The Fed threw investors a bone during the November 1st FOMC meeting but it did not appear until today. The FOMC minutes for that meeting were released today at 2:PM and the market cheered. Regulators not only questioned the potential risks of going too far but also discussed the need to change the language from measured pace. Estimates for future rate hikes dropped sharply and the markets accelerated out of their pre-release slumber.
Dow Chart - Daily
Nasdaq Chart - Weekly
SPX Chart - Weekly
The FOMC minutes were a shock to the bond market and yields dropped sharply within seconds of the release. Yields on the ten-year note were stuck at 4.465% ahead of the news and fell sharply to 4.42% after the news. That may not sound like much to stock traders but for bond traders it was a major move in just a couple candles. The major points in the minutes began with a less hawkish posture towards future events and a bullish view of the economy. The committee noted "some recent favorable data on core inflation and labor costs". They also saw "underlying slack was likely quite limited" and short term inflation should be contained. The committee noted the housing market continued to be robust despite rising rates but that the long awaited cooling period was near. Overall they expect the economy to continue to grow and even pickup speed in early 2006 as the rebuilding pace increases.
The minutes contained this phrase, "some members cautioned that risks of going too far with the tightening process could eventually emerge." This was like waving a red flag in front of a stock bull. If members are worried about going too far then the likelihood of that occurring becomes less. They also said, "several aspects of the statement language (measured pace) would have to change before long, particularly those related to the characterization of and outlook for policy." Despite the discussion the members finally agreed the current statement structure could be maintained for the November statement as it accurately conveyed near-term economic and policy outlook.
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While all the suppositions could keep an English major in fits for a week the outlook clearly changed for stock and bond traders. Prior to the minutes a 4.75% Fed rate was almost guaranteed in March 2006 with a better than 50:50 chance of 5% at the next meeting. After the minutes the chances of 4.75% fell from slightly over 80% to 30%. A 5% rate is nearly impossible as forecast by the Fed funds futures. There is a meeting in December, January and March, which would have brought the rate to 4.75% given the measured pace language. Now the March hike is in serious doubt and 4.5% is sitting right in the crosshairs as the last hike.
This is very positive for the market since the number one thing stock traders want is for the Fed to move to the sidelines and let the economy find its own way. If they are planning on a halt in January then it stands to reason they really think the rate of inflation is slowing and by their own admission the economy is still growing. This is as close to the all-clear signal for stock traders as you can get. The markets rallied to new highs on the news and backslapping was the order of the day.
Good times rarely last long and that was the case tonight. Ben Bernanke filed his written responses to Sen. Jim Bunning and they may not be taken well tomorrow. Bernanke took a position against Fannie (FNM) and Freddie (FRE) and backed current proposals to cut their assets and limit their growth. He said capping their portfolios is important for controlling potential systemic risk. This happens to mirror the oft-repeated view of Greenspan. Bunning said after receiving the remarks that "Dr Bernanke doesn't give me much assurance that he will bring any meaningful change to the Federal Reserve." This suggests Bernanke will have to take a firmer stand on the pair to assure everyone he is not just a Greenspan clone. The combined portfolios of the two entities is over $1.5 trillion.
Bernanke also said that further energy price increases would pose upside risks to the outlook for inflation. Ben, you can count on that. He also said the housing market should be watched closely as growth in housing prices slows. He said a sharp slowdown is less likely than a moderate pause but is still possible with potentially strong impact to the economy. He said he did not see foreign investors losing their appetite for U.S. securities. He said if it did change the U.S. markets could absorb a significant shift in demands for U.S. debt, including investments by China.
