The Contrarian Trader

Stock market, economic and political analysis for the intermediate term stock, commodity and equity option trader.

Contrarian Commentary, The Week Ahead 01.21.07

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On Friday the S&P 500 closed up on above average volume.The NASDAQ has found support at it’s 50 day moving average on volume that was slightly above average. So, the number one question is where to from here? It is going to be an earnings driven market for the next few weeks. Thus far earnings reports that have exceeded expectations have been met with selling. I feel the reaction of selling caused more by near term overbought conditions.Companies that have missed earnings have been taken to the wood shed. The question is will the correction continue? Friday’s short covering rally in the Semi Conductor Sector and Oil Service Stocks prevented the S&P 500 from rolling over. The support level to watch is the 1400 level. Should we close below that level you can expect additional profit taking and shorts adding to their positions.

The Banking Sector is somewhat concerning. The sector remains in a short term oversold level and has been getting bid up but with little conviction. Note the size of the candlestick bodies. If it were a solid rally in the sector you would see long white bodies rather then short bodies. If the Banking Sector is being manipulated at this point to keep the S&P 500 alive then I would caution people to keep an eye on the BKX chart. If the BKX drops below it’s support level at 116 you’ll then see the shorts come in.

The Utilities Sector still trades below it’s 50 day moving average. This is another sector to watch closely as it has formed a head and shoulders pattern that sets it up for an intermediate term correction. If it fails here you can expect interest rate fears to permeate the market. This sector is critical to watch as it’s the promise of interest rate cuts that have caused this bull run. The CPI data from last week indicates that although inflation is not menacing it still does exist. The Phily Fed Index came in at 8.3 vs Decembers negative 2.5 reading. A reading below 0 indicates a contraction in manufacturing while a number above 0 indicates an expansion in manufacturing. January’s reading is a clear indication that the economy is still on a strong footing. So, with inflation under control and manufacturing expanding the FOMC has little reason to move from the current Fed Funds Rate.The current Fed Funds Futures are pricing in no move by the FOMC in the first half of 07′. At one point the Fed Funds Futures were pricing in a 2% chance of a Fed Rate hike in March 07′. 

The Retailers have been the chief beneficiaries of the unusually warm weather patterns in a number of regions in the US. The north east in particular has benefited as many homes here are heated by oil. The correction in Crude Oil prices has meant more spending dollars in the pockets of consumers. The Retail Sector had a very good showing last week but it will be the first to feel the effects of a rally in Crude Oil prices or a cold snap.   As  Crude Oil looks poised to rally we are going to maintain our current net short position of our retailer although we are keeping a tight stop loss on the trade.

Going into the week it’s critical to understand why we rallied from the July lows. We were fed the line by CNBC and Bulls and Bears that interest rates would be lower in 07′. That hope is all but gone. If earnings guidance comes in lower you can expect that fears of higher or simply flat interest rates in an environment of declining earning will cause a multiple contraction of the PE ratios of stocks which is a recipe for a sell off.

There is alot of money floating around the globe and much of it is finding it’s way to the US equity markets. Mutual funds are flush with new money and until the money supplies of not just the United States but the world are tightened up you can expect the stock market to maintain it’s long term upward bias. Given that European and Asian central banks are now starting to tighten up the money supply in their respective economies you should see some effect in the coming months. The Chinese and Indian companies are now having to raise the pay of their employees at a 10 -15% annual clip. Expect their banks to have an ever keener eye on avoiding their economies from getting super nova hot.

I bring up the global money supply for a reason. Although I am of the opinion that the markets are fully priced and overbought that doesn’t mean that people will appease me and sell. No, to much cheap money is looking for a home and the US stock markets although not the best performing in the world is certainly the most secure. So investors may continue to throw money into the market and fund managers will continue to buy blindly all the while setting the markets up for a not so safe correction. Corrections often and small not rare but large.

To our members we will cover our current holdings, watch list and strategy in Monday evenings Contrarian Commentary.

For those interested in becoming a member of the Contrarian Trader’s investment group please take advantage of our 30 day free trial offer. Simply visit our home page and click on the free trial button.

Robert A. Desmond

President and Chief Investment Strategist

The Contrarian Trader

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