At These Levels

Google and dissapointing earnings do not mix well in the same sentence. I am sure they will buy it again after the initial selloff (which can carry further than $350 where it was trading at one point after-hours), but if it happens again it will be more serious. Not that it is not serious now.

I am busy tomorrow so I will try to post something tomorrow night. Where is Koepke when the hammer comes down? Safely away at a conference in Florida.

First the S&P 500 takes out the lows, then the highs of the day, and then goes right where it was before the Fed action. Another typical FOMC decision day. Don’t draw any conclusions until tomorrow.

FOMC days very often serve as turning points or acceleration points in a move. A lot can happen tomorrow: the State of the Union speech (watch for those Iran references that move oil), Google earnings, etc.

I talked to my auto mechanic at lunch. I had to see him for some scheduled maintenance, and I got some interesting anecdotal evidence that confirms the GM saga is not over.

He said that auction prices for used Japanese small cars are rising, and that during the last auction he attended GM trucks failed to attract meaningful bids and were not sold. I didn't ask if they use a reserve system like eBay, but they must if the vehicles are not selling. If the dealers are not bidding for vehicles, that means the vehicles are very difficult to move off the lots. Maybe it just took a while for those high gas prices to sink in.

Every selloff in GM stock gets deeper and deeper. Kerkorian did re-acquire his shares after the tax loss he took, but man, what is he thinking? I sincerely hope he pulls a rabbit out of the hat in this truly contrarian move (GM scale right, Toyota Motor scale left).

www.stockcharts.com

The relevant part of today's Fed statement is quoted below. The rest is just who voted. The Fed is not buying the weak GDP numbers and it looks like fed funds rate will go to 4.75 in March:

"The Federal Open Market Committee decided today to raise its target for the federal funds rate by 25 basis points to 4.5 percent.

"Although recent economic data have been uneven, the expansion in economic activity appears solid. Core inflation has stayed relatively low in recent months and longer-term inflation expectations remain contained. Nevertheless, possible increases in resource utilization as well as elevated energy prices have the potential to add to inflation pressures.

"The Committee judges that some further policy firming may be needed to keep the risks to the attainment of both sustainable economic growth and price stability roughly in balance. In any event, the Committee will respond to changes in economic prospects as needed to foster these objectives. "

We have the usual wild up/down/up/down action in the S&P futures. They did take out the lows of the day though, so this is not being taken positively.

Below the chart is a selection I wrote January 12 for remaining WSW subscribers, "What Is It With March?" I didn't illustrate it with the S&P 500 chart at the time, but here it is now. It looks compelling to me. Keep in mind that there is room for the market to decline in February--historically the second weakest month of the year after September--and then rally into March and make a top.

I have no idea if it will work again this year, but in the last five years March has been either a major top or a major bottom. Since the market is high now, this March may be a top.

I look forward to the statement emerging from the last Greenspan-led FOMC meeting at 2:15 pm.

It should be memorable.

www.stockcharts.com

"It was in March 2004 and 2005 that we saw the US stock market start its deepest corrections for both years. The impressive rally off the 2003 lows started in March 2003, and the market topped out in March 2002 before an equally impressive decline.

"If you have to go farther back in time, in March 2001 we had another impressive rally attempt before it fizzled out in the summer of that year. And most important, the all-time highs of both the S&P 500 and the Nasdaq came in March 2000. The oversimplified conclusion is that March has seen many important tops and bottoms. They weren't necessarily the tops and bottom for all the last five years, but they were very important turning points nonetheless. Could the same happen here?

"If I had to make a choice for the next five years between developed markets or emerging markets and commodities, I'd stick with commodities and emerging markets. This is where the real bull markets are. Emerging market have done spectacularly in the last three years, and commodities have done spectacularly in the last four years.

"But historically, there's rarely been no major shakeout in such protracted bull markets. It remains to be seen if 2006 produces a shakeout and a buying opportunity or if it's the same old momentum game again.

"It's only normal to expect superior stock market performance from emerging markets that have much faster growing economies. Unfortunately, stock market and economic performances sometimes diverge substantially and for prolonged periods of time.

"Also, remember that the stock market always leads the economy. Stocks weaken before the economy weakens and rally before the economy improves. Such cases in recent memory are the decline off the March 2000 all-time high and the rally of the March 2003 low. I'm a firm believer that one needs to pay close attention to stock market action."

This weekend, I received this letter from my real estate agent. I thought you might be interested in knowing the perspective of a seasoned real estate professional in the current environment. I didn't expect him to say anything different--how many stockbrokers were bearish in late 1999?--and I still think he's very good at what the does:

Real Estate 2006: What Should We Expect??

