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The tragedies of Hurricane Katrina are now starting to be seen more clearly. The markets are struggling to adjust for the damages created by the storm. We have havoc in the energy market with crude coming down on the announcement that supplies will be released from the Strategic Petroleum Reserve, but natural gas and gasoline are going through the roof due to infrastructure damages throughout the Gulf Coast. Treasuries have caught a huge bid, especially the two-year note, in a flight to safety. Interest rates are moving lower, as the Fed still talks of higher interest rates to come. The dollar finally caved today, but nothing can shake the Dow Industrials, as Dow 10,400 is vigorously defended! More than anything, I want to say my heart and prayers go out to the victims on the Gulf Coast. Millions of people are dislocated; there are many dead and missing; FEMA says it will be weeks to sort it all out; if you are financially able to help, much is needed for relief. Above all I pray these folks will get the shelter, comfort, support and hope that they so dearly need! The markets were hit with some very negative news early this morning. The Commerce Department adjusted second quarter GDP down to 3.3% growth from the estimated 3.4% last month. This follows a growth rate of 3.8% in the first quarter. The economy is clearly slowing, and interest rate analysts are saying the Fed might now reconsider on their measured rate hikes. The much bigger negative piece of news came from the Chicago Purchasing Managers when they said their Business Barometer fell to 49.2 from 63.5 in July, following expectations the number would drop to 61. This was the biggest decline on record and the first contraction in the NAPM index since April 2003, making a new 28 month low. The new orders index fell from 69.6 to 46.5; the production index dropped from 70.5 to 56.2; the measure of prices paid by manufacturers for materials rose from 61.3 to 62.9, and the employment index declined from 56.1 to 51.7. Four out of four components of the Purchasing Managers Report were all very negative for growth moving forward! Treasuries are doing what they should be doing with the capital flight to the safety of the two-year note. At one point this morning the yield was higher on the two-year note than the yield of the three-year note. This is an inversion of the yield curve on the short end as fast money scrambles for safety. The Fed is still expected to raise another 25 basis points, but there is now some doubt if they will continue with increases later in the year. For now the Fed wants higher rates, but the bond market is doing just the opposite. Today’s update from the Mortgage Bankers Association said the thirty-year fixed mortgage rate fell five basis points to 5.73%, with the average one-year ARM rate moving four basis points higher to 4.88%. The Fed wants to cool the froth in the housing market by offering less incentive to take a variable rate mortgage. Short-term financing is becoming more expensive, but overall, mortgage rates remain historically low. Mortgage rates will remain soft as long as money continues to flow into the perceived relative safety of U.S. Treasury debt. Rates have softened up over the last week, but the MBA said their applications index fell 4.5%, with the purchase index falling by 3.6% and the re-fi index down by 5.4%. The decline in the applications index was the eighth decline in the last eleven weeks. Be careful before you bite off more than you can chew in the real estate market…it is clearly slowing, but low rates will keep things going for a while. Dollar and Stocks In my opening paragraph, I said the dollar finally caved today by falling 0.76 on the Dollar Index to close at 87.56. The euro rose nearly 1% to 1.2344, the Swiss Franc gained 1.2% to 79.84, and the yen picked up 0.5% to settle at 90.54. I expected the dollar to take a serious hit due to Katrina on Monday, but it didn’t happen. It didn’t happen yesterday either, but today it appears reality of the problems on the Gulf Coast are beginning to assert themselves, along with the very negative report from the Chicago Purchasing Managers. On Monday I expected stocks and the dollar to go down, but in my opinion, damage control was put into full force by the Working Group on Financial Markets. So far, the worst spin of the week came on Monday with this blurb from Bloomberg News: “DOLLAR RISES AS HURRICANE IS DOWNGRADED, OIL BACKS OFF RECORD” (Aug. 29) “The dollar gained versus the euro, yen and 12 other most active currencies as oil prices retreated from a record and Hurricane Katrina’s damage wasn’t as bad as forecast. ‘The fact is that the hurricane is not going to be as devastating as initially thought,’ said Michael Malpede, senior currency analyst in Chicago at futures broker Refco Group, Ltd. ‘The downgrading is being used as an excuse to buy dollars.’” They sure got it wrong with the hurricane not being as bad as forecast, but