Friday, September 28, 2007

Quotable Quotes: Endings

Since today is the end of the third quarter, a few words on endings seems fitting.

“The Angel ended, and in Adam's ear So charming left his voice, that he awhile Thought him still speaking, still stood fix'd to hear.”
John Milton

“When you have completed 95 percent of your journey, you are only halfway there.”
Japanese proverb

“If you want a happy ending, that depends, of course, on where you stop your story.”
Orson Welles

“A man in love is incomplete until he has married. Then he's finished.”
Zsa Zsa Gabor

Have a good weekend.

Thursday, September 27, 2007

Technical Thursdays: Dow Transports – The Technical Canary in the Bull’s Mineshaft

Throughout the nearly five-year bull market, the technical support beams for higher highs have remained solidly intact. No major market top, no major divergences, and moving averages trending nicely to the upside. There is, however, an issue of concern that has emerged recently that bears noting: applying the Moving Averages principle, the Dow Transports is flirting with a trend change signal that has overall market implications.

First, a refresher re the Moving Averages principle:

As noted on August 2nd, “When the 200-day (moving average) slope is set (up or down), the current price and the 50 day tends to lead in that direction (above or below). In other words, a mega trend contains two elements: the current price and the 50-day moving average must lead the 200-day and the slope of the 200-day must point in a clearly defined direction. 

A preliminary warning signal to a mega trend occurs when the current price crosses the 200-day. A slightly more significant warning signal occurs when the 50-day crosses the 200-day. BUT, it is only when both current price and 50-day cross the 200-day AND the 200-day changes direction that the existing mega trend can be considered over.

Now, let’s take a look at the two charts above*.

The first chart shows the Dow Transports over the past five years. What is clear is the fact that by adhering to the Moving Averages principle an investor would have stayed long the Transports and, presumably, the market as a whole. For, at no time did the Transports violate the Moving Averages principle noted above. That is, until now.

As can be seen more clearly in the second year-to-date chart, the underlined points noted in the above Moving Averages principle have occurred. Price is below the moving averages, the 50 day has crossed the 200 day, and both the 50 and 200 day are now downwardly sloped. Now, here is where a little judgment (and history) must come into play.

Given the fact that the magnitude of the above trend change points noted are at the earliest of stages, the potential for a whipsaw cannot be ruled out. For, when it comes to more cyclically oriented sectors (the Transports being such a sector), whipsaw moves are more common than in less cyclically sensitive sectors (or in a broader index such as the S&P 500).

Investment Strategy Implications

The primary point of drawing your attention to the potential trend change in the Dow Transports is that it suggests a certain fraying of the market’s broad technical strength. For example, over the past months, the technical readings for several economic sectors (Financials, Consumer Discretionary, and Healthcare) have either turned negative or are close to doing so. In other words, the Transports recent market action is an early warning sign that should be ignored.

As stated several times before, it’s a bull market ‘til it ain’t. However, as any prudent investment miner knows, if the canary stops singing, it’s time to stop the digging.

*To view a larger version of the charts, click on the image.

Wednesday, September 26, 2007

Out with the Old, In with the Relevant: Sectors in the Thematic Spotlight

With 3Q07 earnings season about to unfold, perhaps a far more productive use of investor time is to turn away from the well known and the insignificant and focus instead on identifying the themes that are playing out in the market and their prospects of continuing. For the well documented and the largely irrelevant issues (credit squeeze and the GM strike, respectively) may be vital to media ratings but they have the effect of taking the investor eye off the more productive alpha ball when they have past their useful investment value. Like the shelf life of any product, when news is old and quite well known (or in the case of the GM strike, irrelevant), it’s time to shop elsewhere.

With that said, let's consider the year to date performance of the 10 economic sectors that comprise the S&P 500 and any investment insights we can glean.

What is noticeable in the above chart (click on image for larger view) is how neatly the performance of each sector is tracking various identifiable themes. For example, at the top of the performance list are Energy (XLE) and Basic Materials (XLB), both major beneficiaries of the global growth/Asian infrastructure build story.

Next are a trio of growth issues that are clustered very tightly around the +15% category: Tech (IYW), Telecom (IYZ), and Industrials (XLI). Tech and Industrials have both a touch of the global growth dynamic as well as the weak US dollar/export benefit, while Telecom remains in its long term, undervalued recovery mode.

