Monday, June 18, 2007

The last mad dash?

What a difference one week makes! As the 10-year stabilized below the 5.25% level, bulls took over the reins again. By the end of the triple-witching Friday, the Dow had managed a stunning, 3-day, 240+ pts advance.

There was some speculation that the sudden drop in the bond market was China sending a message in response to the new bill about it being a currency manipulator. I regard this as likely as I have previously noticed at least two other market moving gestures from China following political developments among China/Taiwan/US (one for a currency revaluation and one for removing export tax rebates on certain base metals). Whatever the reason behind the bond market plunge, even if the yield on the 10 year stabilizes between 5.1 and 5.25% it will still be a real drag on the economy, not to mention holders of the ARMs to be resetting later this year. The ARM reset schedule from the famous Ivy Zellman report shows a peak due in Nov 2007.

The housing story has been the cornerstone of the bearish view. I myself have repeatedly predicted a housing induced economic slow-down. However, where I differ from most bearish analysts is that I think we will make new highs before reality finally catches up with this market, probably through a significant deterioration in earnings.

The importance of the second bottom
In the last weekly review, I said I was waiting for the “next leg down” to see what kind of divergences there may be. The second bottom came on Tuesday, sooner than I anticipated; at the same time, it was quite unambiguous. In the S&P chart, a clear “higher low” along the 50 DMA was made. The real give away was the bigger, higher volume move on Wednesday which signaled that bulls were back in control. There was likely substantial short-covering on Thursday and Friday.

Commodities boom
Brazil (EWZ) made new highs this week, but I thought the action in DBA (PowerShares DB agriculture ETF) was more notable in that it broke out before and help up well during the bond induced swoon.

Not too long ago, just as people are uniformly calling the Chinese stock market a bubble, I voiced my doubts. The weekly chart with the uptrend line is updated here. 3404 was part of a one day 370 pt (10%!) reversal. The closing low was 3670 made on the day before, so I consider the uptrend still intact. Noteworthy is the divergence in FXI which lingered below the yearly high as $SSEC made new highs. FXI finally broke to new highs with decent volume last week.

I have commented previously on the lack of retail participation for much of this bull market. The point was that retail investors must be sucked into being bag holders for this market to go down. Right now, the action in FXI as well as other evidence is signaling that they may be coming back finally. We may well be starting the blow-off phase just as the underpinning economy is under more and more strain. A year from now, one may marvel at the timing of the Blackstone IPO, but that will be missing the point. IMO, someone like Steve Schwartzman (co-founder of Blackstone) dictates the timing.

As far as what I'm doing, I'm sure you can guess by now. I'm staying long unless there is a clear signal to do otherwise.