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Index Wrap

Dollar, stocks and Treasuries gain

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Stocks recouped roughly half of Tuesday's losses, where a strong 5-year auction, boosted largely by foreign participation, had Treasuries as well as the dollar gaining against major foreign currencies. Meanwhile, metals and the stocks of miners found selling.

Despite continued builds in the energy inventories, crude oil and heating oil both found gains, where more than likely, some very profitable bears that had been doing their homework cashed in some gains.

U.S. Market Watch - 12/08/04 Close

While metals stocks got hammered lower earlier today, the AMEX Gold Bugs Index ($HUI.X) 215.10 -1.61% did manage to battle back from a session low of 208.

Semiconductors (SOX.X) 431.91 -1.27% struggled mightily after a Banc of America securities downgraded a host of chip stocks (ADI, ALTR, ACTL, ISIL, NSM, SMTC and XLNX).

Meanwhile, IDC said its research (IDC's Worldwide Quarterly PC Tracker) showed growth in worldwide consumer PC shipments slipped to just less than +8% in the third-quarter from a peak of over 25% a year ago, where 15.9% growth in commercial shipments was down just 1% from the same quarter last year.

IDC's Loren Loverde, director of IDC's Worldwide Quarterly PC Tracker said that the recent quarter's trends have them looking for the PC market to grow by 10% in 2005, with consumer growth of 8%, while stronger commercial growth of 11.3% is forecasted.

I will note that in tonight's extended session, Jim Brown has noted in the Market Monitor that Altera (NASDAQ:ALTR) $22.20 -1.94% fell to $20.40, and Xlinx (NASDAQ:XLNX) $30.73 -1.66% dropped to $28.52 after warning on various fundamental fronts.

The Semiconductor HOLDRs (AMEX:SMH) $33.03 -2.07% also fell in its extended session to $32.30.

In today's Market Monitor and 01:00 PM EST intra-day update, I profiled/mentioned the SELLING of NAKED puts on the SMH for the Dec. $32.50 puts (SMH-XZ). If tonight's extended session trade holds into tomorrow, I need to get a damage control plan in place for traders that may NOT want to hold this security if assigned.

While my Market Monitor profiles also holds LONG, two (2) Jan. $32.50 calls (SMH-AZ), one plan for consideration that I will have to deliberate on later this evening, is the possibility of either closing out the NAKED Puts, or SELLING Dec. $32.50 calls, or just outright shorting the SMH into next Friday's expiration. Again, I need to think more about this after writing tonight's Wrap.

December "Max Pain" theory is $32.50 ($2.50 increments) I want to quickly follow up on a few things regarding Treasuries and the "spread" between the 5-year and longer-dated 10-year, or 30-year yields. I'm not going to try and make you an expert on yield curve, or spreads, but do want traders/investors to have an idea what I'm talking about, and will be monitoring in the sessions ahead.

Tonight, I added the 5-year yield ($FVX.X) to our Market Snapshot/Internals, as well as a "yield spread" field, where I hope to show traders and investors how even during a day (hour to hour benchmark) the widening or narrowing may be influencing stock traders.

I would encourage traders to also read today's 03:15 PM EST update, to perhaps understand how the strong 5-year auction, had the dollar rising, as FOREIGN investors showed up in force for the auction. Also understand how the strong demand for the 5- year may have swayed bond bulls into buying the 10-year and 30- year. Remember, it has been feared that foreign governments and central banks might NOT want to own any further U.S. debt.

Despite today's SUPPLY, the bond market certainly seemed to show STRONG DEMAND in the face of such fears.

Market Snapshot / Internals - 12/08/04 Close

To begin, at 10:00 AM EST, the 10-year yield ($TNX.X) was down 3.6 basis points. The 5-year yield ($FVX.X) was down 2.5 basis points. The actual "spread" could be calculated at 0.11, but I have multiplied this difference by a scale factor of 10 so that we have some type of whole number representation.

Now, at each hourly interval, you can see how the yield spread begins to narrow, or "pinch closer" toward 12:00, then at 01:00 and 02:00 the yield spread expands or widens from 0.50 to 1.20.

While these are at the top of the hour benchmarks, we can perhaps see how this narrowing, then widening between the 5 and 10-year yield may influence equity traders. While this is a one-day observation, when we look at the hour-to-hour losses/gains for the major indices, I generally observe that prices for the major indices "peaked" at 02:00, then fell off a bit by 03:00 when the bond market closes.

In today's Market Monitor, I tested things, and said that I thought that equities might fall modestly lower when I observed the "yield spread" narrowing to 0.80 from the wider 1.20.

That didn't happen did it? Stocks tended to move modestly higher. But not all that much from the 02:00 "yield spread" of 1.20.

I will admit that a test from 03:00 to 04:00 is not the best time to be testing an intra-day observation, as the stock market isn't going to have the bond market trade observation. But I do want traders and investors to get a general feel for how the "spread" can be interpreted as either "contraction" or "expansion."