In the middle of the pack, out on its own, is the Utilities (XLU) sector at +10%, staging a rebound from its recent interest rate/over valued driven correction and subject to its sector specific forces.

Then we have the two “defensive” plays – Consumer Staples (XLP) and Healthcare (XLV) – crawling along at the +5% level, with the Healthcare sector being dragged down by big Pharma’s woes (Hillarycare, depleting pipelines) while Consumer Staples is still unable to realize in the minds of investors its feed-the-world potential.

Finally, the bottom of the performance barrel is inhabited by the two toxic economic sectors – Consumer Discretionary (XLY) and Financials (XLF) – solidly in negative territory, both heavily impacted by US consumer issues with Financials getting the extra kick in pants from the aftermath of the excesses of financial innovation.

Investment Strategy Implications

Insights will be gained over the next month as the themes noted above and other important sector forces become revealed via 3Q07 earnings reports. Contrarily, insights will not be gained by a continued fixation on yesterday’s macro news. Out with the old, in with the relevant.

Tuesday, September 25, 2007

Exploiting the Growth Investor

Growth investors invest in growth stories. Therefore, when the growth story of financial innovation dropped from favor, the growth investor had a choice – stick with the losing position or seek out alternative growth opportunities.

The chart* to your left highlights the performance change that taken place over the past several months (since the credit squeeze took center stage) for two growth stories: financial innovation and technology.

We all know the individual stories each sector has experienced. What may have gone unnoticed by some, however, is the shift forced upon growth investors as many such oriented investors abandon the financial innovation growth story and, out of mandated necessity, seek out other, more reliable growth opportunities. In other words, out of Financials (XLF and the broker/dealers, IAI) and into Tech and Telecom (XLK).

Investment Strategy Implications

With earnings season upon us and as the macro story on credit problems and the Fed’s rate action fades from the front page (and most investors’ minds), the focus will now shift to the micro stories of individual economic sectors and investment styles. One aspect of this shift is the growth part of the style equation.

There are several economic reasons to overweight Tech and Telecom, especially the big cap issues. Global growth and a weak US dollar are two. Then there is the above noted style factors: A pattern that is likely to remain intact, particularly through the upcoming earnings season.

*To view a larger version of the chart, click on the image.

Monday, September 24, 2007


excerpts from this week's report:

"So, is it Benjamin Bernanke or Benjamin Betray Me?

Last week’s abrupt monetary policy about face by the Fed (matched earlier by the Bank of England) has been greeted by two clearly divergent market responses: cheers from equity investors, jeers from..."

"The Fed’s action also signals the seeming demise of the data driven decision process and the return of pre-emptive thinking. And that brings me to the central point I wish to address today: moral hazard...."

" today’s FT, former US Treasury Secretary, Larry Summers, makes the argument for the pre-emptive philosophy and cautions against being too harsh on the Fed re the moral hazard consequences raised by many, present company included. Mr. Summers sums up his views as follows..."

"What Mr. Summers fails to include in his overall excellent commentary is the fact that the solution to the problem might have been better obtained with a more surgical approach..."

Investment Strategy Implications

"As the Fed’s decision fades from the front page yet lingers in the real economy, factors such as earnings results and outlooks and valuation models will step to the forefront and become the focus of investment decision-making. With 3Q earnings results just around the corner and as 2008 forecasts come into view, the time is at hand to..."

also in this week's report:

* Valuation Model
* Model Growth Portfolio
* Investor Sentiment Data
* Technical Analysis Focus
* Sectors and Styles Market Monitor
* Key Economic Indicators

To gain access to this and all reports, click on the subscription info link to your left.

Friday, September 21, 2007

Quotable Quotes: Optimists and Pessimists

As investors wrestle with the consequences of the Fed’s decision, only time will tell who will be proven right.

“An optimist is a person who sees a green light everywhere, while a pessimist sees only the red stoplight. . . The truly wise person is colorblind.”
Albert Schweitzer

“An optimist may see a light where there is none, but why must the pessimist always run to blow it out?”
Rene Descartes

“The optimist thinks this is the best of all possible worlds. The pessimist fears it is true.”
J. Robert Oppenheimer

“A pessimist is one who feels bad when he feels good for fear he'll feel worse when he feels better.”

Have a good weekend.

