Liftoff, Soft Landing or Crash? Part II
by M.A. Nystrom
December 19, 2005
Cambridge, MA
Click here for
Part I
With last week’s Fed rate hike decision out
of the way, I was expecting to see a little more clarity regarding
the stock market’s direction. Unfortunately, with this bit
of ambiguity removed, the market still seems worried, and as a result
we did not see anything near the rally I was expecting. This week,
I’d like to review what happened in the context of last week’s
observations and present a framework for what to expect in the coming
week.
Please note that in Part I, I’m not trying to
make any predictions, just looking to identify technical trends
and support and resistance levels that will either confirm or negate
the trends in effect. Part II is where I’ll weigh in with
my own two cents. I plan to make this a weekly report, so if you’re
interested in being notified immediately when it goes up on my website,
please sign up here.
Part I: Current Trends
As expected, last week the Fed raised short-term rates
to 4.25%. While the accompanying statement removed some amount of
ambiguity regarding further rate hikes, it hardly clarified anything.
Is the Fed done or not? When will they stop? What will Bernanke
be like as new Chairman? The statement was like a Rorschach test
for each individual market, causing each to reflect its own individual
bias / opinion / insecurity. The entire market is like a painting,
and each individual market is a brush stroke in the larger, ever
evolving picture. Let’s take a look at each individual market
to see what is emerging:
S&P 500
The stock market reacted immediately, as soon as the
Fed’s statement was made public at 2:15. The market cheered
and popped up for a decent gain, but the enthusiasm petered out
by the close. It managed to close up for the day, but it was nothing
like the price explosions (both up and down) that we have seen as
a result of past Fed meetings. Wednesday saw a continuation of the
muted rally, but by Thursday and Friday, the bears were back, bringing
the market back almost exactly to its Tuesday close. The weekly
chart thus added a new bar, but no new information (see
last week’s report) The market remains in its tentative,
lazy uptrend. From the daily futures chart (March contract) we see
that the market broke through its consolidation downtrend, but hardly
convincingly. We’ll just have to continue to watch this market
for signs of a break or bounce. The new range is bound by 1274 on
the downside and 1284. Watch for moves outside of this range to
determine likely future direction.
US Dollar Index
The dollar fell off a cliff with the Fed’s announcement, but
has so far stopped short of breaking through its six-month uptrend.
The daily chart looks terrible - we’re likely to see further
declines and a test of the weekly trend line in the coming week
or so. Watch the 89 level carefully for signs of a break or bounce.
I know that sentiment is extremely bearish, but technically speaking,
the intermediate trend is still in tact, and that trend must be
respected.
Bonds
The most curious event of all last week was the big
rally in Treasury Bonds and Notes. While the Fed was busy pushing
short-term rates higher, the bond market was busy pushing long-term
rates lower, something Chairman Greenspan has in the past referred
to as a ‘conundrum.’ The result of this conundrum is
a flattening yield curve, one that is threatening to invert, an
event that nearly always leads to a recession. Greenspan has said
that a recession may not result this time, but his reasoning on
this likely has more to do with his leaving office on a high note
than any logic. The New York Fed is on record as saying that an
inverted yield curve has essentially predicted every recession since
1950, with only one false signal. This may help explain why stocks
have failed to rally.
Inflation Complex
The metals and the energies - what I call the inflation
complex - saw dramatic declines this week (with the notable exception
of copper), beyond what just about anyone expected. As I said last
week:
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.
 Gold
indeed declined sharply, from its high north of 544 to a low south
of 500 in Asian trading. But the mystery remains: both gold and
the dollar declined together. These two seem to have become best
buddies of late, rising and falling together. The meaning of this
new relationship is yet to be revealed.
After the huge decline in gold, it is reasonable to
expect at the very least a decent dead
cat bounce or a consolidation and rise to new highs. The open
gap on the daily chart is ripe to be filled. One need only refer
to the gold charts of 1979
and 1980
to see how big declines are simply precursors to even bigger price
rises. $500 is obviously key support for the bulls.
Oil
After a brief rally early in the week, oil declined
with gold and the dollar at the end of the week. As the chart shows,
the week ended in (what else?) an ambiguous spot, with daily prices
resting at the top of oil’s downtrend from the Katrina highs.
The bulls have a chance to bounce off this support next week and
start the next leg up in the rally, if they are going to. It is
possible that last week’s declines were just the first pullback
in a new advance. On the other hand, further declines should confirm
the resumption of the downtrend that began in August.
The charts above should give you some idea as to what
to expect in the coming week with regard to prices in the markets
discussed. We have clear levels of support and resistance, but I
have my own opinion as to the big picture that is being drawn.
Part II: Nystrom’s Two Cents
The lack of follow through in the stock market to
the seemingly positive news from the Fed is troubling. I expected
a strong rally following the announcement, carrying into the end
of the year. This could still happen next week, but if the markets
fail to rally during this seasonally bullish time of year, the odds
increase that something fundamental is shifting under the surface.
