The Contrarian Trader

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

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The Contrarian Trader >> The Week Ahead Forecast

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bull_fight_by_vegasmike.jpgThe employment numbers came out on Friday and wow! We grew jobs which is great for the economy but not so great for those speculating that the Federal Reserve will lower interest rates anytime soon.That’s why we added to our  position in the SPY March 139 puts It is my contention that although there may not exist the rampant speculation in the .coms and technology stocks that we saw in 2000 there is a speculative bubble built into the market by those betting that the Federal Reserve will lower interest rates in the first half of 2007. Federal Reserve Chairman Bernanke has put the markets on notice that policy decisions would be based upon the most recent economic data. As long as there is job growth in the United States there is no reason for the Federal Reserve to lower interest rates anytime soon. There are certain indicators that are flashing on my screen that tell me the smart money is beginning to think more in terms of a neutral stance with a potential bias to the upside for interest rates. Take one look at the US Dollar which rallied last week. Perhaps it was an oversold reaction but it coincides with a weakness in the Utilities Sector which is dependent upon lower interest rates for a continued rally in the XLU.

Why do rates count so much? Great question. The economy has had such a great run since March 2003 due to the massive boom in new home construction and the ripple effect that it has had on the economy. The affect of lower interest rates sparked a rally in existing home prices which leads us to our current situation. Introductory adjustable rate mortgages are due to convert to higher  rate mortgages in the coming months. People are now running to the banks to wisely refinance those existing mortgages to longer term fixed rate mortgages. There is one problem, the values of the home that they purchased only a couple of years ago is now worth less then the amount due on the mortgage. What say you? How can this be? That is going to be the reaction of thousands of home owners across this country. The rally you are seeing in the Housing Stocks now is a false rally. Let us see if these stocks can come back in an successfully retest these lows. With a new Democratic Congress I’ll bet you are going to see Congressional Hearings into the underwriting practices of the major banks like Citi Group (C) in the coming months.

As my readers can attest I have been saying to tighten up their trailing stop loss orders and begin to accumulate a short position in the markets. Going into the Christmas and New Year Holiday’s you can expect that the “window dressing” will continue as well as some tax loss selling which appears largely to have abated. After the first you can expect to see profit taking by those who chose to avoid taking capital gains in 2006 thereby deferring those gains into 2007.

The S&P 500 last week closed higher on good volume. It held support at the 1400 level which is critical. The key indicators to watch these next couple of weeks will be a) Volume b) the Advance Decline line. If the S&P 500 continues higher on declining volume on a weekly basis this rally is suspect to say the least. Volume and broad participation is what matters now. Profits have been decelerating and all hopes have been pinned on the the Federal Reserve lowering interest rates. By most measures on an intermediate term basis the markets are overbought and ripe for a correction. I think that great buying opportunities will present themselves in the coming months. But with the VIX near historic lows and with improving technical indicators (Disclaimer: We are long the VIX May 25 Call options), decelerating profits, a declining US Dollar and inflationary pressures (anyone taken a look at the steel stocks lately?) it remains far from certain and my opinion at his juncture that a Federal Reserve rate cut is not an option. The inverted yield curve is forecasting a recession which was backed up this week by the ISM’s manufacturing numbers falling below 50. A number below 50 indicates that manufacturing in the US is contracting where as a number above 50 would indicate expansion.

In closing we are not forecasting a sell off like we saw in 2000 nor are we suggesting a market crash as seen in 1987. What we do forecast is a 10% correction in the stock market. I have not closed out all of our long positions but, my tightened stop loss orders have allowed the market to close out some long positions.

This week we closed out:

LOJN March 15 call options which we opened a position on 11/30 we closed out for an 18% profit.

DSTI which we re entered this week we closed out 50% of the position for an 6% loss.

COH which we opened as an intemediate term trade was closed out this week. This trade was inspired by Susan, a dear friend who in my opinion, was in need of a great handbag. She still remains a dear friend and as I appropriatly termed at that time a very Classy Lady. We closed this position with a 28% profit. Susan is a Dietitian for Hospice and a major advocte. Did you make a few dollars off of the “Susan Trade”? Then please, give a few dollars to

To our members we will conduct an analysis of our current Long/Short positions in Monday evenings Contrarian Commentary.

