At These Levels

While I prefer that you read the entirety of the May FOMC minutes, I know that it may seem too much work to separate the wheat from the chaff. Here are some highlights that just took the fed fund futures to predict a 74 percent hike in June.

I guess the pause hope is out the window?

From the May FOMC minutes (selected paragraphs or parts of, in order):

Headline inflation turned up in March. Although the price of natural gas had fallen because of continued plentiful inventories, retail gasoline prices surged, leading to a jump in overall energy prices for the month. Prices of core goods and services also rose more quickly in March, largely because of a spike in the apparel component that unwound a decline in February and a one-time step-up in medical prices related to changes in Medicare reimbursement rules. During the twelve months ending in March, overall inflation rose at a slightly faster pace than that in the preceding twelve-month period, while core prices for the same period increased a bit more slowly than in the previous year. Producer price inflation also moved up in March, driven largely by higher food and energy prices. Readings on the growth in the cost of labor were mixed. Over the three months ending in March, the employment cost index for hourly compensation of private industry workers rose at its slowest pace in several years. Data on compensation per hour in the nonfarm business sector, however, pointed toward notably faster growth in the first quarter. Some financial-market and survey indicators suggested that inflation expectations, both for the upcoming year and for the longer term, had moved up since the March meeting.

Investors anticipated the FOMC's decision at its March meeting to raise the target federal funds rate 25 basis points, but the Committee's post-meeting statement evidently led them to mark up somewhat their expected path for the federal funds rate. Subsequently, the path was pushed up further by data releases that were, on balance, stronger than market participants had expected. Speeches by Federal Reserve officials, the minutes of the March meeting, and Congressional testimony by the Chairman combined to restrain policy expectations some. On net, the anticipated path of the federal funds rate over the next two years nonetheless rotated upward. Yields on inflation-indexed Treasury securities moved up over the intermeeting period, but yields on nominal Treasury issues rose more. Spreads of yields on investment-grade bonds over those on comparable-maturity Treasury securities were about unchanged, while those on speculative-grade bonds declined. Major stock price indexes were up a bit over the intermeeting period, as positive first-quarter earnings reports more than offset the negative effects of higher energy prices and rising interest rates.

Most participants expected that, after allowing for some possible near-term volatility related to the recent jump in energy and other commodity prices, core inflation would probably remain around the levels experienced on average over the past year. However, recent developments suggested that upside risks to inflation had risen somewhat since the time of the March meeting.

Certain features of recently popular nontraditional mortgage products had the potential to cause financial difficulties for some households and erode mortgage loan performance for some lenders. Nonetheless, the household sector seemed likely to remain in sound financial condition overall. On balance, consumption spending was viewed as most likely to expand at a moderate pace in coming quarters.

Meeting participants expressed some concern about recent price developments and their implications for inflation prospects. Core consumer inflation lately had been a little higher than expected. Moreover, energy prices had risen steeply in the period since the March meeting, and, although pass-through apparently had been limited to date, the most recent increases might be reflected to a greater degree in core inflation in coming months. Participants noted that prices of non-energy commodities, such as industrial metals and building supplies, also had been climbing. The recent decline in the dollar was another factor that could add to inflation pressures, although the effect of prior changes in the foreign exchange value of the dollar on core consumer prices had apparently been limited. Business contacts had reported continued shortages of certain types of skilled labor and related wage pressures in some occupations, which would tend to boost costs.

Participants discussed in some detail inflation expectations--a potentially important factor influencing future inflation trends. Some surveys suggested that inflation expectations had risen in recent weeks, but others implied that expectations were little changed. Measures of inflation compensation based on the difference between yields on nominal Treasury securities and inflation-indexed issues had edged higher. It was possible, though, that investors' uncertainty regarding inflation prospects, not just inflation expectations themselves, had risen. On balance, participants judged that inflation expectations had risen somewhat--a development that would have to be taken into account in policymaking and warranted close monitoring--but remained contained.

Although the Committee discussed policy approaches ranging from leaving the stance of policy unchanged at this meeting to increasing the federal funds rate 50 basis points, all members believed that an additional 25 basis point firming of policy was appropriate today to keep inflation from rising and promote sustainable economic expansion.