The recovery is getting long in the tooth, and in many respects
was quite anemic to begin with in spite of the official numbers.
The economy has suffered the abuse of the catastrophic hurricanes
and extremely high gas prices, not to mention the current slowing
of the housing market and rising interest rates. A rally failure
in the market and the flattening yield curve may be telling us something
important.
That important something could be a recession, or
at the very least, an economic slowdown on the horizon next year.
While oil prices have come down substantially – 20% since
their August highs, and gas is down, too, the damage to the economy
may have already been done. In spite of recent declines in oil,
it will cost most people much more to heat their homes this winter.
These added expenses are like taxes that remove discretionary spending
from the economy. And we all know what powers the US economy: consumer
spending. Significant energy spikes in the past have nearly always
led to recession, and there is little reason to think this time
should be any different. Should a slowdown occur next year, it will
arrive just in time to test the mettle of incoming Chairman Bernake.
A significant decline in the stock market between
now and the end of the year would be a strong signal that recession
is on the way. Falling oil and gold prices would then make sense,
because demand for oil would not be as high during recession, and
the threat of inflation is also reduced.
While declining, oil prices are still at historic
highs. But high oil prices and recessions aren’t all bad.
Because of all the hype of “peak oil,” the search is
on for alternate energy sources and for ways to conserve and cherish
what we have. While these searches seemed to bear little fruit during
the 1970’s, this time around technology seems to be moving
much faster. Don’t be surprised to find significant alternatives
to petroleum as a fuel source in the next several years. It is no
coincidence that the Japanese, so aware of their vulnerabilities
as a result of their lack of natural resources, are leaders in hybrid
technology. (Not to mention that their aging population has spurred
them to become the world’s leader in robotics, in a bid help
them solve their looming elder health crisis). Recessions and constraints
do wonders for innovation. Necessity, after all, is the mother of
invention.
Will we see the dollar get back to its contracyclical
relationship with gold, and other commodities? They rose together;
now they’re falling together. Something has to give, but it
remains to be seen just what. The historic imbalances we’re
experiencing are likely to have unpredictable effects going forward,
and this will only be exacerbated by having a new guy on the job
in the Fed Chairman’s seat.
As many a college gradate has found out only too painfully,
life in the real world is different from what it’s like back
at school! Bernanke himself has stated, "[I]f making monetary
policy is like driving a car, then the car is one that has an unreliable
speedometer, a foggy windshield, and a tendency to respond unpredictably
and with a delay to the accelerator or brake." Is this supposed
to inspire confidence during these uncertain times?! One thing that
we can be certain of, Bernanke will be no Greenspan!
But then again, Greenspan is no Greenspan either.
In his famous 1967 essay, Gold
and Economic Freedom Greenspan railed against the “statists
of all persuasions” and their antagonism towards the gold
standard:
In the absence of the gold standard, there
is no way to protect savings from confiscation through inflation.
There is no safe store of value. If there were, the government would
have to make its holding illegal, as was done in the case of gold.
If everyone decided, for example, to convert all his bank deposits
to silver or copper or any other good, and thereafter declined to
accept checks as payment for goods, bank deposits would lose their
purchasing power and government-created bank credit would be worthless
as a claim on goods. The financial policy of the welfare state requires
that there be no way for the owners of wealth to protect themselves.
Surprising not only because the words are (for once)
crystal clear and easy to understand, but because Greenspan has
said in congressional testimony that he stands by these views even
today. (See
the Ron Paul – Alan Greenspan Transcripts)
The point of this is that we shouldn’t expect
to know Bernanke, based only on his past writings. Yes, we all know
the story about the helicopter and the printing press. But what
if the economy does not respond the way he expects it to, based
on his academic theories and models? Will he panic, and try something
new? Of course this feeds into the market’s uncertainty.
Greenspan the gold bug turned out to be a closet inflationist
– a “statist” that he once expressed such disdain
for. It just may be that helicopter Ben is actually a closet goldbug,
or something else. Don’t laugh! Stranger, things have happened
in history, and don’t forget, we are living history every
day, one day at a time.
To remember that there are still things we do not
understand, just think back to the 1970’s for a moment. Back
then, it was thought impossible that that high inflation could be
accompanied by high unemployment. There was no room for such a possibility
in the Keynesian economic models. It was so impossible that there
wasn’t even a word for it. But sure enough, it happened, and
a new word was invented to describe it: Stagflation. I believe that
we may be entering a similar period – similar in that it will
be different from what we have known in the past. A fictional period
in which nothing is what it seems, and strange, unexpected things
occur as truth interferes rudely with that fiction. Moving forward
will demand an open mind, not the certain expectation that future
financial relationships conform strictly to past behaviors, nor
that the story of the economy can be told with government statistics.
Stay tuned as we watch history unfold.
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