Liftoff, Soft Landing or Crash?
by M.A. Nystrom
December 12, 2005
Cambridge, MA
Click
here for Part II
The Federal Reserve Open Market Committee will meet
this Tuesday the 13th and release its decision on short term US
interest rates at 2:15 pm EST. It is already foregone conclusion
what the Fed will do, but what really matters is what the Fed will
say. Rates are certain to be increased (for the 13th straight time)
to 4.25%, but the open question is whether the Fed will change its
mind about further increases. Whatever the Fed says, the effects
of its words are likely to be visible immediately in US markets,
and certainly by the close of trading on Tuesday.
The jury is still out on whether the Fed will change
its stance and soften its tone on further rate increases, or whether
it will continue to sound the warning bell on the specter of inflation.
This uncertainty has both the analysts and the markets guessing.
The uncertainty can be clearly seen in a number of financial and
commodity charts, as I will demonstrate. What follows is a brief
overview of four key markets that are likely to be impacted following
Tuesday’s Fed decision: 1) The S&P 500 (as a proxy for
the entire US stock market), 2) The US Dollar Index, 3) Gold, and
4) Oil. Briefly, the stock market and the dollar are clearly in
holding patterns and should remain so until Tuesday, waiting for
a signal from the Fed to continue their advance or to stand back
down. Gold has already cast a clear vote for inflation, while oil
appears still to be in the process of making up its mind.
S&P 500
 As
shown in the accompanying weekly chart, the SPX, has been in a steady,
if not spectacular, uptrend since the beginning of the Iraq War
in March, 2003. The 50-week moving average has held as support for
the rise on a number of occasions, most recently this during the
declines of last October. With that solid support, prices surged
through long-term resistance of 1245 in November on indications
that the Fed may be softening its stance towards further interest
rate hikes. After the sharp run-up, prices are now consolidating
at their highs (as shown on the accompanying daily chart), which
is not necessarily bearish. What is bearish is weakening breadth,
volume and momentum indicators at these highs (not shown). Prices
have reached a stalemate, and are waiting for a catalyst. They may
turn down from here, or this consolidation may simply be the pause
that refreshes, allowing them to move higher. My bet is that we
will have a clear answer to this question by the close of trading
on Tuesday.
While we’re on the subject, the Dow (not shown)
is in a similar situation, having been turned away recently from
resistance at 11,000. If this level is penetrated to the upside,
it would give a big psychological boost to the bulls and prices
could quickly move to new all-time highs, furthering bullish sentiment
for US markets in general.
US Dollar Index
 The
daily chart of the March US Dollar index looks surprisingly similar
to the SPX daily chart – a move to new highs with a downward
sloping consolidation. However, like the SPX, the dollar is beginning
to look a little tired on a momentum basis. But pulling back to
the weekly view, we see a large potentially bullish reverse head
and shoulders pattern. While this chart pattern has a high degree
of reliability, it is certainly no sure thing – see the daily
chart in gold below for an example! The only certainty in the market
is that there is no certainty. Furthermore, this reverse head and
shoulders pattern is clearly visible to all participants, and has
already been widely discussed. Markets are rarely ever so simple
and clear in signaling their intentions. Like the Dow & SPX,
the dollar is in a holding pattern, waiting for a catalyst to push
it in one direction or another. That catalyst should arrive on Tuesday
at 2:15 pm.
Gold & Oil
 Gold,
as we have all seen over the past few weeks, has voiced its inflationary
opinion quite clearly. The accompanying daily chart shows the busted
head and shoulders pattern that led to the spectacular rise in gold
that is still in progress (currently at 535 as I write). Gold really
began its takeoff after the announcement on November 10th that the
Fed
would discontinue publishing M3, in March, shortly after Bernanke
takes over as Chairman. This announcement, combined with Bernanke’s
inflationary reputation, was apparently all that was necessary to
convince traders that future inflation is a sure thing and that
the Fed is taking steps to be able to hide it. As a result, gold
took off.
Curiously, while gold is clearly signaling inflation,
oil is telling a different story. Oil has been in a steady decline
since Katrina, from a high of almost 72 to a recent low of near
to 56 (January basis), a 22% decline. After hitting its near term
low, it has had a decent 9% rally, and popped outside of the downtrend
line that has contained its recent decline. Whether this is the
start of a new uptrend or just a bear market rally remains to be
seen. Friday’s key reversal and big decline cannot be encouraging
for the bulls. However, markets rarely reverse on a dime, and choppy
trading such as this can be an indication of an approaching change
in trend. This market needs to be watched carefully as a signal
for inflation.
The fact that the dollar has been stubbornly holding
its ground while gold has been rising so strongly presents, as Chairman
Greenspan himself might put it, a conundrum. One of these markets
is not telling the truth. If the inflation that gold is signaling
is real, then we should see a decline in the dollar and the US stock
market soon, and oil should resume its bull market, rising in tandem
with gold. However, if the Fed were to indicate that inflation is
in check, gold may turn down sharply in a “buy the rumor,
sell the news” type of event. This would free the dollar and
the US stock market to continue in their respective rallies.
Nystrom’s Two Cents
While it may seem nonsensical to average Americans
that the dollar remains so strong in spite of the apparent weakness
of the US economy (GM and Ford each laying off 30,000 highly paid
workers, and a housing market bust on the horizon that may cost
up to 800,000 jobs), I have an explanation. We are living in fictitious
times, and perhaps the twilight of this illusion is near. But as
of yet, the financial economy that is the domain of governments
and big international banks still trumps the real economy of production,
workers and labor. At present, it is widely accepted that the dollar
is holding its strength based on its interest rate advantage over
other major currencies such as the yen and euro. In spite of the
government’s precarious financial situation, US government
debt is still considered to be a “risk free” investment.
(After all, it is backed by the full taxing authority of the US
government. That means your back, fellow citizen). International
investors can thus feel safe when they borrow in foreign currencies
at a low rate, and invest in US government debt a higher rate for
“guaranteed” returns. It is the next best thing to having
what Bernanke calls the government’s printing press –
free money. In essence, this is what makes the US dollar attractive
to investors (especially foreign ones, and especially rich ones)
and keeps it strong, in spite of the nation’s abysmal balance
sheet. This investment relationship pushes up the value of the dollar,
making it more difficult for US manufacturers to sell their products
overseas, and makes it more difficult for Americans to find decent
paying work. Yes, it is bad for the real economy, but it is good
for the bankers.
Perhaps one day we’ll live in a real world,
a world in which production, labor and hard work are once again
valued. In that world, the market won’t cheer when a dying
American icon announces
plans to layoff of 30,000 employees. And in that world, our
political and financial leaders will take responsibility for the
welfare of their workers and citizens, as good leaders should. In
that world, government will once again be of the people, by the
people, and for the people.
But back to our world:
Greenspan’s Legacy
Because Greenspan is nearing the end of his term,
he is most likely interested in preserving his legacy as one of
the most powerful and popular Fed Chairmen ever. As a result, he’ll
want to go out on a high note, being remembered for what it was
like during the best of his tenure in the mid-90’s: A strong
dollar and a strong and rising bull market in US stocks. Forget
the imbalances that
he has been silently warning about – it’s too late
to correct them – better just to leave them to the new guy
to handle. Like an old rock star on a reunion tour, Greenspan is
sure to want to strike up the band one last time and let the good
times roll! Based on this alone, my best guess for Tuesday is that
we’re going to party again like it’s 1999.
---
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