Thursday, September 20, 2007

Technical Thursdays: Lowering the Noise Level, Focusing the Mind

The recent questionable rate cut decision by the Fed has sparked numerous speculative comments re the implications of their actions.
• Does the Fed know something re the economy that is far worse than we mere mortals are clued into?
• Has the risk of inflation increased?
• Has the risk of stagflation increased?
• Has the Fed reinstated the Greenspan put and, thereby, moral hazard?

And on it goes. Sadly, the only clear result that came out of this Tuesday’s Fed meeting is that the investor noise level has gone up exponentially. And with it so has the tendency for confusion via the mental gymnastics investors tend to go through when the applecart gets upset. So, let’s try to cut through the clutter and chatter and “keep the main thing the main thing”, as Jim Barksdale would say.

The mega investment strategy question to be answered is, “Are US equities in the process of producing a major market top?”

Last Thursday’s “It’s a Bull Market ‘til it Ain’t” blog entry (S&P at 1485) describes why stocks must be assumed to be in a bull market until the technical conditions dictate otherwise. Despite the justifiable concerns re the Fed’s recent actions noted here and elsewhere, nothing can alter the fundamental technical analysis principle that a bull market is a bull market until it forms a major market top. Since that has not occurred, the relevant question becomes, “Is it in the process of doing so?” The answer (as it was last fall) is maybe. And here is where anticipation is most essential to successful investment strategy decision-making.

There are two primary* technical analysis conditions that would signify a major market top: Divergences (Size, Dow Theory, and other key indices) and Moving Averages. I have described divergences re Dow Theory last Thursday and moving averages on August 2nd (see prior blog entries). I have also touched on key aspects of divergences re Size (market cap) on August 23rd. Let me elaborate and update the Size issue today.

The above chart** shows the four major cap sizes (OEF, mega; SPX, large; MDY, mid, IJR, small) and the micro cap group, IWC. From a size divergences perspective, the key issue to focus on is whether new highs in the closely watched large cap SPX is confirmed by the SMIDS (small and mid). If yes, then higher highs are in store for investors. The bull is intact. If not, then a warning bell has to be rung.

As you can see, no such event has occurred, mainly because no new highs have been made in any index, most notably SPX. That’s where anticipation comes into play.

Investment Strategy Implications

If, in the coming weeks, SPX makes a new high and if it is not accompanied by new highs in the other size metrics, then you have one piece of the major market top puzzle in place. And that’s where anticipation can help focus the mind on what to look and listen for and diminish the noise emanating from the market.

*Supporting technical analysis conditions would include investor sentiment and divergences with other indices.

**To view a larger version of the chart, simply click on the image.

Wednesday, September 19, 2007

Bernanke Blinks

As the cost of money went down yesterday, so did the credibility of Ben Bernanke.

Since when did John Kerry become Fed chairman? Talk about flip flops. How do you go from being an advocate of the market discipline and exude confidence in holding the line against bailouts and then do exactly the opposite in less than 2 weeks!?!?

Frankly, I am less stunned by the ½ point Fed Funds rate cut and more so with the unanimous vote that supported it. Accordingly, I am sensing that this is not Bernanke’s Fed. The dynamics of the Fed board bear studying and the minutes of yesterday's meeting will be most illuminating re Bernanke’s leadership skills (release next month). Until then, upcoming economic and earnings data points will shed light on just where the US (not the global) economy stands. For now, a useful exercise would be to consider what the rate cut means to valuation models, which is where all economic matters must lead investors to.

From a valuation perspective, what yesterday’s Fed action implies is that we have taken a step back toward the PE (private equity) valuation model*. And in doing so, has put back in play (to some degree) the takeover premium and hot money game that the global liquidity drainage action of the past year was slowly taking away. Therefore, valuation metrics and earnings expectations for 2008 must now come into view.

Once again, the simple, elegant yet very effective modified Fed model that I use (see update table above - click on image to enlarge) provides a guide to possible scenarios. It is the yellow zone of the table that I wish to draw your attention to. Specifically, the prospects that a $96 S&P operating earnings number is a reasonable earnings expectations for the next 12 months. If rates rise (thanks to concerns of rising global inflation), then the enlarged yellow box implies a high single digit return for US equities from current levels.

This, of course, assumes that the credibility damage created by yesterday’s Fed action does not produce unintended consequences. And in a highly uncertain world, unintended consequences should always be assumed.