Having already taken the heat for throwing in the towel as a "last bear" (it's funny when you think about it), Stephen Roach discusses a Morgan Stanley proprietary indicator that intrigues me here. I'm posting a part of the piece:

There can be no mistaking the power of the risk reduction trade that has just occurred. It is on a par with the big reversals of the past. What is particularly interesting is that this outbreak of risk aversion has occurred in the absence of a financial crisis and in the absence of a major shift in the underlying fundamentals of the global economy. The tentative conclusion is that this episode is more about the markets than anything else--and the fear that the liquidity goose that hatched the golden egg is about to take flight.

A couple of years ago, our foreign exchange strategy group constructed a proprietary measure of the appetite for risk embedded in world financial markets (see their 13 May 2004 note, “Introducing the MS Global Risk Demand Index”). The GRDI is both cross-border and multi-asset in scope. It is designed to measure the movements in a variety of risky assets relative to their riskless counterparts. It includes comparisons between emerging-market and developed-market bonds, base metals versus precious metals, cyclical versus non-cyclical equities, equities versus bonds, volatility in equities, bonds, and FX markets, and credit market and swap spreads. Some ten sub-indices are constructed daily and geometrically weighted to create the aggregate GDRI. The index has been back-tested to 1995 and has a good record in capturing the big moves in risk appetite clustered around the major financial crises of the past decade--including the Asian crisis of 1997, the Russian debt crisis of 1998, the bursting of the Nasdaq bubble in 2000, the 9/11 terrorist attacks of 2001, and the deflation scare of 2003. It is more descriptive than predictive, but can certainly signal important flash points at either end of the risk spectrum.

Recent trends in the GRDI underscore the significance of the latest risk-reduction trade. In late May, the risk-appetite metric moved to extremes last seen during the deflation scare of 2003. At work was a widening of spreads in a number of segments of the risk universe--especially, emerging-market debt and base metals--together with a long-overdue rebound in market-based measures of volatility. A widening of credit and swap spreads also contributed to this move. For those who claim that asset bubbles cannot be identified until after the fact, this dramatic move in the GRDI provides compelling ex post confirmation of a bursting of a bubble in risky assets. On a daily basis, the GRDI hit a low on Tuesday, 23 May, and has since retraced about half its plunge into negative territory. It’s hard to know from the empirical history of the GRDI if this latest move signals an end to the risk reduction trade. The extremes of recent fluctuations in the index contain an equal number of examples of both single-event and multi-bottom shifts in risk appetite.

As far as I know, public servants of this stature have to either sell out of their common stocks or put them in a blind trust so that their policy making does not directly benefit the companies that they are shareholders in. Goldman's CEO that is about to take over the Treasury Department is worth half a billion dollars (or more); Bloomberg says he has 3.23 million shares X $150 in GS stock only, so you do the math.

Still, Goldman is an institutional brokerage firm. If equity markets continue to weaken worldwide in the months ahead, Goldman's stock will decline, probably a lot. It will decline not because Goldman's traders that brought in more than half of profits last year will not play the markets right – I bet that they will – but because brokerage stocks are considered the riskiest type of financial companies and decline disproportionably when markets begin to shake. So, is Henry bailing at the top? He very well may be.

Goldman's stock has gotten as overbought and extended only three times as much in it history as a public company. The last two times was just around the Dot-Com bubble when Goldman was the king of IPOs. Now Goldman is the king of fixed income, currency and commodity trading and the stock has performed a similar "parabola". The last two times it begun to decline form such extended levels it fell $50-60. Incidentally, it is the head of the trading unit, Lloyd Blankfein, that is likely to take over according to Bloomberg

www.stockcharts.com

Also according to Bloomberg:

"Blankfein joined commodities trader J. Aron & Co. as a gold salesman shortly after Goldman bought the firm in late 1981. The company has since been folded into Goldman's fixed-income, currencies and commodities unit, known as FICC."

Goldman bought a commodities trading firm right after the top in commodities and Blankfein did become a gold salesman after the top in gold. Hmmm…

I am bullish on the commodity sector for the long haul , but maybe there is a bigger correction to come there.

No wonder he is furious.

For a futures trader's perspective on the correction in gold read here. He caught the trading top too. Yeah, knowing him personally I can say he is that good.

