At the Center of the Teeter-totter
Remember childhood where occasionally you sat at the center of the teeter-totter and nothing much happened, even as one person on one end was almost flung from their seat while the other hit the ground with impact? Here we sit at the center waiting for a victor to emerge as the biggest kid. Will it be stocks or bonds? As market-neutral traders who shouldn't care if the market moves up or down, we can use puts or calls to profit, depending on current market conditions. Either way, we are still the smart kid at the center. Welcome back to the future. It may help you to trade better in the coming days if you remember this metaphor. The point is to remain flexible and play the market we're given. Don't move too far to either end of the teeter-totter until we see which way this market wants to run.
You may be wonder why this even matters. The short answer is that inflation matters to the health of the market. Investors are nervous that if inflation rears its head, thereby sending interest rates up over 6%, bonds will become a more attractive investment, which would cause a massive stock market sell-off. A number of things will affect the rate of inflation. With that in mind, let's take a look in the Economy 101 book of seemingly innocuous factors that might cause concern with Papa Bear, Greenspan in this Goldilocks economy.
First, and foremost, the price of oil. Whether we like it or not, oil is the engine that drives the Western World's economy. Without it, the power for our PC's, cell phones and pagers, not to mention the network circuits and communications infrastructure would go out. Our information and manufacturing-based livelihoods would be non-existent. Our homes would be dark. Our cars would run out of gas. Is this really an option? Of course not. We have to have it no matter what it costs. If OPEC can arbitrarily raise prices through implementing production limits by its members, the costs of producing goods and services rise.
Our ace in the hole in the past has been that emerging nations with oil reserves count on the cash from oil sales to feed their economy. They don't dare give up the revenue stream for any reason. Thus OPEC's members lie to each other between meetings about their oil production volume and prices. Members may say that they are honoring the agreement, but in reality, they are producing their little hearts out as they undercut the price to consuming nations shopping for the cheapest source of oil. In short, production quotas rarely stick because the producers have to compete too.
So what happens if quotas actually stick? To nobody's surprise, the cost of goods and services rise and we have inflated prices, or inflation! Investors assumed that since oil prices are rising, OPEC's must have finally been adhering to its quotas. WRONG! Gasoline stockpiles are on the rise and word on the Street today was that OPEC was "adhering to 85%" of the quota. Perhaps they are cheating again. No one really knows for sure, but the evidence will only show itself empirically. In other words, we have to see it to really know it. We see it by government indicators like CPI, PPI, unemployment and hourly wage rates - all things that tip investors (and Alan Greenspan) as to whether inflation is here, or not.
Currently, the market fears that inflation is rising again and that the FED will have to raise rates before its next meeting in August. That's why investors are twitchy until the Producers Price Index (PPI) is released on Thursday, which is expected to show a +.4% to +.5% increase in April. If we subtract out the energy component, the core rate should only be +.1%. Investors expect the CPI to come in at +.4% too. Anything greater on either of these numbers would confirm inflation fears, send bond rates higher (perhaps to 6%) and send stocks into a tailspin. That is the heart of why investors and the market sit on the teeter-totter.
While we wouldn't normally go into such detail on economic theory, we bring up this oil/interest rate lesson to show the invisible riptide forming under seemingly normal ocean surface currents. It is far more powerful than each individual daily market wave. We want to keep this in the back of our mind during the daily business of trading. Having a better understanding of the whole economic picture helps to be better traders.
That said, let's get out the magnifying glass and look a little more closely at today's market, after which we'll tie it all together for a glimpse on what to expect for the rest of the week.
As a natural reflection of market uncertainty, volume was unusually low today, while most of the news centered around mergers and acquisitions. We woke up today to learn that HSBC was buying Republic Bank of New York for $10.3 bln. and that, in fact, Chevron, the #4 U.S. oil company is having discussions with #5, Texaco in a merger that could be worth $42 bln., despite Friday's rumors to the contrary. More interestingly, Microsoft is spending $600 mln. to acquire a 4.25% interest in Craig McCaw's Nextel, a cellular phone network. (As an aside, anyone who thinks MSFT is a has-been just got a tip-of-the-hand that they are not a one-trick pony banking on Windows to carry them into the future. Investments in AT&T and Nextel signal MSFT's intent to be a winner in the broadband communications future too.)
You might think with all the merger announcements this morning that we'd follow through with a strong market rally. Alas, it was not to be. After a morning stretch rally that took the DOW to 11,100, the DOW closed down -24 at 11,007 on just 767 mln. shares (a little light). Breadth was not bad though at 1700 up to 1300 down. The S&P suffered a bit too as it closed off-4 at 1340, after rising as high as 1352 in the first half of the day. Some standouts though included AOL ($128, +10) on general Internet strength; CPQ ($26.25, +1.50) on news that they would strengthen their distribution relationships with Ingram Micro, Inacom, Tech Data and Merisel (so much for the direct selling model. . .guess Dell wins); and MO ($38, +1) after winning a jury verdict that found them not liable for the cancers caused prior to commencement of the plaintiffs actual smoking habit.
The NASDAQ and the Russell 2000 were a bit more exciting, as the tech stocks came back to life today. NASDAQ closed up +22 at 2526 on 836 mln. shares traded, while the Russell 2000 had a great day, up +7 at 441. Both indexes owe thanks, in no small part, to a resurgence in techs and Internets like CMGI ($237, +17) who benefitted from a rise in its stake in Lycos ($105, +15) after it was learned that USA Networks would not likely complete its offer to buy them due to shareholder opposition. Another Internet merger made headlines today as well. GE's NBC division will form a new Internet portal/content company called NBCi. NBC, who will control 53% of the venture is teaming up with XMCM ($90, +6.75) who will own 34%, and Snap.com, a division of CNET ($136, +22) who will own the remaining 13%.
Others putting on a show today included DELL ($42.50, +2), AMZN ($147, +10), YHOO ($155, +8), EBAY ($193, +17) GTW ($67, +2.50), and EGRP($112, +9) to name a few. Other than Dell, surprisingly, no others from the Big 5 (MSFT, INTC, WCOM, CSCO) participated that much in the action.
This action is telling us that there is still interest in the techs and Internets, but one day does not a trend make. Thus we need to be a bit careful on reading too much into this, especially given the light volume. The really good news is that the Russell 2000 closed above its 435 benchmark.
It's also noteworthy to us in the grand scheme of things that gold is trading at its lowest price in 20 years - about $278 per ounce. Granted, England is reported to be selling half of its reserves in the open market. While superficially, there is a short-term surge in gold supply, the bigger picture is that low gold prices mean we live in an economically stable time and there really is no world- wide fear of inflation
Now, Let's distill everything. Long term, OPEC members cheat their stated quotas; gold is cheap. There doesn't appear to be an inflationary problem even if the international economy is recovering. Yes, we think the inflation thing is over-blown. Short-term however, we can't stop investor's fear, rational or irrational, of how economic indicators might cause Greenspan to react. Until Investors see it for themselves (hopefully this Thursday and Friday), it's going to be uncertain and choppy. Ken Fisher a long-tenured contributor to Forbes Magazine, and son of famed value investor Phil Fisher frequently notes that the markets job is to humiliate as many investors as possible. Thus, a healthy dose of fear and a high wall of worry create a good environment for price rises.
Nonetheless, stay at the center of the teeter-totter, wait for a good market entry, set stops just in case and sell too soon.