at least the senior currency analyst at Refco got it right by saying it was an “excuse” to buy the dollar. The dollar tried to hold on with damage control pushing all other currencies lower, but today reality is taking hold as motorists line up to put gas in their tanks. Some analysts are suggesting we could be on gas-rationing within a week or so if refining capacity doesn’t come back online quickly. The transportation sector is struggling with concerns over fuel shortages! The major stock indexes slumped in the first hour of trading, but refuse to go lower in the midst of all the bad news! With all the upheaval this week, the Dow Industrial Index absolutely refuses to close below the close last week. On Friday the Industrials closed at 10,397 and each day this week the index has gone below Friday’s close, but each day has crawled back to close higher, and in the last two hours of today’s session the index moved higher to close with a gain of 68 points at 10,481. Have a look at the chart to see what I mean:
Rather than just accepting my explanation that the Plunge Protection Team was aggressively buying S&P index futures, it is worth considering the explanation I received from one of my email buddies, Mr. Richard. If you trade commodities it is important to watch the Commitment of Traders Report, as savvy traders will fade the specs and attempt to ride on the coattails of the commercial traders. Similarly in stocks, the “public” would be considered the specs and the “specialists” would be considered the commercials. With that brief preamble, here is part of the analysis from the Wall Street Courier: Apparently anybody who is short the market right now can be classified as dumb money because small traders have not been this short compared to specialists since 1943. Not even in the ’73 – ’74 time frame, when they did not have options, meaning if you wanted to be short stocks, outright sales of borrowed stock was the only method, have small traders been this short. (See Figure 3) Figure
3 So, not only do you have stubbornly high index related put / call ratios because of speculators and hedging strategies by the funds, we also have the small trader reading about the increasingly bad news out there and getting short like never before. Thus, a floor is put in place for stocks against the backdrop of generous liquidity provided by the Fed, and even if there is an unexpected hiccup to the downside, it’s a buying opportunity. This of course explains why the CBOE Volatility Index (VIX) remains lows, not to mention the fact speculators are long call options on this index as well, meaning in it’s own right, prices will not rise until this condition is burned off. We must congratulate the banker boys on bringing out options on the VIX. That was a stroke of genius in terms of perpetuating the squeeze. Bravo. (See Figure 4) Figure
4 It used to be easy making money shorting the market before conditions matured to this point, but now it’s hard. The competition is now so intense, largely brought on by the hedge fund industry, where their hedging strategies are a large part of the reason stocks remain buoyant to this day, that market returns have flattened out, causing investors to pull their money out of these heavily leveraged plays, often in favor of real estate these days. One would think that with money flow coming out of the stock market that prices would go down. But, of course it appears this process may just be starting, so in the meantime stocks can get squeezed higher when everybody gets back from vacation in September, the best month of the year to buy stocks on a historical basis. The stock market could well get squeezed higher as we approach the Fall Season, but I still don’t like the risks of the broad stock market. I received another email today from my friend Jim Willie, who thinks we could have the makings of an inverse “Head & Shoulders” formation for the HUI Gold Stock Index. I agree wholeheartedly with Mr. Willie! Last week I mentioned we will probably get a nasty take-down in silver before it breaks-out to new highs, and it appears the shakeout has taken place. I’ll be watching silver very closely to confirm that the near-term bottom is in. I like to close with an “opportunity” chart, so thanks to Jim Willie, I’ll draw a couple potential necklines and look for the completion of the right shoulder, then look for the potential breakout to new highs!
Overall, it is going to take weeks to sort-out the damages from what can be considered the worst natural disaster in U.S. history. Impacts from the storm will be felt for months to come. I just got late word that fuel rationing has already begun in some cities on the East Coast. If you can help the storm victims financially with a donation, more power to you!! If you are not able to help financially, a trip to the prayer closet requesting help, comfort and hope for the victims won’t cost you a dime!! Have a Great Evening! Mike Hartman
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