So far this looks too much like the October bottom. The comparison is too close. Rapid selling for a couple of weeks that stops miraculously in the vicinity of the 200-day moving average of the S&P 500, violent flipping for a week or two (we still have not seen that part in this case) and if the similarities continue, new highs?

www.stockcharts.com

I can go on and on. There are much more similarities here also in the short-term indicator setups. Now let's look at some key differences.

www.stockcharts.com

While this violent spike in the S&P 500 Volatility Index and subsequent two gap-down down days when the index fell five points form its highs on Wednesday is a short-term positive – some people view such gap downs as short-term BUY signals – the severity of the stock market decline this time was clearly more pronounced, worldwide.

The VIX took out its October highs, and it's showing a clear bottoming pattern. As I wrote yesterday in a different forum: " While I think the selloff isn’t over (due to uncertainly over Fed policy, inflation concerns, housing market jitters, etc.), I suspect we may have hit a temporary selling climax on Wednesday when the S&P 500 traded down to 1,245. This was the low from the first trading day of 2006 as well as the high from last summer, natural points at which to look for support in stock prices."

"But while short-term market timing models all call for a dead-cat bounce, longer-term indicators suggest there’s much more potential for the selling to continue. The rapid selling in the Nasdaq 100, even after badly underperforming in 2006, is an indication that institutional investors have decided to get serious about playing defense. That's not going to change in a matter of days or even weeks."

" The S&P 500 Volatility Index (VIX) rose well above its October 2005 spike. This is the first time “the fear gauge” has risen above any major spike in its precipitous decline during the past three years. The index is clearly bottoming, carving higher lows after having declined as low as 9.88 in July 2005. This is very different behavior than what we’re used to. And given how depressed the VIX is, it can rise a long way from here."

So, if you are bullish keep your fingers crossed, but keep an eye on those differences. If you are bearish, you can keep your fingers crossed too as the market just dealt you a strong hand and it is currently in no man's land. The prize is up for grabs and neither the bulls, nor the bears have won here. Any upside momentum past 1280-1285 on the S&P 500 will look like yet another fakeout for the bears and a victory for the bulls. Any downside momentum past 1245 on the S&P 500 will look more like a bear victory.  But right here, it's still a truce in the buffer zone, with no clear winners.

I'm a little pressed for time catching up in the office after being away for a week. Luckily, there are plenty of worthy links that I can post here. Here is The Cunning Realist with his always sober take on the markets.

www.stockcharts.com

This is right about where one should be looking for the proverbial bounce in the stock market. If they sell it mercilessly, you'll get a better sense if there's more downside coming. My guess is that they will, but let the bounce come first. They bought it yesterday right at the low of 2006 and the high from the summer of 2005. That's not a coincidence.

Anecdotes form the frontlines say a lot. I don't think the bounce that's coming is anything more than the dead-cat type.

The chickens are coming home to roost. I'd have guessed that the selloff should have started a couple of months ago, and I'm not exactly sure why it took until mid-May to materialize. It was the misquided expectation for a celebratory rally to the end of the Fed hikes I suppose.

As Jeffrey Saut of Raymond James elaborates this week, it's that unwinding leverage that's hitting sticks across the globe, something I've noted repeatedly in the past (see how fast the sold the first bounce in the Nasdaq and the other high-beta sticks today?):

"Another misnomer relates to the current question of, 'When will the Fed be done raising interest rates, because that will lead to a stock market upside explosion?' Again, that just does not foot with historic precedence, since most successions of Fed tightening have seen exactly the opposite stock market effect (read: lower stock prices).

"Another 'media mantra,' replete on the airwaves, has been that the 'late comers,' who bought the stuff-stocks, commodities, and the emerging market complexes, have been exiting those 'wrong bets' over the past few sessions. Late comers? We think NOT since, in our opinion, these asset classes are in the early stages of a secular bull market. 'Hot money' (read: hedge funds) exiting…well maybe, because the “carry trade” is likely being unwound.

"Consider this, for the past few years 'hot money' has been borrowing money in Japan at effectively zero percent interest rates. Then that hot money has leveraged that borrowed money and bought anything that has been rising in value, namely stuff stocks, commodities, and emerging markets. Given the Bank of Japan’s recent statement that it is 'moving quickly' to take away its zero interest rate policy, is it any wonder emerging markets, commodities, and, consequently, stuff stocks have taken a pounding recently as those hedge fund 'carry trades' have been unwound?