Investment Strategy Implications

With the strong rally and the expected rise in longer term rates, the valuation gap to full value has and will continue to close. Accordingly, the recent 100% invested position expressed in my Model Growth Portfolio (see performance data in left column) will be reduced at the next re-balancing (Monday). Until then, the trade recommendation made nearly two weeks ago (buy Homebuilders – XHB) has achieved its target and is hereby removed. Other changes are forthcoming.

*see prior blog postings on Private Equity via the Topics Discussed listings in the left column of this blog.

Tuesday, September 18, 2007

A Cake Not A Soufflé

Re the subject of the day, everyone has an opinion so here’s mine: Fed cuts Fed Funds rate ¼ point, cuts the discount rate cut by a ½ point. That, or some version of it, is what is baked into the cake. What is not in the ingredients is a little something extra that the Fed might stir into the mix, perhaps re the terms for loans at the discount window or some other creative, unforeseen way to ease the credit risk pressure. And this may make today’s decision and accompanying language that much more interesting and informative.

Clearly, the Fed’s task goes far beyond what will appease investors. It must strike the balance between a US economic slowdown morphing into a recession and solid global growth with still considerable levels of excess money creation. For example, according to the IMF, the BRIC countries' money supply growth ranges from the upper teens (India) to over 50% (Russia). And when you include the money created by the financial innovation wizards of Wall Street, an abundance of dough is still sloshing around the world.

All this excess liquidity (along with strong global growth) points to the lingering and potentially growing risk of global inflationary pressures in the midst of a US economic slowdown/recession. For the US, this is stagflation on a global scale. And definitely unmanageable by any one central bank (with domestic considerations at the top of its to do list).

Therefore, if the Fed can continue to find the right mixture and progress in appropriate steps and if the market discipline is allowed to continue to do its part, the world’s markets might be able to work their way out of the current mess. The alternative (global stagflation) is unacceptable, let alone highly dangerous.

The Fed wants a cake, not a soufflé.

Monday, September 17, 2007

"The Fever Will Break. It Always Has."

excerpts from this week's report:"

"So said the Maestro during yesterday’s 60 Minutes interview referring to the current credit squeeze. And despite the run-on-the-bank visuals of British depositors of Northern Rock standing on line, passbooks in hand, the growing impression from this desk can be summed up in two words – Old News. In fact, we seem to getting to the point where it's time to say, in the words of the Chris Matthews show, “tell me something I don’t know.”

"Without a doubt, other shoes will drop. But it’s going to take a very big shoe (global growth slowdown, for example) to impact the overall market. Anything less will simply damage the affected area in question and not likely bleed into sectors of the global economy. "

"The large economic issue is Decoupling. That is now the key area to focus on. It is about to get its long awaited test. All indications point to a US economic slowdown, or worse. The US consumer will likely cut back spending. But the investment strategy question to answer is “Just how much does that matter?"..."

"Model Growth Portfolio re-balancing:
-2% Consumers Staples
-2% Oil Equipment and Service
-1% Gold

+2% Homebuilders
+1% each Telecom and Utilities
+1% Europe 350"

also in this week's report
• Valuation Model
• ETF Model Growth Portfolio
• Model Growth Portfolio re-balancing
• Key Economic Indicators

Note: To gain access to this week's report (and all previous reports), please click on the Blue Marble Research Subscription link to your left.

Friday, September 14, 2007

Quotable Quotes: Regret

As investors contemplate the words of the Maestro on this Sunday’s 60 Minutes, a few thoughts on regret.

“No, I don't regret anything at this point. That may change on the next phone call, but at the moment I don't regret anything.”
William Shatner

“The only thing I regret about my past is the length of it. If I had to live my life again I'd make all the same mistakes - only sooner.”
Tallulah Bankhead

“My one regret in life is that I am not someone else.”
Woody Allen

“I was recently on a tour of Latin America, and the only regret I have was that I didn't study Latin harder in school so I could converse with those people.”
Dan Quayle

Have a good weekend.

Thursday, September 13, 2007

Technical Thursdays: It’s a Bull Market ‘til it Ain’t

Next Monday evening I will attend the retirement party for technical analysis legend Ralph Acampora at Grand Central Terminal in New York. Over the years, Ralph has been both a mentor and friend. His participation in numerous events that I have produced and conducted over the past decade has enabled many to gain from the market insights he shared. There isn’t a more generous person that I know than Ralph.

