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There is a great deal of volatility in the markets today. The U.S. dollar took three tough blows beginning yesterday from the Federal Reserve, overnight a positive economic report from Japan, and this morning another record trade deficit for the U.S. economy. Throughout the morning stocks have been mixed with the NASDAQ lower and the larger market cap shares in the Dow Industrials catching a modest bid. Treasury notes and bonds are also catching a bid so far today (pushing yields/interest rates lower) with the softened rhetoric from the Fed and tame inflation data on import prices. The dollar took its first blow after the Fed softened their language by removing the word “accommodative” in their statement yesterday. Overseas traders began selling the dollar in anticipation the Fed will back-off the rate increases soon. Overseas traders continued selling the dollar when the Bank of Japan said its Tankan Index of confidence among large manufacturers moved from 19 in the third quarter to 21 in the fourth. Most notably, the non-manufacturing index in Japan climbed from 13 to 17, a fresh new 13-year high. Hens Can’t Fly Maybe hens can’t fly, but the yen has sprouted wings to take off!! If the trend continues with moves like today, the yen will look more like a rocket in flight. Things are looking good for the Japanese economy as their trade surplus with the U.S. grew and confidence builds in the business sector. The March yen contract closed in the U.S. yesterday at 84.3 and gapped higher this morning to 85.5. Shortly thereafter, the Commerce Department announced an unexpected increase in the trade deficit and the yen continued to climb to an intra-day high of 86.65, a gain of 2.8% and the biggest dollar loss versus yen in more than four months. From one of today’s Bloomberg articles, “We’re confident the recovery in Japan is going to continue,” said Steve Friebe, a currency strategist at Credit Suisse Group in Zurich. “The yen has been underperforming big time and really has some catching-up to do. This is a buying opportunity.” I agree!
The big driving force in the markets today is the announcement of yet another record trade deficit at $68.9 billion. The report becomes much more significant when we see that it was truly a big surprise to economic analysts. Quoting from Bloomberg, “Economists expected the deficit to narrow to $62.8 billion for the month compared with a previously reported $59 billion gap in September, according to the median of 61 estimates in a Bloomberg News survey. The estimates ranged from $59.5 billion to $65 billion.” With the very highest expectation coming in at $65 billion from 61 different sources, it’s safe to say today’s reading of $68.9 is off the map! Imports rose 2.7% in October and exports rose by 1.7%. Trade Deficit Impact on Stocks One of the clues for the action in the stock market today came in the details of the trade report. Boeing exports increased by 173% which helped boost the overall exports to a gain of 1.7%, but the red flags go up for the technology sector in the U.S. as exports declined in consumer goods, computer accessories, and telecom equipment. I suspect another underlying force could be a flight to safety in the larger cap shares away from the more speculative issues trading on the NASDAQ. A falling dollar could prove to be positive for the larger multinational conglomerates. The strong dollar certainly didn’t help exporters here in the U.S. as we struggle against the global competition for low cost manufacturing. In the broader picture for stocks, traders are positioning for the close of the year. Most investors are wondering if we are going to get a late “Santa Clause” rally, or if we got it early with the run-up in November. Last year investors who jumped in the market in mid-December got burned in January unless they had a quick trigger finger to hit the sell button. Last year on December 1st the S&P 500 was at 1,173 and touched 1,217 on December 31st. Just three weeks later on January 24, the S&P 500 fell to 1,163. Last year the big sellers waited until January to take profits in the new tax year. I’m expecting some marginal new highs in the S&P 500 to close the year, but I believe we are near the top for stocks.
The bulls argue that P/E multiples will expand when the Fed is done with rate increases, but I’m not so sure. Last year the biggest year-end gains came in November, and I believe this year will repeat with a rollover in the coming weeks. From a technical standpoint, we are now getting that “marginal new high” for the S&P 500 index, but it is not confirmed with relative strength. From the chart you can see the price has moved higher, with a divergence in the momentum indicator. I’m waiting patiently to enter the market on the short side. I’ll be smiling to see a non-confirmed blow-off to 1,290! A Final Look at the Trade Deficit I found the trade data by region to be quite interesting, if nothing else. When I view the data by region I try to envision the political and economic implications for the near-term, roughly three to six months out. Here is some of the regional data presented in the same Bloomberg article I quoted earlier and a link to the full article. “By region, the Commerce Department reported that the trade deficit with Japan widened to $7.4 billion from $6.4 billion. The deficit with the Organization of Petroleum Exporting Countries grew to a record $9.4 billion.” “Elsewhere, the deficit with Canada, the largest U.S. trading partner, widened to $8.1 billion. The gap with Mexico increased to $4.8 billion. The deficit with the European Union widened to a record $12.1 billion from $10.1 billion.” “The monthly trade deficit with China increased to $20.5 billion, the highest ever, from $20.1 billion in September. The U.S. trade deficit with China for the first 10 months of the year was $166.8 billion, compared with $131.1 billion at the same time last year.” “Some U.S. lawmakers and manufacturers claim China keeps the value of its currency, the yuan, artificially low, giving it an unfair advantage by making Chinese goods cheaper abroad.” “China's trade surplus narrowed in November as exports rose at the slowest pace in more than three years, the Beijing-based commerce ministry said last week. The smaller surplus is unlikely to ease U.S. pressure on China to allow its currency to appreciate, economists said.” In a nutshell, the data above simply says the global imbalances are growing larger. I am reading more and more about foreign governments wishing to accumulate fewer dollars and diversify a portion of the forex reserves into gold, euros, yen, etc. The borrowing needs of the U.S. government continue to grow right along with the trade deficits. These trends are unsustainable…something will have to give. A lower dollar should cause import prices to rise, but China (along with other central governments) are not allowing it to happen. Pressure is building. I believe all the players just want