Shares outstanding contracting --- The Buyout and Merger effect

"... shares outstanding in the U.S. contracted by at least $600 billion this year -- roughly 3.1% of the market's total value, according to TrimTabs."The U.S. equity market hasn't shrunk by that much in at least a decade. In 2005, the market contracted by roughly 2% and by less than 0.1% in 2004, TrimTabs estimates. From 1999 through 2003, the market expanded every year. (Percentages are based on the market capitalization of the U.S. equity market at the end of each year.)"

Revisiting Copper

DJ Industrials priced in Gold (inflation's still alive)

Who says there's no inflation ??? Look at the Dow Jones Industrials' performance priced in Gold instead of the $ ....
When priced in gold rather than dollars, the Dow was down 5.7% in 4Q 2006, down 3.3% for the 2006 year, and down 53% since the peak in 2000

PPI , CPI

The battle continues

Total Household Net Worth -- Revisiting the 2003 Tax Cuts

GDP --- Developed economies

3Q GDP #'s have been reported for most major economies , and while there will be revisions to these figures as more data comes in , here are the preliminary figures so far :

US +2.0%
Japan +0.8%
UK +0.7%
Germany +0.6%
France +0%
Italy +0.3%
Spain +0.9%
Canada +1.8%

Comeback of Crude

WTI Light Crude just crossed over its 50-Day moving average and is poised to attempt a rally to its 200-day m.a.

$$$$

Should we really believe that the $ won't hold the same importance in world trade in the future that it does now ...... that the Euro will displace it .... that the Chinese and Japanese will diversify their foreign holdings by selling more $'s and instead buy the Euro

S&P500 Earnings : Now vs. Then

This chart illustrates S&P 500 earnings per share and price over the past several years: observe how much higher EPS is than the last time the index was at 1400

1986-1997 Inflation-Adjusted Housing Prices

Stock Options

This chart shows the average stock price movements 30 days before and 30 days after the awarding of 7,786 option grants to the CEOs of 1,970 companies between 1996 and 2005

3Q S&P 500 Earnings report card : A+

S&P 500 profit growth for the third quarter came in around 20% versus a long-term historical average of 7%, according to Thomson Financial. This marks the 17th straight quarter of double-digit profit growth, the best streak since recording keeping began in 1936.... another great quarter for corporate America and for equities

Post-Election..... now what ?????

Housing Starts

New Home Sales Prices

Real Estate Futures update

" Real " Interest Rates

Sentiment

Rate Cuts ???

On the back of the most recent weak economic numbers ( GDP only 2.6% in 2Q , Durable Goods Orders -0.5% in August , Housing Prices falling for the first time in 11 years , etc. ) , the Bond market is starting to price in the possibility of Rate cuts as soon as the 1Q of 2007 . Additionaly , the implied rates are even starting to price in the possibility of a second rate cut by next August

Large Caps / Small Caps

For the better part of the past 6 years the places to be in equities have been Mid- and Small -cap stocks . They have clearly ourperformed their larger cap brethren . Since January 1 , 2000 , the Russell Large Cap Index has returned an annualized 0.77% / year while the Russell Small Cap Index has returned 3.65% /year , and the Russell Mid-Cap Index has returned 8.62%/year .
The pundits have called for Large Caps to start to outperform for quite a while now , to no avail , but things may start to change as the Large/Small cap chart is indicating

Killing Commodities

Liquidity is the key driver in all financial markets and when Central Banks decide to pour it on ( or turn off the spigot ) the ramifications are felt almost immediately . Commodities , which thrive on leverage in the futures markets , can see extreme movements , and this past summer was no exception as a series of rate tightenings and monetary directives conspired to break the back of most commodities .

Demand and Supply are usually forefront in measuring all asset classes , but liquidity has a very heavy hand

Oil Inventories

As we have witnessed over the last 6 weeks , crude oil has fallen from $78/bbl . down to $63/bbl , a rapid decline and a major factor leading to the rally in Equities and Bonds . While we are happy to see retail gas prices falling from $3/gallon to $2.55/gallon at the pump , we shouldn't get overly optimistic that oil continues to fall towards $40/bbl. anytime soon.

This week the IEA cut worldwide Oil demand to 84.7 Million bbl./day for the balance of 2006 , down from a previous estimate of 84.8 Million bbl./day made last May , and its 2007 daily Oil estimates was cut by 160 Thousand to 86.2Million bbl. /day --- not exactly huge declines . Recently OPEC cut worldwide demand estimates as well , also by token accounts .OPEC, which controls 40% of the world's crude, opted to keep its production quota at 28 million barrels per day to help lower prices and has maintained that level since July 2005 . For 2006 , OPEC expects demand growth in the U.S. to grow by only 90,000 barrels per day. In 2005, growth jumped by 230,000 barrels per day and in 2004 the growth was 520,000 barrels per day .