In having the benefit of hearing Ralph these many years, a common theme comes through – don’t over complicate your analysis. Keep your eye on a few important balls as they matter most. It is a message that I try to adhere to (my “critical variables”). It is also a similar message to the one I heard Jim Barksdale (of Netscape fame and a panelist at my Jackson, MS Market Forecast dinner earlier this year) say time and again – “keep the main thing the main thing”. With that solid advice from two extraordinary people, take a moment to consider a very simple technical analysis tool, the granddaddy of all technical analysis tools – the Dow Theory.

As the chart above* shows, there has been no divergence between the Dow Industrials and Dow Transports. To be sure, over the life of the current bull market there have been moments when a non confirmation** occurred for a while (mid to late 2006 is the most recent example) only to be confirmed a few months later.

Going into the current correction, the Dow Theory did not generate a sell signal. Moreover, when taken in conjunction with other simple yet important market indicators such as the moving averages (see blog entry of August 2, 2007), the only reasonable conclusion I can come to is that the correction we are in is…well, a correction and not the start of a bear market regardless of the angst of a potential recession or sub prime inspired contagion.

Investment Strategy Implications

There is comfort in numbers. Too often in today’s markets momentum “investing” takes the place of independent analysis and thinking. After all, careers can be wrecked by marching to the beat of a different drummer. Much better to stay close to the pack. It increases the chances of not getting fired for being too off the mark. Gotta keep that house in Greenwich.

I believe that this herd thinking is manifested in the record high correlations between and within asset classes. You see this in the willingness to surge then purge into and out of investment positions. For those with a contrarian bone in their bodies, this is a pattern that can and should be exploited. And something worth remembering should either Dow Theory components break to a new low anytime soon and the momentum lemmings jump off the cliff.

Thank you, Ralph, for many years of great advice and counsel. And thank you for your friendship. You will be missed but never forgotten.

*To view a larger version of the chart, simply click on the image.
**One index makes a new high or low while the other does not.

Wednesday, September 12, 2007

Valuation Distortions

As investors struggle with the plethora of credit related acronyms – SIV, EN, CDO, LLA, ABCP, SLN, LAPA, etc. – and their implications for the markets, the flight to quality in US treasuries that has occurred as a result of the credit-related chaos has created distortions in the valuation models used by many. The obvious direct effect is to drive down the interest rate component of the valuation model and, thereby, drive up the fair value estimates.

Whether one uses the Discounted Cash Flow method (with the Capital Asset Pricing Model (CAPM) containing the interest rate component) or the modified Fed Model above*, the effect is the same – lower rates equal higher valuation.

Since the assumption that the decline in the risk free rate (US Treasury) is a result of the flight to quality, two questions must be considered:

1 – Is the flight to quality temporary?
2 – Should adjustments be made to the valuation models used?

If the answer to the first question is yes, then the answer to the second question is also yes. If so, then the impact would be an increase in the interest rate component and a downward revision in the fair value calculations. What exactly that adjustment would be is a matter of judgment. For example, some form of normalization could be employed in which the average of the 10 year US Treasury rate would be used versus the current level (judgment required for time period to be determined).

If the answer to the first question is no, however, then a serious review of earnings expectations must be considered as the expected return (to fair value) is extraordinarily high.

Investment Strategy Implications

If expected operating earnings are not to be lowered and lower risk free rates are not to be adjusted, then the market is very undervalued. For example, using the above model the expected return is 15.00 to 19.41%, with an projected average P/E of just under 19x.

More on this in future blog entries and reports.

* To view a larger version of the table, simply click on the image

Tuesday, September 11, 2007

If Not Now, When?

While investors sit around staring at their screens waiting for next Tuesday, perhaps a few words re the arguments pro and con a rate cut would be a worthwhile exercise.

The argument for a rate cut is predicated on the assumption that the US consumer, under increasing economic stress, will cut back on his/her shop-‘til-I-drop mentality thereby impacting global growth, potentially bringing the world economy to its knees.

A supporting element of the rate cut argument is the disbelief that decoupling (global growth continues without the major support from the US consumer) will fill the gap and sustain global growth and corporate profits and profitability.