to get through the Holiday Shopping Season so everyone has a chance to “make their nut.” In the trade report today our import prices declined by 1.7% on lower crude oil prices and a pegged yuan. This is giving the Fed more room to back-off the interest rate increases with muted inflation data. Keep an eye on the CPI report tomorrow to see how much more the markets will react to “tame” inflation. For now, interest rates are moving lower and stocks got an afternoon bid with the hopes of continuing lower interest rates. Also with regard to interest rates, the Mortgage Bankers Association said the 30-year fixed mortgage rate fell four basis points to 6.28% and the one-year ARM moved up one basis point to 5.50%. There appears to be less incentive to take on an adjustable rate mortgage, but ARM’s as a percentage of applications rose from 33.1% to 33.5%. The variable rate borrowers had better be hoping China does not lose its appetite for consuming U.S. Treasury debt. If they quit buying, rates move higher! Also from the MBA, their applications index fell 5.7% with the purchase index down by 3.5% and the re-fi index much lower by 9.7%. The re-fi index has been lower four out of the last five weeks. I’ll be watching to see if re-financing begins to increase after the shopping season to knock out those nasty credit card balances. Energy, Precious Metals, and Commodities Marked to Market There is a great deal to cover in commenting on what transpired in the markets today, and they are all inter-related. Another item that gave stocks a modest lift was the report from the Energy Department with better than expected inventories for crude oil. Traders expected to see a draw of roughly a million barrels, but instead got an inventory build of 900,000 barrels. Crude fell $0.52 to close at $60.85 a barrel. Unleaded gas saw a better than expected build and closed a half-cent lower at $1.64 a gallon. Distillates came in with a bullish draw of 100,000 barrels following expectations of a build around a million barrels. Heating oil inventory was down by 400,000 barrels and the price added nearly a penny to close at $1.845 a barrel. I’m expecting to see higher energy prices, but not so much due to supply/demand fundamentals. I expect to see crude move higher as the dollar moves lower, since the global trade is still predominantly denominated in U.S. dollars…for now. In the last few days gold and silver have been correcting off their recent highs. February gold closed $14.50 lower at $509.60 and March silver fell $0.12 to close at $8.465. I view this as a short-term correction and expect to see new highs in the first quarter. Gold was down 2.9% today and the HUI Gold Stock Index was only down by 2.6%. In the past, when gold was tagged for nearly 3% you could expect the stocks to get whacked for at least 5% to 10%...not so this time around. Overall we are seeing a great deal of volatility in the commodities market. Gold and silver are correcting, natural gas has been all over the place with a very wide price range, copper was down nearly 3% today. Most investors are not accustomed to the practices in the commodity market when it comes to taxation at the end of the year. With stocks, you can defer your tax liability by taking profits in January, but in commodities, open positions are “marked to market” and taxed as if they were sold. In the Midas commentary on Monday 12/12 by Bill Murphy (lemetropolecafe.com) I caught a tidbit from an anonymous contributor that will give you some insight as to what could possibly be happening in commodities overall. To be fair with his explanation, I will include the excerpt in its entirety as follows: hello
bill, anyway, something to think about, many of your readers are physical buyers or stock traders. many might be surprised to understand profits on commodities are marked to market at year end. even if they once knew this fact many not active in commodities accounts forget this important fact. this may prove very useful knowledge for what might be coming up. ie if a party were trying to cover a very large short position or establish a very large new position, an approach would be to begin the buying campaign in the fall of a year, which of course would put upward pressure on the commodity in question, (sound familiar) then as year end approaches many "weak hand" competing buyers with the resulting large profits on their position would be forced to consider the taxes due as a result of mark to market year end. these "weak hands" not knowing the true power behind the move in effect often sell for fear they will have large tax implications and should the price drop back quickly after year end the weak hands fear they would be stuck owing the large tax on the possibly now break even position. that is how most small traders think. as such a big accumulator knowing this and using it to continue their purchases with the price effectively stabilizing for a week or so from all the tax fearing weak hand selling all the while the accumulators were taking all they could. this will then lead to an explosive move when the tax fear selling abates ie the last week or december and into january. no way to tell if this will happen in the next week or so but if the prices stabilize a bit here, coupled with your research it may point to a major up move late december and after the first of the year taking most market participants breath away. just look at the move in fall of 1979, the brief tax selling stagnation around dec 14-21 and massive moves late december into january 1980 to get an idea of what i speak. history doesn't always repeat but it often rhymes. regards, here is a nice chart showing the move in gold 1979-80 which highlights my point: http://news.goldseek.com/GoldSeek/1134140466.php As I sit back and try to draw some conclusions in search of where money flows will be headed in the near-term, I see markets that lack near-term direction but are clearly exhibiting volatility. We could well be at a major turning point for stocks and the U.S. dollar. The next few weeks should be quite telling for the direction of markets and will set the tone for the balance of 2006. In the big picture I see the financial markets today as one big casino. There is too much cash chasing too few goods, leaving the excess cash free to run wild…chasing its tail for a return on investment…lots of “hot” money!. I believe the Fed has created a mess with excess liquidity causing rampant speculation in the financial markets and excess consumption for anyone who owns a credit card. The record trade deficit should speak for itself. The consumption binge in the U.S. is being viewed as economic growth while we mortgage our future with more debt today. I believe we will see some major trend changes as we move into the New Year! I wish you all the very best in your investment and trading decisions!! May His Peace be with you throughout this Holiday Season!! Have a Great Evening! Mike Hartman
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