No fear in numbers but October looms

September 22, 2014 04:59 AM

In retrospect, last week looked easy to handicap but the reality was quite different. You’ll recall we had a sequence the prior week where the market dropped briefly on the hypothesis the Fed would extract its phrase, ‘considerable time.’ Here’s what I had to say about it in Tuesday night’s Short Term Update to clients.

“I can’t base tomorrow’s action on whether the Fed takes those two words ‘considerable time’ out of the mix or not. I don’t know, if I did, it might be insider trading, right? All I can tell you is I hope they don’t take it out because it would mean the smartest financial people in the world (according to some) have learned absolutely nothing from history. Perhaps last week’s ‘leak’ was a trial balloon just to see how the market would react. I’ll tell you this; the market is smarter than the Fed. The mass mind of us all knows darn well we are reproducing 1937 right now. Do you think Janet Yellen owes any allegiance to Obama? If so they don’t take those words out until after the election. Am I being a little cynical? Perhaps but I am trying to leave no stone unturned. I’m still in the camp that believes the market stays elevated this month. So while I have no idea what the Fed will say personally I would lean into the camp where they leave things exactly the same this time. I can’t believe these Fed heads would be that dumb to threaten to raise rates right now. That means I’m still looking for a bullish outcome.”

How could you possibly live without this analysis?

Have you been watching the PBS documentary on the Roosevelts? In the episode concerning the late 1930’s they make a point to state that Roosevelt himself may have become a little too overconfident. By 1936, due to political backlash they slowed down the New Deal stimulus programs to a grinding halt. The result was a deep recession in the depression known as Great Depression II which lasted nine months. According to the Ken Burns people the economy finally started turning back up when Roosevelt unleashed a second round of stimuli into the economy.

Last week was strange as we had conflicting data in the housing market. Home builder confidence went through the roof while new housing starts fell sharply. According to the National Association of Home Builders Wells Fargo Housing Market Index the reading hit its highest level in nine years; with a reading of 59 (anything over 50 is good). September was the 4th month in a row the index rose. At the same time the Census Bureau reported that new housing starts in August fell sharply, a 14.4% drop off the revised July rate. New building permits also dropped in July.

Traders are understandably vexed. Don’t get me wrong, confidence is similar to sentiment where Roosevelt said the only thing we have to fear is fear itself. But Roosevelt wasn’t dealing in bubbles.  Do you think it’s just a tiny bit possible home builder’s confidence could be misplaced? According to socionomic theory the business community has its highest level of optimism right near the end of the business cycle and their lowest level is obviously just as the market is turning up. That’s why the stock market always climbs a wall of worry. I’d be more concerned about the drop in new housing starts then any builder’s confidence reading five years off the bottom. Remember I told you about the Scottsdale Realty Whiner’s Index? My wife works in the beauty business and had a number of real estate clients in those days. In July 2007 (when the Russell topped) deals stopped going into escrow and the ones that were in escrow found a way not to close. We’ve seen this script before.

Why shouldn’t builders be confident? Were you watching the Alibaba(NYSE:baba) sweepstakes on Friday? I’m really glad for Jack Ma who is a true American, oops, Chinese success story. I’m also happy for visionary investors who got involved early. My problem was all of the idol worship on Friday. They wouldn’t or couldn’t stop talking about it. Friends, this was the first time I’ve seen true euphoria this entire sequence with the VIX. It’s been up we know, the complacency has spilled into the geopolitical realm, we know that. But Friday was in a class by itself.

So you can’t blame the homebuilders for being a little happy. There appears to be enough to go around. I’m happy because the Fed didn’t remove that phrase. I didn’t think they’d be dumb enough to do it right now. But I am going to tell you this as the day is long and you can it to the bank. The day is going to come in the not too distant future where they will start to raise rates and it’s going to be a result of either overconfidence or being premature. History has spoken loud and clear. Aside from the fact that social security and the National Labor Relations Board were relatively new institutions I don’t see much difference between now and 1937.

Our view for Friday was the good technical action wasn’t likely to be sustained as some traders would view Friday as a good day to take profits. Going forward the greenback actually closed above the long-term Andrews’s line we’ve been monitoring. It has a Fibonacci target in the 85 handle which should go a long way in telling us whether we are about to enter some kind of new secular bull market (see chart below). The dollar is strange; its history is either feast or famine every time it’s hit the line. However, looking at other instruments that have hit long term lines such as these, they’ve spent weeks or months testing the line. The two that come most to mind were the SPX spending nearly two years on either side of its mid line before pulling away to the good and most recently the Nikkei which has spent this entire year testing a long term trend line that goes back to 1996. I’d like to tell you the greenback is about to spend lots of time at these levels but we’ll just have to see about that.

For now, the Dow Transports still look fine as does the BKX even if the HGX housing index appears confused with that conflicting data. You know by now that nothing bad happens to the market when the BKX is up. Dow theorists will also tell you nothing bad happens when the Transports are up. So when both are up there’s no use fighting the tape. We could get a reaction later in the week by Wednesday/Thursday but I find no reason to go against the euphoria just yet. Hope dies hard and fear drops like a rock. No fear right now and we are still looking at our cycle points in October.

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