A final point supporting a rate cut is the holdover belief that a preemptive approach to matters economic should be maintained. This was a staple of the Greenspan era and one that many still advocate.

The counter arguments made against a rate cut center on the beliefs that (a) decoupling, even in a less than completely robust form, will be more than sufficient to sustain global growth (even if individual regions and/or countries suffer to some degree), (b) a long, overdue adjustment of financial innovation-juiced growth is necessary, and (c) issues like structural imbalances (global demand, current account deficits, trade deficits) must be corrected.

Supporting the no rate cut argument is the fact that the combination of corporate and emerging countries’ financial condition has never been better thereby enabling any pain to be experienced will be manageable.

In my humble opinion, the latter should be allowed to play out further. In other words, a rate cut blast to the entire system (the point of yesterday’s little soap opera dialogue) is neither warranted nor appropriate at this time. The targeted, surgical approach currently employed by the Fed should continue and the blockages in the financial system should be addressed directly versus a blast the system Fed rate cut.

Now, for those that say that unless the Fed acts now with a rate cut a recession is inevitable, I offer this: If you could not foresee the credit fiasco we are now experiencing why should we believe you now?

What if you are wrong and a recession is not just around the corner? What if global growth remains reasonably robust? What if the US economy was poised to simply experience a slowdown and not a recession? If so, what is the likely consequence of an economy-wide rate cut? Perhaps an overheated global economy?

If bad behavior (which includes financial innovation-juiced deals and the structural imbalances points noted above) and questionable decision-making needs to be changed, what better time to make that change than the present – when the global economic wherewithal exists? If not now, when?

Monday, September 10, 2007

General Hospital

excerpts from this week’s report:

"Scene: The emergency room at the FOMC Hospital in Washington, DC.

Hospital loudspeaker: “Paging Doctor Bernanke. Paging Doctor Bernanke. Please come to the emergency room.”

Doctor Bernanke arrives moments later.

Emergency Room Nurse: “The patient just arrived with a broken ARM (pun intended) and there’s a risk of infection.”

Doctor Bernanke: “How did this happen?”

ERN: “He slipped on a patch of sub prime slime. We did blood work on him. He apparently was intoxicated as we found high levels of liquidity in his system.”

Dr. B: “Has this happened before?”

ERN: “Yes, doctor. Twice. Back in 1987 and then again in 1998. Dr. Greenspan was on call at the time.”

Dr. B: “What did Dr. Greenspan prescribe?”

ERN: “Lots of liquidity.”

Dr. B’s eyebrow rises a la Mr. Spock.

“Doc, you gotta do something”, begs a man in an expensive suit.

Dr. B: “Who’s this person?”

ERN: “ We think he is the patient’s supplier, someone from Wall Street.”

Dr. B to the supplier in his most sincere consoling voice: “We will do what we can.”

Wall Street Supplier: “Please, doc. Don’t let the infection spread.”

As the supplier steps away and out of earshot of Dr. B, he starts making frantic phone calls to people in government.

Dr. B: “Let’s start by treating the broken ARM with a localized painkiller and some antibiotics.”

As Dr. B and the ERN step into the lobby of the emergency room, they encounter a mob of reporters and media mavens. “Booya. They don’t know anything. Nothing”, shouts a bald guy with a goatie.

Dr. B: “Who’s this guy?”

ERN: “I think he is someone from a major cable network.”

Dr. B: “Get him outta here.”

“Booya, booya”, shouts the crowd as the police drag the guy away.

Dr. B: “This may be worse than I suspected. I need to consult with my team.”

Dr. B then heads down the hallway to meet with his expert team (and his destiny). Their decision is expected next Tuesday.

Stay tuned to the next episode of (organ music, please) FOMC General Hospital.

Until then, here are a few thoughts for viewers to consider:…"

also in this week's report

• Valuation Model
• ETF Model Growth Portfolio
• Key Economic Indicators

Note: To gain access to this week's report (and all previous reports), please click on the Blue Marble Research Services link to your left for info.

Friday, September 7, 2007

Quotable Quotes: Temptation

As the pressure builds on the Fed to cut rates, a few words on temptation.

