Bull! Not bull.
THINK!
    About | Home | Blog | Gallery | Archive | Bibliography | Trading | Elliott Wave | Commodity Charts | Subscribe/Contact | Search Site

 

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.

---

If you would like to be notified of updates, and new articles, subscribe to my low volume announcement list

Turn off the TV and think!



  • If you have comments on this article, please feel free to drop me an email at: bull@bullnotbull.com
  • New charts, news and financial links -- both the bull and the not bull -- updated each day on the homepage.






Back to the Archive


All contents © Michael Nystrom













Bull! Not bull is hosted by Dreamhost - Employee-owned hosting since 1997.