There was a story making the rounds today that Russia was adding to gold reserves to increase holdings up to 15% of its foreign currency portfolio. With gold soaring over $495 on Monday it appears there is definitely a big buyer in the market. There is speculation that the rest of this decade could bring some drastic changes in currencies as the fallout from future higher energy prices circles the globe. With energy prices expected to double or triple before 2010 it could upset the global currency balance and destabilize the markets. By scaling down investment in potentially weak currencies and adding to gold reserves it will protect against a string of currency devaluations. It is thought that Asian countries, who typically hold very little gold in relation to their currency portfolios, could also start to add to gold hedges. For example China currently holds 600 tons, Japan 765 tons, Taiwan 423 tons. To reach the 15% level currently targeted by Russia China would have to buy 8000 tons, Japan 9000 tons and the basket of other Asian nations 9600 tons. Where would they get this money? From selling other currencies and U.S. treasuries. Obviously this would be a world changing event and does not take into account the demand from Middle Eastern nations like Saudi Arabia who typically hold gold as an offset for the drop in dollar denominated oil prices. I doubt anybody expects the Asian nations to buy anywhere near the amount needed to reach 15% of their portfolio but even a jump to 5% from their current 1-2% levels would be a major change in gold prices.
I personally feel that OPEC nations, especially Saudi, are probably active in the market now and are accumulating gold for the time when Peak Oil finally passes. Remember, most of the world's energy agencies are relying on OPEC's good faith reserve estimates as their supply cushion out to 2030. However, the worlds oil experts ALL claim those numbers to be overstated by a factor of 2 or 3 times. When the day comes that Saudi admits they can't increase production any further the worlds currencies will begin an inexorable decline that could last for a decade or more. It would be a good time to own gold since $1000 an ounce would then be in the realm of reality. Could this current run on gold be a sign that the hoarding has begun in advance of that event?
The boom in China may be slowing. China's Baosteel cut prices on steel by -10% today indicating there may be a surplus of steel in the market. China has been consuming steel and concrete faster than a football team stacking plates at an all you can eat buffet. This price cut could signal a cooling of that rapid pace of growth. China has been building roads and facilities like crazy ahead of the Beijing Olympics in 2008. It is possible those projects have passed the steel stage and that is reducing demand. It is also possible that global supply has simply caught up with demand. According to Fitch Ratings, the steel industry has enjoyed "extraordinarily robust market conditions." It is probably just time for a pause. US Steel (X) and Nucor both paused to the tune of about a buck on the news.
RIMM Chart - Daily
RIMM may soon know its fate as the case against NTP winds down. The judge in the case, James Spencer, has lost patience with the pair and said he was going to rule quickly on the current issues so he could get on with his life. He is frustrated with RIMM and NTP making the ruling anybody's guess. That ruling could come this week. With millions of Blackberries in user hands I seriously doubt they will be turned off as some have predicted. The government has already said they can't be turned off for government users as it would impact national security. NTP has accumulated $210 million in credit for the 8.55% of sales that Spencer awarded NTP the first time he ruled on the case. Both parties previously agreed to a $450 million settlement but that settlement fell apart when the U.S. Patent office rejected some of the patents on which the suit was based. RIMM claims all will eventually be rejected but time is running out on RIMM. If the judge rules against RIMM this week it will be forced to settle under the gun and it is likely to be very painful. Some estimates are over $1 billion. Last year RIMM sold more than $850 million in Blackberry products that were covered by the dispute. Personally I believe RIMM will either win or be forced to settle and life will go on. I do not believe it is a death sentence for the Blackberry. I believe all the bad news is priced into the stock and baring a massive change in the case of a whopping settlement over $1 billion I think $50 is the floor in the stock. The upside is huge. NTP will stand to profit from future sales on whatever terms the agreement stipulates and Blackberry sales are likely to spike sharply once the fighting is over. For that reason I believe RIMM will see $80 or higher on any successful termination of the case. The way to play this would be a long term call, say a March $80, currently $4, with the expectation of a drop to something in the $2 range on a negative event and something in the $10 range on a successful conclusion with RIMM still in the Blackberry business. You could also do a credit spread using the December $65-$90 puts ($19.30) or the January $60-$90 puts ($19.80). I like the deep in the money puts as the best way to catch the majority of a move.
The bulls are running and there appears to be nothing ahead to stop them. That is always a scary picture for me since disaster strikes when it is the least expected. Joe Battipaglia, a known market bull, was on CNBC today predicting another +10% gain in the markets over the next 4-6 months. That would be 1386 on the S&P and right at Dow 12000 for those who were wondering. While Joe's track record has not been stellar I give him credit for sticking to his guns in the face of bearish attacks. I would love for him to be right this time and for readers to profit from what would be an amazing move. However, there are some fundamental issues that we should discuss. Remember back earlier this year when funds were sitting on piles of cash? Well that is no longer the case. Fund cash positions are now at historic lows. Everybody has voted with their cash and have little left to invest. Hedge funds are still sitting on piles of money but most of them are already long as well and those with cash are looking to short the top.
