Sunday Morning Coffee - The Big Picture and More

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Fundamental backdrop: Imagine somehow that you were in the shoes of the Federal Reserve Board, considering your mandate, the combination of economic growth, minimizing unemployment, and price stability. Of course, wouldn't you be tempted to 1) cherry pick and 2) produce self-serving results?

There is only so much you can do amidst policy choices, ranging from setting interest rates, adjusting the money supply, and determining the relationships with foreign currency. Some argue that most of what you do relates to interest rates, but you know better. You want to be seen as 'fighting inflation', inflation that robs ordinary Americans of purchasing power, but amidst a massive current accounts deficit, you can 'monetize' the debt by printing currency.

You have the options of 'increasing transparency', which Wall Street likes, but you also prefer to keep the money supply 'adjustments' to yourself, the ultimate power of the state being to define money.

You want 'enough' inflation, but fear deflation, as your constituency, your masters are the rich and powerful who rely on inflation (asset inflation).

You've had some setbacks, as your predecessor, the architect of serial bubbles, Alan Greenspan, has left you with a massive housing bubble, amidst his encouragement (and denial) of consumers to take on adjustable rate mortgage and subprime debt.

Going forward, you face issues concerning dollar weakness (meaning inflation for foreign products), your relationship with trading partners who finance your debts, and the realization that globalization contributes to inflation (commodity) via competition for scarce resources and deflation as their cheap labor drives capital to its most efficient use.

Industrial production

The ISM continues to EXPAND. You've stated you want growth, and obviously you don't want recession. Can you seriously discuss rate reductions in the face of expansion? The question becomes however, amidst globalization, how important is US manufacturing, other than 'symbolic'? With automobile sales plummeting at both GM and Ford, how do you reconcile this?

Yield curve

The yield curve is positive, although not very steep. You own the short end, and the bond market speaks its own language. Short and longer-term rates are higher.

Rate spreads

Concerns about rate reflect investor time preference and credit quality. Even with the investment grade bonds here, such as two-tens, spreads are increasing. The financial economy produces 'something for everyone'. And the CDO market, which we have discussed here repeatedly, hasn't impacted the broad market to the extent that it could. Good management, or a market's unwillingness (inability) to mark-to-market, because of the potential house of cards of derivatives.
Here's the Broker Dealers Index, with falling MACD peaks and a 'forever' divergence. Price becomes the final arbiter, and this market has left a lot of dead bears in its wake. But even a broken clock tells the right time eventually.

Every investor needs to watch for the contamination of 'toxic waste' (equity tranches), which could spill far beyond what has been currently stated. Products to watch, the bank index, the bond index, the ratings agencies (e.g. Moody's (MCO), S&P (MHP), bond insurers (ABK, MBI), and more.

Volatility
Here's the monthly chart of the VIX, with upsloping 13 and 26 period averages, MACD in positive territory (histograms) and preparing to go MACD positive for the lines as well. Central bankers have a role in controlling volatility through expansion of the money supply, but it eventually shows up elsewhere (inflation, commodity prices).

Volatility is inversely proportional to liquidity. Our economic competitors loan us money (via bond purchases), to promote job creation and trade for their countries, a symbiotic relationship, as we are their consumers. The yuan-dollar linkage keeps our import prices DOWN, and a decoupling guarantees higher prices. Be careful what we wish for. Some (including I) believe that foreign central banks recycle some of the dollars into US equities, which shows up as ETF demand.
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Commodity Prices

Different commodity indexes have different compositions, but even so, what are the commodities doing?

The trio of charts above (Goldman Sachs Commodity Index ETF), CRB, and copper futures speak with one voice, an overall increase in the demand-supply ratio. A falling dollar also gets translated into the equation, and Commodity prices have their own cyclicality as Jim Rogers has aptly demonstrated in his book Hot Commodities.
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Well, how does this all translate for us, the investors, trying to sort out our own demand-supply, time preferences, and asset allocation?Currently, we have 68 ETFs trading at least 400K shares daily. 15 have stochastics less than 50, and among those less than 20, they include only four, three INVERSE ETFs (priced opposite major ETFs), plus the homebuilders. Are we ready to call the bottom for the homebuilders? Last week I had sold puts against HOV, but bought them back prior to the weekend. The Barrons article on the homebuilders may provide further sobrietary to this sector.
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The Utilities (here the weekly DJ-15) clings barely to its elevation above the close 15 weeks previously. MACD has gone subzero and the 13 period EMA has rolled over. Fosback's classic Stock Market Logic reminds us that utilities often lead the market.
__________________________________________________________________________________The pundits keep screaming that the large caps will outperform the small fry. Here's the RUT to SPY relative strength ratio. Tie goes to nobody.
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And despite the slight uptick in European rates, the EFA (weekly) to SP500 ratio still favors the foreign models.
__________________________________________________________________________________Gold has been in a sideways consolidation for about a year. Is that about to change? The GDX showed serious signs of life last week, and we'll see what it has to offer going forward. The deflation-fearing Fed has the 'problem' of currency creation, and ultimately commodities become the beneficiaries.
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Newmont Mining (NEM) made a statement Friday (price makes news) with a high volume gap above the down trendline, although MACD 'saw' this a couple of days (circle) earlier (long NEM calls)
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As we move into earnings season, we should see how the market reprices the second half of the year, with prices on many US indexes at resistance. Traders' eyes focus on everything - the bank index (114), brokers (many rumored to hold a lot more subprime paper than they acknowledge), utilities, and of course, the dollar, once again threatening to break down. And we want China to revalue?

Good trading and great risk management to all.
Educational use only. Never intended as investment advice. Not a registered investment advisor.