For you yield curve traders, I would be amiss if I did not make certain that traders and investors understand the DIRECTION yields were moving today, as this is where the "spread" either narrowing or expanding combined with the DIRECTION yields are moving, will then determine the shape of the yield curve.

As mentioned earlier, I'm not trying to make yield curve experts out of you, or spread traders out of you. What I am trying to do is take something from the bond market, and tie it to my fundamental thoughts regarding banks.

For banks, all I want you to do is PRETEND that you are a bank. You borrow money from the government at a shorter-term rate (pretend 5-year yield) of interest, and you may be LOANING it at a longer-term rate (pretend 10-year yield) of interest.

Right now, as oil prices have fallen, I believe traders and investors are still going to be monitoring oil prices, but the recent decline has moved this "worry" to the backburner of the economic stove.

In my opinion, the recent decline in oil prices should be beneficial to the consumer and industry in the weeks ahead, and now its time to move on to other worries. The MARKET is always worried about something, and part of my job, with the help of others, is to interpret what the MARKET may be saying about these worries.

Today, the strong 5-year auction may also have put to near-term rest, the "worry" that foreign central banks aren't interested in the U.S. government's debt.

Do you see why I alerted traders and investors a couple of days ago to be somewhat cautious as to some analysts' thoughts regarding "stocks advanced as the dollar declined again...."

The dollar/stock relationship is way more complex than that, and today's dollar gain was attributed to strong foreign central bank participation in the 5-year auction, as foreign central banks may well have sold gold, to generate cash of their own currency, which they then exchange for a U.S. dollar, to then buy the 5- year Treasury.

An EQUITY bear that simply assumes a higher dollar is equal to falling stock price, doesn't do so well today.

Hey... a 0.48% gain in the SPX if you were short last night is not a lot of heat. But a trader/investor that simply assumes that stocks will move INVERSE the dollar, could be in for a rude surprise in the months to come. The same could be true for a bullish equity trader that goes into a mode of buying stocks based solely on the dollar's rise or fall.

Now I need to move on, and quickly discuss what I feel could be an important economic report tomorrow morning at 08:30 AM EST.

I (Jeff Bailey) will be monitoring Treasury YIELDS and the dollar for an early market pulse when both November Export Prices (ex- agriculture) and Import Prices (ex-oil) are released.

Export Prices may be the key number for U.S. equity traders to be monitoring. Here's why I think this is true.

What has the dollar been doing since September? The U.S. Dollar Index (dx00y) has fallen from around 88.50 to 83.00 by mid- November, and further lower by the end of November to 81.34. In general, the dollar has been falling.

What impact SHOULD the falling dollar have for U.S. EXPORTS? It SHOULD be helping US-made products become more price competitive against foreign-made goods. If your local currency were a euro, then the strength of the euro against the dollar would have a US- made bar of soap, probably becoming less expensive compared to a European-made bar of soap.

Here is where traders and investors may want to be careful how they interpret the EXPORT Prices for November. The recent September U.S. trade balance figures showed EXPORTS hitting a record high of $97.5 billion.

The October EXPORT PRICES (ex-agriculture) rose by 1%. (What did stocks do in October?)

Bullish scenario: With the dollar falling to new multi-year lows in early December, an INCREASE in EXPORT PRICES could be viewed as BULLISH for U.S. equities. Think about this. Some might interpret HIGHER export PRICES as inflationary (not for the U.S. though). But if you are a US-based exporter, and trade figures show the U.S. exported a record amount of goods/services in September, then any RISE in EXPORT PRICES could add to the bottom line of earnings, especially if the amount of good/services you are exporting is also increasing.

Bearish scenario: With the dollar falling to new multi-year lows in early December, foreign economies and consumers may be suffering because their currencies are so strong, that demand for their EXPORTS will be falling off, as US consumers begin switching to US-made products/services. A DECLINE in US EXPORT Prices could be viewed as "global economic slowing" where a decline in US EXPORT prices would be considered a "wash," where the weaker dollar has not been enough to fuel foreign demand for US-made products.

And this is why I wanted to get traders some basic background on why I'm focusing a bit more on Treasuries right now.

The basic preface is that a steepening yield curve (short-term rates moving UP at a slower rate than longer-dated Treasury yield) is viewed as EXPANSION. In my opinion, if we as traders/investors can have some type of grasp or measuring device like "spread" between shorter-dated and longer-dated Treasury yield, then we might well be able to judge a MARKET response to some of this price data.

Let's talk about the IMPORT prices (ex-oil) which rose 2.7% in November. It is this figure that would draw more attention on the inflation front.

Bullish Scenario: With the dollar falling to new multi-year lows in early December, foreign EXPORTERS may have to LOWER the prices of their goods/services that are being consumed by US consumers. For the US consumer, a falling price of your favorite imported good/service is probably somewhat appreciated, considering your dollar doesn't go as far as it has in years past.