"Also worth consideration is the fact that most Asian Central Banks are now raising interest rates, an event almost totally unreported by this country’s media. Ladies and gentlemen, the raising of interest rates by the Asian Central Banks is likely the observation/question du jour and not 'when will the Federal Reserve quit raising rates?'! Indeed, as one savvy seer laments, 'It’s not the snake you see that bites you.'

"We think the recent downside 'heart attack' in 'stuff,' as well as stuff-stocks, represents a buying opportunity, although we are not sure if said opportunity is here or a few months from here. Yet we are convinced that over the longer term, the worldwide demand for 'stuff' should put the wind at the back of this asset class for years to come. The question now is how low the correction will carry before the stuff-stock rally resumes. And that is why we use a 'scale-in' buying approach to these complexes. It is also why for folks like us, who have held stuff-stocks for the last five years and had them grow into a huge 'bet' in the portfolio, we have recommended re-balancing (read: selling partial positions) all of our stuff stock positions for the past few months. That technique re-balances such positions to keep their weighting more in-line with the portfolio’s objectives. It also allows long-term gains to accrue in the portfolio giving us the 'cushion' to withstand the inevitable downside price heart-attacks.

"As for the equity markets, we think the markets have entered one of these 17 – 25 session selling stampedes. In past missives we have discussed both Buying Stampedes and Selling Stampedes in that they tend to last 17 – 25 sessions, with only 1 – 3 day counter-trend moves, before they exhaust themselves. By our count today would be day 8 off of the Dow’s May 10th peak. That said, given the current oversold nature of the equity markets, it would be surprising if we didn’t get some kind of 'throwback' rally this week. It is also worth noting that the S&P 500 tested, and held (so far), its 200-DMA (1258) on Friday, which is a logical place to attempt a throwback rally. Whether it is sustainable is unknowable, but we think it is not and therefore remain cautious. Yet, if we don’t get some kind of throwback rally soon, this decline would take on the characteristics of a mini-crash. Consequently, we are still predominantly defensive on the equity markets, as well as on stuff-stocks, thinking that just like a heart-attack patient doesn’t get right out of bed and run the 100-yard dash, the equity markets should not do that either."

The whole report is here. Keep in mind that it'll be gone next week, so now's the time to check it out. There is also an interesting letter to clients of the Raymond James Indian affiliate. I had no idea they had an Indian affiliate, but I guess brokerage firms go where the money has been going. My guess is that the selloff in India is not over yet.

vegas2.ppt (PowerPoint required).

Comments for all entries have been allowed again. The tech wiz at the office fixed the problem, or so he tells me. Make sure you see the PowerPoint presentation posted on Sunday.

This was my first presentation in Vegas. You need PowerPoint to view it (the second one I’ll post tomorrow). If PowerPoint opens inside your browser, keep clicking on top of the slides to change them.

I still have not fixed the spam issue, so no comments yet.

I am going to be traveling this week to the Las Vegas Money Show, so I won't be able to post as often. I may not be able to check in here till Friday night. That probably is a little bit on the safe side, but a wise man once told me that the key to happiness is "low expectations" so it's better to be conservative here. It's a long flight to Las Vegas from the East Coast. It's the same as going to London (I would personally prefer to go to London, but Vegas is a piece of Americana that has to be visited periodically for amusement purposes, even though in this case, it's on business.)

I am going to an investment conference in the gambling capital of the world. Get it?

I will likely only gamble with my quarters on the airport as I don't believe in gambling. I do believe in casino stocks because the house, as they say, always wins. You just have to keep playing.

The Blogs and Resources section to the right has plenty of reading material to keep you happy in the meantime. That's why it's there.

And no, the selloff is not over. It looks that is just begun. We have had one too many false breakdowns and breakouts lately, but this feels genuine. It could carry for a couple of months, much longer if this is a top, which we cannot say with 100 percent certainty right now. It could be a top, though.

Across the board selling in anything investable, Lordee mercy. This is what happens when everything investable goes up at the same time; it goes down at the same time too.