The Contrarian Trader

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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

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