Bearish Scenario: With the dollar falling to new multi-year lows in early December, if foreign EXPORTERS refuse, or simply can't lower prices, despite their currencies rise, then their (Europe, Asia) economies may falter, should US consumers decide to "switch" to only those products/services made in the US that are deemed a viable substitute. While this may seem good for the U.S. economy, it can be a NEGATIVE as our exports to foreign markets then struggle.

Bottom Line: It is very much give-and-take isn't it? Almost as if there is a point of "equilibrium" where the market can remain happy/bullish, or negative/bearish.

The dollar is very much an example of "equilibrium" where it can really flow up or down, and still not give a decisive direction on the EQUITY markets, but the dollars GAIN/DECLINE can and will eventually have an impact of IMPORTS and EXPORTS and well as inflation/deflation.

Were you surprised today that OIL, DOLLAR, Treasury prices and STOCKS rose together? There's a partial relationship with the dollar in so many things. Not just stock price. Not just Treasury prices, and certainly not just stock prices.

I (Jeff Bailey) believe that traders/investors should be viewing the dollar as a currency, where its rise/fall will certainly have greater eventual impact on imports/exports.

The dollar's strength/weakness may always be a reflection of US government surpluses and deficits, but its rise or fall may not always be a daily, weekly, or monthly predictor of US stock market prices.

With that said, I believe Treasuries become an important point of observation at this point (as well as what we've discussed regarding corporate and junk bonds).

And just as it is fundamentally favorable for banks to be able to borrow at a lower rate of interest than it lends money to its customers, and that the SPREAD (narrow or wide) can influence its bottom line, I think Treasuries will be an important indication (with oil prices having fallen in recent months) in the sessions and weeks to come.

View the "spreads" between the shorter-dated and longer-dated maturities almost as if you would the US economy as being a bank.

The worry that I have right now was depicted in last night's Index Trader Wrap, when we looked at the 20-day net basis point narrowing between the 5 and 30-year. The 20-day narrowing was largely attributed to Tuesday's trade, but something I immediately turned to when the "worry" of higher oil prices was put on the near-term back burner.

As I said, when a day like Tuesday's trade was "confusing" and "didn't make sense," then we usually explain it away with valuations or an option expiration.

But the narrowing "spread" or flattening of the yield curve, despite oil's decline, which should be somewhat re-flationary to not only the U.S. economy, but global economies as well, needs to be monitored at this point.

Yes, I understand that stock prices may have advance in anticipation, or as an accurate forecaster that oil prices were going to fall. That's why I'm looking for signs of "trouble" in Treasuries as both the dollar's decline and lower oil prices should be beneficial for stock prices.

S&P 500 Index (SPX.X) Chart - Daily Intervals

The SPX did recoup some of yesterday's losses, where buyers were found above WEEKLY S1 and MONTHLY pivot retracement of 1,178. See the rising 21-day SMA (pink) at 1,179.70? In my mind, and based on last night's Index Trader wrap and the discussion regarding the "narrowing spread" of the 5 and 30-year yield over the past 20-days, begin to think that if we're going to see the SPX remain so strong above that SMA, then some type of steepening in the yield curve, will most likely have to take place. The SPX's WEEKLY S1 identifies the near-term support and 1,200 certainly looks to be a sticking point of resistance, provided by bullish profit takers.

NASDAQ-100 Index (NDX.X) Chart - Daily Intervals

With SOX.X weakness today, and further chip-weakness in the extended session, I'm looking at the e-mini NASDAQ-100 futures (nq04z) trading 1,595.00 after the ALTR and XLNX warnings.

I've also placed some of tomorrow's DAILY Pivot levels on the chart. Here's what I'm going to do with the NAKED puts I profiled in the SMH tomorrow. As long as the NDX.X can stay above 1,591-1,589, I will look for NDX strength to have the semiconductors showing some type of stability. If the NDX.X begins to slip much below that level, then I must assume that further weakness in semiconductors is the cause, and must then take some type of DEFENSIVE posture with that position.

I will of course provide greater attention to the SMH/SOX.X action, but would only look for NDX.X strength/resiliency to have some type of buying interest holding for the chips.

Pivot Matrix -

The U.S. Dollar Index (dx00y) did trade as high as 82.73 prior to the 09:05 AM EST hour this morning, thus my marking of WEEKLY R2. Why did the dollar move that high? Probably because of foreign capital lining up for today's 5-year auction is my thought. You can see that by the 03:00 EST hour, the dollar had given back early morning gains.

I will not focus on the Treasury "spread" or "yield curve" as much as I have the past two wraps, but I really feel I needed to lay some groundwork, as future comments I make, may be tied to the recent couple of Index Wraps.

Jeff Bailey

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