The increase of supply output , prospects of new Oil reserves in the GofM , and no Hurricane-related dislocations , have kept Crude and Gasoline prices under enormous pressure recently . BUT , that doesn't necessarily mean that the Demand side of the equation is fully eliminated . The U.S. consumer is still "addicted" to oil and Chinese demand is not going anywhere soon .

One way to look at the supply side is Total Oil crude and products in inventory which points to relatively high levels , but a better gauge to look at is the supply in storage needed to cover existing demand . In 1991 we had approximately 65 days of supply to cover demand , but in 2006 the supply is down to a lower level of 50 days supply to cover daily demand .

Don't throw away your bicycle just yet

Put / Call ratios

The Put/Call ratio measures the trading volume of put options to call options. It is an indicator which measures sentiment in the Options markets and thus can be used to gauge investor sentiment in the underlying Equity markets . As an example , a high volume of puts compared to calls indicates a bearish sentiment in the market , and vice versa .
It's believed by many market practitioners that certain extreme levels in the Put/Call ratio are good determinants of forecasting future market direction . A very high Put/Call level would indicate too much Bearish sentiment and would point to a reversal Bull rally in the market . Conversely , a low P/C level could point to an ensuing market sell-off .
On days when the major averages perform strongly, the number of calls bought typically far outweighs the number of puts. On these days, greed prevails and the P/C ratio may be very low -- perhaps in the neighborhood of 0.70/1 . On days of deep market weakness, however, fear prevails and the number of puts purchased is generally far greater than calls -- possibly reaching 1.5/1 . While 1/1 might seem to be a neutral reading, usually more calls than puts trade on an "average" day. As such, a reading of around 0.80 is about "normal" on this indicator.
The daily P/C line is very uneven and most measurements need to be plotted over a moving average to smooth out the raw data , usually an average period of 10 days .

With the market's recent rally over these past 2 months , can we discern anything from today's Put/Call level ? A cursory glance indicates that Puts are still relatively high and may allow for further gains in the S&P500 . The sentiment may still mean that investors are very suspicious and cautious of the recent rally .......

Housing Futures

One of the more innovative derivative instruments to be brought to market is the Housing Future . Trading began in May , with futures contracts targeted to housing-price indexes in 10 major metropolitan areas . The contracts are the brainchild of economists Robert Shiller of Yale and Karl Case of Wellesley ( S&P/Case-Shiller Home Price Indices ) and trade on the Chicago Mercantile Exchange .

The proposition is straight forward : if you spend $1 Million on a Manhattan apartment , and want to hedge against the risk that it might be worth $750 Thousand two years from now, you can sell contracts that will reap you a profit if local prices fall . Conversely , if you think housing will continue to boom you can place a bet that will pay off if prices keep rising .

The contracts may be better suited to large Home Builders or Institutional Investors and may not be easily collateralized , but Investors have a new tool to speculate and hedge with . If enough traders participate in the market, it could become a valuable predictor of housing prices in different cities .

With housing prices declining some and inventories building , the Housing Boom seems to have halted and/or " popped " . The futures markets are presently indicating expectations of price declines for contracts going out as far as August of 2007

Quadruple Witching

With this Friday's Quadruple Witching ( contracts for stock index futures, stock index options, stock options and single stock futures all expire ) right around the bend , investors should take advantage of the week's volatility in "closing out " In-the-money positions and begin rolling them into new October , November and December positions .
The phenomenon of a Quad Witching has sometimes been referred to as "Freaky Friday" as it leads to many counter trends throughout the week leading into the final day of expiration . Aggressive accounts , usually hedge funds , proprietary trading desks and commodity funds are the most active players during this period and they need to weigh and rebalance their portfolios as certain positions come to a close . As they step up their activities , they try to " play " the diminishing option and futures premiums , yet tend to all rush out the exit at the same time . This action brings on severe swings in price and leads to some dislocations.

In taking advantage of this week we should focus on Implied Volatility and judge whether or not a stock's options and futures are priced appropriately for a "roll" or if the positions should be allowed to expire .

M1

Money Supply as measured by M1 is a good tool to follow in determining the path of interest rates , Debt markets and also future Fed actions

If we are to believe that "inflation is always and everywhere a monetary phenomenon" , then we should look not only at interest rates but at the amount of Dollars in circulation . The most recent figures from the St. Louis Fed point to a steep decline of M1 , even an outright contraction in percentage terms .

Why should we care that the Fed needs to fight inflation ? That age old question and its answers and ensuing arguments usually point to the loss of buying power .... in other words , with inflation, " stuff " , gets more expensive. Too much money chases too few goods , so prices are forced upwards .