If you have questions with regard to this our forecast please email me at Robert@TheContrarianTrader

Robert Desmond

President & Chief Investment Analyst

The Contrarian Trader


The Week Ahead

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The FOMC minutes which were released this past Wednesday cast a cloud over the potential expansion of the US economy. The Housing Sector they forecasted would continue to be a drag on the US economy. Concerns abound about the looming train wreck in the Banking industry with regard to the conversion of ARM’s to fixed rate mortgages. People who took out those mortgages were buying houses that they could not afford. In many cases the mortgages were interest only loans. Now the day of reckoning is coming for many borrowers. There payments will convert to fixed rates which will substantially increase their monthly payments. Many will try and refinance these mortgages only to find out that their current mortgage balance exceeds the depreciated value of their homes. Foreclosures will rise and will add to the current inventory of houses on the market. The sector that may suffer the most from the slow down in housing my be the Retail Sector. A rise in monthly payments will have a direct effect on the buying power of the consumer. The consumer has used their home’s equity as an ATM machine and the banks have been only so happy to oblige. Home equity loan rates are usually based up on the prime rate. I touch upon this issue because if inflation were to rear its head the Federal Reserve would be forced to raise rates rather then stay with its current policy of keeping rates on hold.  The stock market’s rally since August has been based upon three things. The first is Federal Reserve’s policy of keeping rates on hold and speculation that they would begin to reduce rates in early 2007. The drop in energy prices accounts for the second. And thirdly, the unemployment rate is at multi year lows. Although the unemployment rate is great it also causes wage inflation which could become an issue and prevent the reduction in rates that the markets have been factoring in. So, keep an eye on the unemployment numbers and wages.  The S&P 500 rose 20.3 points this week to close at 1401 on volume that was equal to the previous weeks up volume. Ideally you would like to see volume rise on a sequential basis but since we were well above the weekly average on the S&P 500 I’ll give it a pass. Look for the Banking Index to break out above the 115 level. If it does it’s all but certain that the S&P 500 will continue to rally. Critical support for the Banking Index is the 112.50 level. Use the Utilities Sector as your barometer of as to where rates are headed. It’s the Utilities Sector that borrows the most money therefore it is most greatly effected by a rise in rates. The NASDAQ which powered higher again last week did so on declining up volume. Again, it did trade on above average volume but unlike the S&P 500 I am not willing to give it a pass. At present the NASDAQ is suspect. Volume is the “rocket fuel” that must accompany any bull market. It’s one of the few absolutes in trading. That being said the NASDAQ should continue to rally. I will touch upon the weekly sell indicators in Monday evening’s Contrarian Commentary. 

 Now to one of my favorite indicators. The Volatility Index also known as the VIX this week closed at lows not seen since July of 2005 when it hit a low of 9.88. After hitting that low the markets which had been on a significant rally entered a three month corrective phase. The NASDAQ didn’t return to those new highs until November 2005. What the VIX is telling us is that there is a massive amount of complacency in the markets. It’s at times like these that I find it best to begin adding short positions. 

 New Buy Watch Stocks 

IPII brutal sell off and down volume continues to rise. Perhaps a capitulation day on Friday. Let’s watch as it enter into extreme oversold levels.  

DEPO is retesting a strong support level at  3.75.  Watch for a consolidation at that level. If we enter our stop loss just below that support line. “First out, best out.”

New Short Watch Stocks 

ACTU which has been on a tear of late. It is going up against strong resistance not seen since May 2002. There are sellers up above here. We will be watching for the key reversal day that gives us our short signal.  

 The stocks that I have touched upon in this edition are stocks that must be accumulated. You are almost certain to lose money if you buy your entire position on the first buy. Given the price of commissions these days it’s penny wise and dollar foolish to think you are being smart by saving commissions. If you do not plan on utilizing a stop loss I strongly suggest that you avoid these stocks. It’s OK to be wrong with a stock. It’s not OK to be wrong and then not stand by your stop loss price. So please, use a stop loss order. Pride is an expensive emotion.  When we decide to enter these positions we will advise our subscribers by email and/or text mail. When we stop out of a position we do the same. If you have an idea for a trade you can email us and ask our opinion, we like to call it “Trade Coach”. There is no extra charge; we want our subscribers to make money. I started this site to help level the playing field between the fancy pant Wall Street crooks and the little guy trying to learn the ropes of trading stocks and options. It’s so satisfying when I receive an email from a subscriber who tells me that he or she made money on a stock that they themselves had researched and entered using my rules. You can’t put a price on that.  

 If you would like to take advantage of our 30 day free trial offer please click on the link below and click on the ” Free Trial” button on the top right of the home page. Monday evening’s Contrarian Commentary will cover the day’s action, our positions and new buys or sells. We look forward to hearing from you.  


Robert Desmond

President & Chief Investment Analyst