The Contrarian Trader

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

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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


Contrarian Commentary, The Week Ahead 01/06/07

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The two V V’s (Volatility and Volume) have returned to the markets and can either make or break a speculator. It’s at this point the savvy speculator shows patience, turns off CNBC and researches the historic support levels of those stocks that they had been wishing to buy in this recent run up in the stock market. It’s at those support levels that you will find the best entry levels. You can then place your stop loss orders below the support level. By buying in this fashion you greatly reduce the risk of being shaken out of your position.

The one saying that Crammer has that I must agree with is when you are not trading well then you simply “stop trading”. Just like in sports when you trade well your confidence is high and you trade smarter. When you trade poorly your confidence is low and your trade on emotion. When you trade on emotion you trade on impulse. I address these points for one reason If you believe as I do that we will see a continuation of this market correction which could last from one to three months you’ll see many attempts at a counter trend rally caused by anything from an M&A announcement or a manipulated short covering rally. Normally these end up as head fake rallies which only serve to separate the little guy from his or her hard earned dollar. So, what do we do?

If the S&P 500 breaks and closes below 1400 level it will be a signal to many technicians as well as program trading systems to sell. On the NASDAQ we are looking for support to hold at the 2400 level. It closed on Friday atop its 50 day moving average at 2413. Looking at the NASDAQ chart on a daily basis it looks like a real nice consolidation. But, pull back to a Weekly Chart we are looking at an index that is extremely overbought. Can the index break out? YES! We want to see some heavy distribution days that will give us the green light to load up on the short side.

You’ll remember that during the Santa Claus rally I kept referring to how the bank and brokerages were manipulating the market by buying back stock of their own companies. By doing so they created an atmosphere that lent itself to create a feel good rally. You’ll note that since Christmas the Financial Sector has been correcting. This is no surprise but it’s good to revisit why the markets rallied for no good reason. It was bonus season and compensation dictated behavior. They’ll be back again later this year and it will be the same all over again.

I have also been referencing the Utilities Sector as it is a leading indicator for the future direction of interest rates. This rally has been based purely on the hopes of an interest rate cut in the first quarter of 07′. Well here we are in the first quarter of 07′ and it doesn’t look good. Wage inflation was reported on Friday and that is what has Mr. Bernanke most nervous. The Utilities Sector closed beneath its 50 day moving average on Friday. What is the market telling us? It’s telling us that this much anticipated rate cut is unlikely and institutional investors are giving us an honest heads up by their actions. They are selling the interest rate sensitive utility stocks. Actions speak much louder then their hollow words as when they appear on CNBC to pump these stocks as they are selling.

It’s at this point of the cycle that I am begging everyone to start paying more attention to the weekly charts with particular attention to the MACD. As with bull markets the daily charts can stay overbought for a long time. During a correction the daily charts can stay oversold for a long time as well. The problem is that many people think that stocks are cheap and then buy. After they buy the markets continue their decline. A weekly chart gives you a better perspective of as to how the momentum of selling is either accelerating or declining. Weekly charts also give you a clearer picture of as to where your support and resistance levels are. It’s critical to identify these support levels and when we begin buying again to buy at those levels. This reduces your risk. We are all about the preservation of capital so remember this phrase before you make an impulse buy “today’s highs may be tomorrow’s lows”. Think about it.

To our members we will be covering in detail our current holdings and watch lists in Monday nights Contrarian Commentary. For those interested in becoming a memeber please take advantage of our 30 day free trial.

The “VIX” is in…..

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Yes, the Volatility Index also known as the VIX put in a new multi year intra day low last week. What you can read into that event is that there is little to no fear in this market. So yes, the “VIX” is in for what could be a nasty sell off in this market. The theme of the week last week was the pumping of the Airline Stocks on merger and acquisition talk. By the end of the week the sector’s prices had returned to where they started, once again the little guy was left holding the bag. CNBC received the order from home office to pump the stock of their parent company GE which broke out on huge volume. The S&P 500 “broke out” this week to brand new highs but, don’t get to excited. Friday’s price and volume action was very disappointing. You may say that I am nuts! What is wrong with me? The index closed higher on huge volume. What could be wrong with that you say? In a word “churning”. When you have an up day on huge volume that we saw on Friday you would expect more of a point gain. What we can interpret from the price and volume as we saw on Friday is that there was a lot of sector rotation and profit taking. The Banking Sector also continues to help support this market. When will the rally on the S&P 500 be over? Watch the BKX ,when the Banking Index finally begins to correct you’ll see a market decline because it’s the banks and the winged tip jackals on Wall Street with their computerized trading that is keeping the market up. On the NASDAQ we saw similar price and volume action that accompanies churning. The Semi Conductor Sector continues to struggle to break out above its current resistance levels. Without the participation of the Semi’s it’s going to be difficult for the NASDAQ to have convincing break out. The markets are extremely overbought and two weeks remain in 2006. We are not predicting a sell off in the markets until after the early 2007. The PE ratio on the S&P 500 is now around 20 which have in the past few years represented a top of the trading range. With decelerating profits it’s hard to justify the rally and expansion of PE’s. All hopes are pinned on the FOMC reducing interest rates in early 2007. With job markets still strong and the threat of wage inflation as well as core inflation it’s going to be hard to make the case for a reduction of rates. Add to the list the declining US Dollar which would further deteriorate if the FOMC lowers rates. Sure, the US Dollar had a strong week on the back of Bernanke and Paulson going hat in had to China but I wouldn’t expect the rally to continue. It’s a new world and the Communist Chinese are our number one financier.What I expect to see happening for the remainder of the year is more of the same. Pre market you will see CNBC hype the market by “reporting” via company and sector upgrades and then the subsequent squeezing of the shorts and a continued rally of the banks which will prevent a major sell off. Using history as a guide it’s highly unlikely to see the markets sell off. The markets are overbought but they can stay overbought for a pro longed period of time.We will cover our current holdings in Monday evenings Contrarian Commentary. We are planning to add to our current short positions to take advantage of what we see as a fantastic opportunity to profit from the coming correction.If you have any questions please feel free to email me at Robert Desmond

President & Chief Investment Strategist

The Contrarian Trader