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"A Wild Ride"

Volatility and uncertainty have increased over the last month as traders wait on pins and needles for the next news headline that might point to where the markets are headed. Some analysts are dead certain we have seen the top for stocks as the bear market resumes, while the cheerleaders claim this is a perfect buying opportunity. For the last five days bond prices looked like they were doomed without support from the Bank of Japan, but today they got a bounce on signs the economy is weakening. Gold and silver powered higher but investors questioned the strength of the golden bull with the HUI Gold Index in the red, but ended the day with some nice gains. Oil was pounded to a low of $34.85 a barrel on reports of growing inventories, but bounced right back to end the day closer to $36.00. Will the European Central Bank cut interest rates tomorrow? As today marks the end of the fiscal year for Japan, will they stop supporting the dollar? Do we have inflation or not? The February Producer Price Index will be released tomorrow. How will the markets react to the February employment numbers on Friday? With the markets driven by excess liquidity and news headlines, you can bet on increasing volatility.

Recovery Momentum Slowing

Yesterday consumer confidence fell to 88.3, the lowest in five months after a reading of 88.5 in February and 97.7 for January. Today, the National Association of Purchasing Management announced its primary business index declined to 57.6 after a reading of 63.6 in February, the biggest decline since March 2001. They also said the production index fell for a second straight month to 59.1 after reporting the February number at 73. The new orders index also fell from 67.5 last month to 60.4. So now you ask, did anything go up? Yes indeed… With continuing increases of commodity prices, the prices-paid index jumped a whopping 11.6% from 66.9 to 75.7. As I said earlier, the PPI will be released tomorrow so we will see if the increase is commensurate with the prices-paid index. This is where I question the stock market cheerleaders that insist earnings will increase significantly, since companies are paying much more for raw materials but have very little pricing power to pass the increases through to the retail level.

The weak economic data put a mild damper on stocks with the Dow Industrial Average falling 24 points to close at 10,357, the S&P 500 miraculously held above the technically important level of 1,125 by inching down only a fraction of a point to close at 1,126, and the NASDAQ Composite dropped six points to close below the psychologically important 2,000 level at 1,994. One thing that really caught my eye with stocks today was the big divergence between the Dow Jones Industrial Average and the June Futures Contract for the DJIA. The futures were above the line all day while the index meandered in negative territory almost the entire session. Someone was in there buying futures in a large way! At one point I noticed the index was down 35 points with the futures holding firm at plus 24.

Without the support I suspect we would have seen triple-digit losses. I will be keeping a very close eye on Mike Bolser’s tracking of the Fed repo pool to see if they are pumping up the support for stocks. If you are waiting to short the stock indexes, watch patiently for another day or two since there is new money that goes into the market in the first week of each month. There are many workers with retirement contributions that remain on autopilot for investment to stock mutual funds. It could possibly present a better entry point to go short, but who really knows.

Interest Rate Reprieve

While the bad news on the economy put stocks in the red, it also triggered a flight to safety putting some decent bids into the Treasury market. The ten-year note closed roughly 0.5% higher, dropping the yield to 3.84%. The Mortgage Bankers Association reported today the purchase index fell 1.1%, the application index fell 2.1% and refinancing fell 2.6%. Thirty-year fixed rate mortgages rose to 0.11% to 5.49%, but still remain at historically low levels. If the Feds get their way, mortgages will have to stay low to keep the housing bubble fully inflated and allow more consumers to tap into home equity so they can pay their bills. This is an accident waiting to happen. Have a look at the ten-year chart of Fannie Mae at the top of the WrapUp. Tell me if you see the same massive head-and-shoulders pattern that I see forming. It could get really ugly if the neckline is broken, especially if they announce oversight problems with their enormous book of interest rate derivatives. Their demise would have a huge negative ripple effect on Treasury notes and bonds!

To Cut or Hold?

Tomorrow the European Central Bank will announce their decision on interest rates. After comments last week from ECB President Jean-Claude Trichet, there was much speculation whether or not the ECB would be lowering interest rates to stimulate their economy and possibly to weaken the euro versus the dollar. It is widely expected they will stand pat at 2% versus the 1% Fed Funds Rate here in the States. However, European bonds are pricing in a possible rate cut of 0.25% sometime before June. I doubt very much they will cut rates since the euro is vying for reserve status globally as the U.S. has enjoyed ever since World War II. Their target for inflation remains at 2% for the Eurozone, and the inflation rate has recently fallen back 1.8%. Cutting interest rates would weaken the currency which would help their export businesses, but it could also start a flight of capital out of the euro which would be highly undesirable.

As Jim Puplava has written, everything has gone up over the last year in dollar terms. The investment picture for U.S. assets and commodities looks quite different if you use euros to conduct your daily business. Please take a moment to see the graphic impact of investment returns for the last two years depending on where you live relative to the Atlantic Ocean.

European investors have seen very small gains in U.S. stocks over the last year, and have taken a pretty good beating if they were invested in U.S. Treasury bonds. If you think gas prices are high in the U.S., haven’t you always wondered why Europeans still pay three times as much as we do? It certainly appears the playing field is finally being leveled.

The U.S. has enjoyed artificially low energy prices because the dollar has been the sole reserve currency for the world, causing the dollar to be overvalued. Oil is cheaper now in Europe than it was two years ago, while it has skyrocketed in U.S. dollar terms. Similarly, gold hadn’t done much over the last couple of years in euros, but we see a major gold bull market when denominated in dollars. Notice the recent breakout for gold in euros! Also, note the huge inverse head-and-shoulders pattern that will provide a solid base to propel gold to much higher levels. When it really takes-off in euros, it will go absolutely ballistic in dollar terms! Attempting to place a true “value” on investment assets certainly takes a different perspective when viewed in alternate currencies. Since the value of “money” is constantly changing, it’s like trying to hit a moving target in the investment world.

News Headlines Dictate Market Movement

On Friday the all-important monthly employment will be announced by the Bureau of Labor Statistics. It seems that all eyes are waiting to see what it will be. The number will supposedly tell us if the economic recovery is for real. I believe there is more to it than meets the eye. It has been widely speculated that the BLS tinkers with the number to achieve the desired results. Virtually every month during the “economic recovery,” the number comes out like a shining star, but has been subsequently revised lower while nobody is paying attention. I believe it will be different this time.

It is purely speculation on my part, but I am fully expecting the number to come out below expectations. As it stands the forecast is for job creation over the last month to come in at 120,000. I think it’s going to be reported lower, because our system CANNOT handle rising interest rates right now. The system is way too fragile! Many officials from the Federal Reserve have been out lately on speaking engagements to say that job creation has been held back by increased productivity. President Bush even said, "Increased productivity makes it possible to grow our economy and not have people find jobs." I believe a statement like that is conditioning the market for a bad report. With a weak employment number, more money should move into bonds thereby holding long rates at artificially low levels. The Fed has openly stated they have no intent in the near term to raise interest rates, but they need to “influence” the market to keep long-term rates down. This is especially true if the Bank of Japan is actually going to halt their support of the dollar. A really bad number could tank the stock market, and they don’t want to crush it. Therefore, my prediction for the Friday employment number will be job creation in the range of 70,000 to 90,000. Time will certainly tell on this one!

Have a great evening!

Mike Hartman

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