We all track real estate – it is a big part of our financial well-being. The past few years have been “interesting” to say the least, with double-digit appreciation and very quick sales, often well above asking price. For the last 6 months or so, however, the headlines have frequently included warnings about the “Housing Bubble.” Is your home’s value safe? What can we really expect?

Having been involved in the Northern Virginia real estate market since the late 1970s (yikes, that makes me feel old!!), here are some thoughts.

What is a “Bubble?” A “Bubble” is a situation where prices cannot be sustained by the underlying economics. In the stock market of the late 1990s, the stock prices of companies with little or no revenue were bid up by investors on the “possibility” of future earnings. Earnings did not materialize, and with no revenue, there was really no stock value. Bubble Burst.

What is the Real Estate equivalent of corporate revenue? Jobs. Jobs that provide income to pay mortgages.

In order to have a Housing Bubble, there would need to be huge job losses nationally and regionally, coupled with pay cuts for those with jobs, or huge increases in mortgage rates. This is a highly unlikely scenario.

Today’s Underlying Economics:

• Nationally, the economy is experiencing modest growth. Not too fast, not too slow. (Disasters such as 9/11 and Hurricane Katrina/oil prices created relatively small “anomalies” but did not create major change.)
• Mortgage Rates have been increasing slightly, but the Federal Reserve has signaled that it intends to stop raising rates. Current rates (January ’06):
  • 30-year fixed rate – approximately 5.875%
  • 5-1 fixed/adjustables – approximately 5.5%
  • 7-1 fixed/adjustables – around 5.75%

• The National Unemployment Rate is 4.9% and dropping slightly. (Business Week)

· The Northern Virginia Unemployment Rate is 2.4% and holding relatively steady. (Virginia Employment Commission)

· Job Growth locally has been very strong – 84,500 jobs added in the DC Area from August ’04 to August ’05. Northern Virginia had the lion’s share of that growth, and is projected to continue at a similar pace. (George Mason University Center for Regional Analysis)

· Significant Payroll Increases mean that, in addition to new jobs being created, people who already have jobs are steadily receiving pay raises. (Virginia Employment Commission)

What to Expect. The underlying economics in place for Real Estate in 2006 give us the potential for a good showing in both appreciation and sales.

At the same time, since the market has been so “hot” for so long, there has to be a slowdown. Many of the people with those new jobs and new pay raises have already bought, and are out of the market for the near term. Appreciation rates have also outpaced wage increases in recent years, and for the market to remain healthy over time, appreciation really should slow.

The market has actually been cooling for the past six months or so. The number of houses on the market is up fairly significantly, and the “Days On Market” before a house sells has also increased significantly. (See the attached Housing Report) Multiple offers are a thing of the past, and we are even seeing some Sellers contribute to their Buyer’s closing costs. Part of this is seasonal, and part is due to a slow balancing in the number of Buyers & Sellers.

What seems most likely this year is a “normal market” where there is more of a balance of buyers and sellers than in the past few years. As the market seeks this balance, we may well see some areas of soft prices, but he underlying economics are very sound.

For You. This means that your home’s value should be safe to slightly rising.

For Buyers. This means you have a great opportunity to negotiate.

For Sellers. This means careful preparation and judicious pricing will be the keys to a successful sale.

The disappointing GDP number (1.1 percent) for the fourth quarter is being taken as good news, as it gives Bernanke, the new Federal Reserve cheif, the power to stop hiking interest rates. This is what the market is saying with this rally, in my view.

All that will be fine and hunky dory. But inflation expectations are rising right now, judging by the behavior of the TIP spread. Treasury Inflation Protected Securities (TIPS) are indexed for inflation, while regular Treasurys are not. If the difference in yield between the TIPS and regular Treasuries is rising that means there are rising inflation expectations. The reverse is also true.

The TIP spread rose into November, fell until December and has again been notably rising. Will the Fed stop with rate hikes if there are rising inflation expectations at present?

Bloomberg

There are a lot of positives in this market and a lot of negatives. Bulls focus on the first, bears on the latter. The S&P 500 has been gliding along its 50-day moving average for five days. The Nasdaq 100 has been gliding below its 50-day moving average for five days. No one wins, yet.

Stockcharts.com

Any move above 1,275 on the S&P 500 may bring in buyers. Any decline below 1,260 will bring more sellers. They like to buy them at the end of the month so anything can happen. I doubt the market is out of the woods yet.

Stockcharts.com

I've been reading Internet Outsider, Henry Blodget’s blog. Henry is (was?) a very good analyst, as he's banned from the securities industry. I bet he's getting business for his consulting firm (I don’t know, I just conclude that he is given the content I have seen on his site).

Basically, he was accused of saying “buy” on some crappy Internet stocks, when privately he said “sell.” You don’t think analysts today do that?

Go on, read a couple of posts. You may like it.

