Friday, August 08, 2008

Stocks Soaring into Final Hour on Plunge in Commodities, Less Financial Sector Pessimism and Diminishing Economic Pessimism

BOTTOM LINE: The Portfolio is higher into the final hour on gains in my Technology longs, Medical longs, Biotech longs, Retail longs, Gaming longs and Emerging Market/Commodity shorts. I covered all my (IWM)/(QQQQ) hedges and some of my (EEM) short today, thus leaving the Portfolio 100% net long. The tone of the market is very positive as the advance/decline line is substantially higher, most sectors are rising and volume is above average. Investor anxiety is high. Today’s overall market action is very bullish. The VIX is falling 3.69% and is still above-average at 20.37. The ISE Sentiment Index is below average at 113.0 and the total put/call is slightly above average at .95. Finally, the NYSE Arms has been running high most of the day and is currently 1.08. The Euro Financial Sector Credit Default Swap Index is unch. today at 83.66 basis points. This index is up from a low of 52.66 on May 5th, but down from 129.46 basis points on March 20th. The North American Investment Grade Credit Default Swap Index is rising .55% today to 135.27 basis points. The TED spread is falling 1.67% to 1.11. The 10-year TIPS spread, a good gauge of inflation expectations, is falling another 3 basis points to 2.18%, which is the lowest since January 23rd and down 45 basis points in about a month. Growth stock leaders are especially strong again today with many posting 4-6% gains. The US Dollar Index is blasting higher through resistance and looks poised for further gains next week, which is a large positive. The Citi eurozone economic surprise index is now -171.90, with the US index at +22.2. The Gold(GLD) and Silver(SLV) ETFs are gapping lower through support on above-average volume. Many pundits on CNBC have said recently that China’s demand for commodities will re-accelerate back to prior levels after the Olympics. I strongly disagree. In my opinion, the magnitude of the global slowdown outside the US, and its impact on Chinese exports, is still being underestimated. The Shanghai Composite, the world’s worst-performing major stock index, fell another -4.5% last night and is now down -56.7% in less than a year. I still see further downside in China over the intermediate-term. Russian equities also plunged -6.5% today on the military action and drop in commodities. The Russian index is now down -25.9% in less than three months. I can easily see these stocks fall another 20% over the intermediate-term. The (RSX) is one good way to play the downside. The commodity bubble, which is the driving force behind the current “US negativity bubble,” is intertwined with the emerging market bubble and both appear to be bursting. The magnitude of the positive implications of a bursting of these bubbles for US equities can not be overestimated, in my opinion. For years, global portfolio managers have relied on a strategy of shorting or underweighting US equities to beat their benchmarks. A US Dollar upside breakout is reversing this dynamic. As well, we may look back on the credit crunch as the catalyst that caused the hedge fund de-leveraging that resulted in the beginning of the “mother of all short-squeezes.” It is still too early to know whether the sharp decline in commodities will cushion the global economy enough to prevent further US economic weakness over the intermediate-term. I suspect a sustained decline in oil below $100/bbl., which is much more likely than perceived, would do the trick and result in a massive move higher in US equities. Nikkei futures indicate an +160 open in Japan and DAX futures indicate an +74 open in Germany on Monday. I expect US stocks to trade mixed-to-higher into the close from current levels on short-covering, less financial sector pessimism, falling commodity prices and less economic pessimism.

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