Fundamentally we have the Fed nearing the end of its hike cycle and an economy that is growing. Slow but growing. Current GDP estimates for all of 2005 are +3.6% but they fall to 3.0% for 2006. Corporations are sitting on record amounts of cash, nearly $2 trillion for the S&P-500 according to Thomson Financial. The problem is they don't know what to do with it. They have all raised dividends and buybacks but are finding little to do to expand their business. Mergers and acquisitions have been very strong but there is a limit to those as well. There is a general consensus that earnings are declining and the rate of decline will pick up speed in 2006 with the S&P earnings falling to single digits. There are fears of another energy spike and companies are leery about investing a lot of money if the economy is going to fall flat on $75 or higher oil.
All of these concerns are likely to impact stocks in January even if the Fed takes a pause. With little fund cash on the sidelines and a potentially weaker 2006 we could see some selling appear towards the end of 2005. We know markets tend to over react in both directions. That suggests we could see higher highs over the next month but a cautionary stance is likely to develop towards the end of the year. If cold weather does send natural gas back up to its highs as many expect then profits from manufacturers will shrink. Retail sales, now expected to grow by +6% in December could fall off the cliff in January as the cold weather gets a grip and heating costs climb. This cautionary stance could appear as soon as next week. The Thanksgiving rally has been a profit maker for everyone and now might be a good time for those funds to be locking in profits and for institutional traders to be locking in year-end bonuses.
Crude Oil Chart - Daily
Oil prices have risen back to $59 from their $56.30 low on the current January contract. This has been very strong resistance over the last two weeks. A break over $59 could bring the oil bulls back to the party and a move over $63 would turn into a drunken buying brawl. 32% of natural gas production in the Gulf is still offline and much of that could remain offline until March. A prolonged cold spell could send gas prices soaring and also bring energy bulls back into the market. Goldman, the company that said oil could spike to $105 lowered their estimates today to only $62 for the rest of 2005. They said oil prices for 2006 should average $64. Considering there is normally a three month pause between winter heating and summer driving that could send prices lower it still suggests that we will see price spikes over $70 next year. Inventory levels due out tomorrow are expected to see a +600,000 bbl rise in crude, +1.1 mb rise in gasoline and +700,000 bbls in distillates. If the current cold snap produced a draw down in any of those levels we should expect prices to rise higher. Natural gas inventory levels normally released on Thursday will also be released on Wednesday and you can expect a decline in those levels to begin soon now that winter has started.
The Dow spike today stalled at the 10867 resistance we saw for three weeks in October 2004. It is very close to the January highs of 10984 and the psychological 11,000 barrier. After a strong pre-Thanksgiving run that would be the logical place for the rally to run out of gas. The other indexes are either at 4 yr highs or historic highs in the case of the TRAN, BKX and NYSE Composite. The laggards are the Dow and Russell-2000. The SOX at 482 has a long way to go to recover its 1362 high from 2000 and is still below recent resistance at 485. Even with the Intel and Micron bounce today the SOX has been unable to take out its Aug and Sept highs.
Overall I still want to be bullish with the apparent end to Fed easing in sight but my cautionary instinct is growing. We have come a long way in a short period of time and without any material profit taking along the way. The October lows may seem like just yesterday but they were nearly seven weeks ago. There was a two-day profit taking pause at the end of October but nothing material since. Continue to remain long but keep those stops tight. It is better to pick a new entry than give back your gains on a serious dip. A sharp 20% correction would be -140 Dow points, -18 on the S&P and -45 on the Nasdaq. In my opinion it would be a good buying opportunity for another trade in December. Once Christmas passes I would look for a change in the prevailing winds but we have four more weeks of trading before I pull in my horns. December will be interrupted by a Fed meeting on 12/13 and given the minutes today bullish hopes will be riding high for a change in the statement. Possibly too high.