The move in the 10-year bond futures is as big as the move in the Dow on Friday, but no one is mentioning it. This is positioning in front of the Federal Reserve meeting, as expectations are that the fed funds rate will rise to 4.50. I hope you have long gotten fixed-rate mortgages.

Bloomberg

If the S&P 500 holds the lows of the year at 1,245, this might have been one huge shakeout and nothing more. The losing of 1,275 as a support level is a negative, as well as the downside leadership of the PHLX Bank Index (BKX). The market can't get into a lot of trouble if the large banks are strong; the best example is last October when the banks were rallying when everything was selling off (see chart below). The end result was a sharp, but ultimately reversible, selloff.

Stockcharts.com

The market can get into trouble if the banks are weak. They are the biggest market sector, and they've been very weak. It makes you wonder why there was a big bank rally in October if the problems now pouring out of earnings reports, like Citigroup's, were well known then. I know there are positives out there, but they won't mean a thing if this action in the BKX continues, as I suspect it will.

The Nikkei was up more than 200 points last night in the morning session, ending 2.1 percent higher. This is the second time this has happened during the last five trading days. Someone is selling strength. Also, Livedoor (Japan: 4573), which has been discussed here as the unlikely cause of this selloff, finally opened for trading. Yikes.

This quote is straight out the latest Jeffrey Saut missive (see the Jan. 23, 2005, issue of Raymond James' Equity Research "Mr. Market"):

“Ben Graham, my friend and teacher, long ago described the mental attitude toward market
fluctuations that I believe to be most conductive to investment success. He said that you should imagine market quotations as coming from a remarkably accommodating fellow named Mr. Market who is your partner in a private business. Without fail, Mr. Market appears daily and names a price at which he will either buy your interest or sell you his.

"Even though the business that the two of you own may have economic characteristics that are stable, Mr. Market’s quotations will be anything but. For, sad to say, the poor fellow has incurable emotional problems. At times he feels euphoric and can see only the favorable factors affecting the business. When in that mood, he names a very high buy-sell price because he fears that you will snap up his interest and rob him of imminent gains. At other times he feels depressed and can see nothing but trouble ahead for both the business and the world. On these occasions he will name a very low price, since he is terrified that you will unload your interest on him.

"Mr. Market has another enduring characteristic: he doesn’t mind being ignored. If his quotation is uninteresting to you today, he will be back with a new one tomorrow. Transactions are strictly at your option. Under these conditions, the more manic-depressive his behavior, the better for you.

"But, like Cinderella at the ball, you must heed one warning or everything will turn into pumpkins and mice: Mr. Market is there to serve you, not to guide you. It is his pocketbook, not his wisdom, that you will find useful. If he shows up some day in a particularly foolish mood, you are free to ignore him or take advantage of him, but it will be disastrous if you fall under his influence. Indeed, if you aren’t certain that you understand and can value your business far better than Mr. Market, you don’t belong in the game. As they say in poker, ‘If you’ve been in the game 30 minutes and you don’t know who the patsy is, you’re the patsy.'

"Warren E. Buffett"

Jeffrey does non think that the market is oversold here. Neither do I. So far, the action during the last two days is a classic dead-cat bounce. That can change, but it hasn't happened yet.

GK's bi-weekly commentary is out, and he sees a lot of big moves brewing in many commodities and indexes. Can't say I disagree, you know what I mean?

My thesis has been that the current shellacking of the Nikkei is a correction in a bull market. It doesn't mean the correction is over, but it does mean that, for the time being, I expect a benign outcome.

The current high inventor interest in a secondary offering in one of Japan's largest banks--nearly $5 billion worth in Sumitomo Mitsui (Japan: 8316)-–is indicative that no one has given up on the Nikkei, yet. Provided that Sumitomo Mitsui has risen several fold from its 2003 lows and there are still willing buyers says a lot about investor confidence (see chart below).

Bloomberg

Institutional investors buying stock in conservative financial institution is one thing, and a stop-loss-driven cascade of selling in futures and speculative stocks is another. For what it's worth, my current ballpark target for the Nikkei correction is closer to 14,000.

Bloomberg

There's some risk aversion in the market, as can be seen by the lack of bids four days in a row (see chart above) for Livedoor (Japan: 4753), which has declined during that period from 696 yen to 256 yen, hitting the limit down prices every day without very few shares changing hands (in Japan ,stocks have a maximum amount by which they can decline in a single day). Also, the action in Korea also demonstrates the correction is far from over.

Why should you care about Asian markets or other emerging markets? The current declines come at a time of record mutual fund flows in that part of the world, which is puzzling and suggestive that some of the smart money may be selling into the inflows. We're about to find out if the smart money is right. It usually is; that’s why they call it smart.