The Contrarian 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 HospiceCareNetwork.org

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

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