These charts are self-explanatory , slowing money supply points to slowing economic growth ( maybe even recession ) , slowing inflation pressures , further weakening of commodity prices , further strength in the Treasury market with debt yields falling , and possible Fed rate decreases in 2007

Stocks vs. Commodities

The last 3 years have witnessed a huge move in commodities . The CRB index rose from 189 in 2002 to its all-time high of 367 this past May.... . Crude Oil rose to all-time highs of $78/bbl. .... Gold rose from $350/oz. in early 2003 to its most recent 25-year high of $732/oz ..... Copper rose to an all-time high of $4.04/lb. ..... Silver rose to 22-year highs of $15/oz , and the beat goes on and on and on ........

While the reflation of liquidity was a positive for Equities and Commodities in late 2002 , the current inflationary pressures have witnessed an outflow of money from Equities into Commodities and thus stocks have suffered for months and months .

Now we're witnessing a small shift which may or may not be the start of a new InterMarket flow of money . With the Fed on pause and seemingly in front of inflationary pressures , Bonds and Stocks have both rallied and Commodities have been under pressure . Most commodities are down 10% + from their highs while the Dow Jones Industrials are within 5% of their all-time highs .

Fed Funds

With the Bond market continuing its rally , we need to judge where rates will be in the future to make a judgement as to whether or not they are overbought / oversold . The inversion of the Treasury curve , with 2-year Treasurys yielding 4.80 , 5-year yielding 4.71% , 10-year yielding 4.76% gives us information as to what the market is estimating .

Another place to look is the Fed Funds market . The Fed Funds yield is presently 5.25% after the Fed halted rate increases at its August meeting , and the forward contract prices are indicating no upward moves over the next 6 months . In fact , they're even hinting at a possible rate cut early in 2007 . At present they imply a 50% chance of a cut to 5% by the April meeting . With inflation figures cooling -- especially the Fed's favorite inflation gauge , the PCE-deflator @ 0.1% in August -- Fed Funds futures are a good place to judge where Treasurys are heading.

Volatility

Volatility is one of the more important indicators for a serious investor to follow . Volatility is a measure of risk .... the Higher the Volatility -- the Higher the risk .... the Lower the Volatility -- the Lower the risk . Volatility is also a key factor in determining valuations in options and derivatives ( see Black-Scholes modeling ) .

Why is this significant ? As a determinant of sentiment , "fear" and "greed" are very important to the underlying psychology of a particular stock or index . Knowing how the " crowds " think and act can help an investor act appropriately ( usually contrarian ) rather than follow the lemmings off the cliff.

Two of the more popular Volatility indices in the Equity markets are the VIX -- which measures Volatility in the S&P 500 , and the VXN -- which measures Volatility in the NASDAQ 100 . These indices are thought of as "reverse " indicators . They usually move in the opposite direction of their underlying index . When fear abounds , the indexes will fall and the Volatility indexes will rise . When fear subsides , indexes will rise and Volatility falls.

When Volatility rises to extremes , it usually signifies a panic selling mode , and signals a " Buying " opportunity . When Volatility falls it usually signals a "complacency " and a rising market , and can be used a " Selling " opportunity .

What are the Volatility indices implying now ? A possible topping out of the market -- it may be time to be cautious and defensive in investing , and even selling some overextended positions .

The Fed

Today the Fed published the minutes of the August 8 meeting of the FOMC .
The takeaways are as follows :

" The growth of consumer spending slowed considerably in the second quarter after the surge in purchases around the turn of the year "

" Nonfarm payrolls increased in June and July, but more slowly than in the first quarter "

" Residential construction activity contracted in the second quarter. Single-family starts declined in June to a level well below the average of the previous twelve months "

" In view of the elevated readings on costs and prices, many members thought that the decision to keep policy unchanged at this meeting was a close call,” .........“ But with economic growth having moderated some, most members anticipated that inflation pressures quite possibly would ease gradually "

``The full effect of previous increases in interest rates on activity and prices probably had not yet been felt, and a pause was viewed as appropriate to limit the risks of tightening too much,''

In other words , the Fed sees enough slowing in the economy that it can wait and see before it decides to make any more rate increases --- IF any .... the market can relax as long as inflation #'s don't creep up any more ...... the downward pressure in Oil , Natural Gas and Copper the last few weeks can assuage investors for the time being

Playing Defense

AS the economy decelerates , investors need to focus on how their portfolios are balanced . Presently , with slowing growth in the future ( UBS cut its 2H 2006 GDP estimate to 2% from 2.5% , and 2007 GDP to 2.2% from 2.5% ) we need to find the stocks and indices that will perform well as earnings begin to slow .
In such an environment , stocks with little or no correlation to the economy deserve to be over-weighted in a portfolio . These stocks are the Consumer Non-Durables ( XLP ) , the foods , toothpaste , tobacco , beverages , etc. , that people buy no matter what the economy does . Conversely , Consumer Cyclicals (XLY) , the autos , papers , hotels, manufacturers are the stocks that do less well in a slowing economy . Thus , we should overweight XLP and underweight XLY

Time to short commodities ???

