the electoral college, while losing the popular vote by a percent or two. In others words, with over 100 million votes cast a shift of 0.2% would have been turned the world upside down. Ultimately, things are going fairly well, at the moment. Most people think that jobs are too hard to get, that Iraq is a mess and the price of a gallon of gas is way too high. But most of the same people have a job (maybe two), are not directly affected by events on the other side of the globe and can still afford to fill up the tank on the SUV that they just mortgaged the house to buy. So the incumbent gets to stay four more years (because even though he may not be what the people really want, who knows what the other guy would end up doing. The "other guy", John Kerry, surely doesn't know!)

But in a matter of hours, the Federal Reserve is going to meet. After that meeting, the cost of capital is going to go up 1/4%. That doesn't sound like much, but if you are in hock up to your eyeballs with more house than you need, more car than you need, more vacation cabin than you need, more RV than you need, etc., etc., etc., that $50k home equity line of credit at 3.25% is going to go up to 3.50% and that $350k ARM at 4.25% is going to go up to 4.50%. That is going to cost you about $60 a month more after the Fed meeting. And guess what, next month it is going to go up by the same amount. Matter of fact, the consensus among economists is that the Fed Funds rate will be 3.50% by 12/31/2005, up from 1.75% today. By that time, those two loans will cost you over $400 more per month than they do today. But wait, there's more! Those interest rate hikes will probably slow the economy down some, so those paychecks that aren't growing fast enough for you to afford to buy the house, the car, the cabin, the RV and the etc. without taking on a crushing debt load aren't going to be growing any faster. But somehow, you are going to have to come up with an extra $5,000 that year to make ends meet.

As long as the Iraqi elections go smoothly, the US withdraws and the oil starts flowing fast enough from that nation of tranquility to cause the price of crude to drop to $20 per barrel everything will be fine. If not, will there be a quarter of a million people with "voter's remorse"? Probably. If they had voted differently, would it have made a difference. Probably not.