“The last temptation is the greatest treason: to do the right deed for the wrong reason.”
T. S. Elliot

“Why comes temptation but for man to meet And master and make crouch beneath his foot, And so be pedestaled in triumph?”
Robert Browning

“Devils soonest tempt, resembling spirits of light.”
William Shakespeare

“Temptation is an irresistible force at work on a movable body”
H. L. Mencken

“I generally avoid temptation unless I can't resist it”
Mae West

Have a good weekend.

Thursday, September 6, 2007

Technical Thursdays: Homebuilders – Building a Base for a Dead Cat Bounce

The Divergences principle is an anchor of technical analysis and one of its most reliable tools. The logic is simple: price alone tells half the story and is an incomplete measure of a given trend. Price must be confirmed by other relevant indicators that must confirm the given trend otherwise a trend change is likely to occur. When price is not confirmed by other indices, a divergence has occurred and a potential trend change becomes the most likely next move.

Applying the Divergences principle with price, Momentum, and MACD, is an excellent short-term timing tool. If price is not confirmed by Mo and MACD, the odds of a trend change rise substantially. Such is the case with, of all things, Homebuilders!

As the chart above shows, XHB fits the Divergences principles quite well. Price (new lows) is currently not being matched by a confirming low in either Momentum or MACD. What would make this trade even more compelling is if XHB made a new low over the next few days and Mo and MACD improved further. Unless that new low were a plunge to say 20, the Divergence signal would be even stronger.

Investment Strategy Implications

Nothing’s perfect but when the news is both old (on the verge of getting stale) and bad, an investor should begin assuming that the market value reflects most of the current bad news. To be clear, this call is little more than a trade. But placing a modest bet on a beaten down sector is what a contrarian investor (that’s me) is supposed to do.

P.S. The wide gap between price and its 200-day moving average also argues for a bounce.

Note: At publication time, neither Vinny Catalano nor clients managed by Blue Marble Research had a position in XHB.
**Follow up note: Position removed. See September 13 blog entry.

To view a larger version of the chart, simply click on the image.

Wednesday, September 5, 2007

What Defines Liquidity?

MZM (money at zero maturity) is generally acknowledged as a useful metric for measuring liquidity. Recently, some investment strategists have noted that the current injection of funds into the US financial system by the Fed has boosted MZM to levels not seen since just after 9/11. The conclusion reached is the beneficial effects such liquidity increases are likely to have on financial assets. What is worth noting, however, is what is contained in the chart to your left*.

This data shows that while money growth has recently climbed, the increase (year over year) is still well below the 20% increase in liquidity that occurred in late 2001. What could be argued is the suggestion that the recent rise in liquidity simply offsets the draining of excess liquidity from the system that took place earlier this decade, which ended back in early 2005.

The value in this data may be the ability to better quantify the liquidity rescue efforts of the Fed and other central banks. What complicates the analysis, however, is the global nature of money, its growth, and the free flow of capital, a by-product of globalization. With money growth originating from so many “creative” methods (courtesy the financial wizards), the Fed can do its part and pump money into the system in a variety of ways, but measuring money growth has been compromised. And that makes the task of knowing just how much money is in the system that much more difficult. Yet another unknown among many.

*To view a larger version of the chart, simply click on the image.

Tuesday, September 4, 2007

September Swoon? Not Likely.

excerpts from this week's report:

"September has arrived and the Chicken Little/the Fed better cut rates crowd are in full force racing about the halls of Congress and publishing opinion pieces predicting dire consequences if the Fed doesn’t bailout bad behavior.

As the rest of the investing world continues to catch up to the credit derivatives risks that readers of this report and blog have been well aware of for quite some time, the dominant investment strategy issue entering the dreaded September/October time frame is whether the teeth gnashing, hand wringing, furrowed brows, “woe is us” lament, lookout below angst is warranted? Or is it a tad overdone?

Well, there are two facts that are hard to deny:

1. Throughout this bull market, September has not lived up to its boogie man image
2. Valuation levels are once again supportive of higher markets

On the first point,..."

"As for the second point, a look at the valuation model below (see report) makes it fairly clear that..."

" their credit, the markets are (finally) doing what markets are supposed to do from time to time – ferret out the bad decision making and excess risk taking and adjust the misalignment of values. In the process, change is underway and astute, cool-headed investors can exploit the opportunities such a changeable climate present..."

also in this week's report

• Valuation Model
• ETF Model Growth Portfolio
• Key Economic Indicators

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