The end of the Fed's rate hike escapade has brought about serious debate as to whether they've truly paused , or if they may raise at some later date.
With the Fed Funds futures contracts for September and October showing less than a 10% chance of further rate increases , the Treasury market has voted with their $$$ . With yields below 5% for the whole curve , they seem to feel comfortable with curve inversion.
Intermarket relationships show interesting action in the commodities markets as well . One of the Fed's unstated goals is to keep commodities in check , with some Fed watchers calling for Gold prices to be $450/oz. as equilibrium ( quite a bit away from where we are now ) . Recent selloffs in key commodities indicate that the Fed has accomplished some of its ambitions . Gold has fallen 14% from its $732/oz. high , the CRB index has fallen 8% from its highs , Silver is 18% off its highs , Copper is 17% off its highs , and Crude is 8% off its highs . The question now is , how much further can these commodities fall .....

Taking short positions in any market is always tricky , especially in markets as Hot as commodities have been the past three years . The key to being short the commodity groups is knowing 1) inflationary expectations 2) demand/supply 3) commodity trader activity .
If we judge correctly that the Fed is done raising rates , and weakening global demand coupled with increasing supplies , are in the future , then we should look at shorting commodity indices ( DBC , USO , SLV in the ETF world ) or outright commodity contracts .

Recession on the horizon ???

In the last 60 years , the U.S. economy has slid into recession each time that we've had an inverted yield curve --- defined as 2- yr. Treasuries yielding more than 10-yr. treasuries . This phenomenon has been prevalent with the curve inversion ranging between -1 to -8 bps since June . At present we also have FedFunds (5.25%) higher than the whole curve : 2-yr. 4.86% , 5-yr. 4.74% , 10-yr. 4.80% , 30-yr. 4.92% .
The Fed and the White House don't want to scare the consumer with this type of news , but as the 3Q ends and the Elections pass , economic #'s should continue their downward path...... Harvard Professor Martin Feldstein, who chairs the National Bureau of Economic Research, said a recession could occur if households made a "decision to start saving again" rather than keep spending as the housing market fades ........ and , as economist Gary Shilling says , "The Federal Reserve almost always overshoots. Since 1954, the Fed has undertaken 11 credit-tightening campaigns, and in only one of those -in the mid-1990s - did they succeed in effecting a "soft landing" for the economy. So the odds are that they will keep going until something happens, and that something is almost always a recession. "

10-Year Treasurys

So , where does the 10-year Treasury find resistance ? The next key level is the 200-day m.a. found @ 47.95 .... where did we close today ?? 47.91 .... this may be a key resistance point before we make any more highs in price / lows in yield ... next week's economic #'s are chock full of enough ammo to delay or confirm any moves : 2Q Unemployment , ISM Index , U. Mich sentiment , Chicago PMI and the Fed's FOMC minutes

Bullish on Bonds

When do we see bullish action in the T-bond pits ?
The bullish Treasury action has been occuring for 2 months and will continue as Retail Sales and Housing #'s continue to soften . The consumer is choking on debt and is spent , and as the consumer goes so does the economy ( 70% of GDP is consumption- source BEA ) . A slowing consumer will lead to slower GDP which will lead to lessened inflationary expectations . The yield on the 10-year hovers near 4.80% , and the TIPS has a "real" inflation risk of 2.55% , barely higher than December 2005's final tally of 2.33% .
--Check the futures activity of " smart money " , which gets posted on the commodities exchanges data library .... they are now showing that "large noncommercial " traders ( speculators/hedgies ) added 63,000 contracts to their existing long position, bringing their collective net long to 261,215 contracts, the second-highest tally ever. The high water mark of 263,723 was set March 21
-- Or check the commodity floors ... today a Very bullish trader sold 20k December 105 Treasury puts
-- Housing is finished , it was too much $ chasing bubble dreams and it has popped ......... speculation + too much money = bubble prices ........
New Homes Sales ---- DOWN
Housing Starts ---- DOWN
the Mortgage Bankers Association's purchase application index has DROPPED to 385.9 from 425...........
so how do you play this as an investor ???? ..... stay long the 10- and 30-year , stay short the Homebuilders and start shorting the big S&L's