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Monday Morning

War wages on but the markets don’t seem to mind too much.

I was reading the times this weekend and there was an article on the war in Afghanistan followed by a page on Iraq followed by a page on the war in Africa (which we usually ignore but millions are dead) and then a few pages on the “I don’t know how it isn’t called a war” in Lebanon. It really is a wonder there is any consumer confidence but even Europe is recovering.

Remind me to invest in whoever makes bullets though…

Israel suspended bombing for 48 hours while waiting for Condi to work her magic but that message apparently didn’t get to their Air Force which just dropped some bombs this morning. Oil was heading right down but a pipeline ruptured in Russia and Nigerian rebels forced an oil platform to be abandoned and there are heat warnings for the US (nat gas should shoot up) so it headed right back up again.

Asian stocks are still playing catch-up from last week and are up across the board while Europe is down despite very good retail numbers in Germany and an apparent housing recovery in England.

I still have my concerns about our markets as inflation continues to grow and the economy has slowed drastically since the last quarter.

If we assume a lag of 6 months, or 6 hikes the way the fed has been ratcheting up for 17 consecutive brutal sessions since mid 2004 then it it possible that the numbers we got last week are an indication that the Fed did indeed start to overdo it somewhere around the September rate hike and may have overshot the mark by 6/17ths, let’s call it 35%.
http://www.federalreserve.gov/fomc/fundsrate.htm

The Fed dropped rates from Jan ’01 through June ’03 but took long pauses between moves from 1.75% in Jan ’02 to 1.25% in late ’02 and then waited and hoped that would do the trick all the way to June ’03 when they dropped the final 1/4 point. The economy was already getting in gear around April of ’03 where the ridiculously low rates (Fed was too loose) sparked the famous “housing bubble” which drove, for example, TOL up from $10 in April ’03 to $58 in July ’05.
http://stockcharts.com/gallery/?tol

So the Fed dropped rates from 6% in Jan 2001 all the way down to 1.25% in Nov 2002 and there was no real effect (granted we were still freaked out from 9/11) for 12 more months. If 12 months is the standard lag time we are screwed but let’s assume it’s 6 months and that they overshot by about 1.25%.

That means the correct rate should be about 4% and the current rate is 35% too high already. That means consumers are paying 35% too much for credit, for cars, for homes, etc. and, on the other end of the coin, it means banks and corporations (who currently hold almost $1 Trillion in cash) are being overpaid for money in the bank, keeping it from being put to work properly.

The Fed fund rate was 1.75% or less from December 11th 2001 through November 10th 2004 and the markets turned up in Q2 ’03, 18 months after a 50% rate cut. The fed has given us 2 50% rate hikes in the past 18 months so if they are as wrong now as they were in 2003, they may have gone way too far already.

While I’m certain we have the ability to adjust to these rates over time (rates were between 5% and 6% from 1995 through 2000 while the markets doubled and were up from 3% in 1992) I think this latest round of hikes was done more out of fear (fear of terrorism, fear of a dollar collapse, fear of consumer debt) than out of good monetary policy.

As I said Friday, inflation is far from dead and there is not much the Fed can do about it as the US is no longer most of the world economy. Cutting back on US consumption of resources only makes them cheaper and more attractive for booming Asian economies and we are more in danger of being outproduced now than we were when we first got paranoid about Japan in the ’80s.

I think the general problem is that the guys who are making monetary policy mainly got their degrees during the cold war when half the world was communist and Europe was still rebuilding from a war. The “hipsters” like Bernanke grew up in the 60s when the US was still the world’s economic engine and their schools taught them it was all up to us to run the planet.

Although I feel like Galileo trying to explain that we may not be the center of the universe, I think we need to adopt a more realistic world view in setting economic policy, perhaps put the guys who wrote Freakonomics in charge of the Fed, we certainly need some new blood!

OK, so I’m a little concerned in general and we are already in cash so let’s see how trading plays out today before we go crazy. We are right about at key Fibonacci points in the indices so direction will be very key this week, hopefully we can get over this hump.

Will the Dow hold 11,200? Will the S&P break 1,280 while it absolutely MUST hold 1,271 (still creeping up)? Can the NYSE break 8,300 while holding 8,242 (the prior high) and can the Nasdaq break 2,100 (which will only happen if the SOX can make 415 but 420 would make me happier).

We’ll keep our eye on oil today and see how it handles $74 which should form a good upside resistance if prices are really trending down. I’ve already seen that $73 will fall quickly and $72 is the next resistance level but current events don’t look like they will give us a chance to test that theory unless we get a good inventory report on Wednesday.

Gold remains flat to the dollar which itself is flat at the moment and that means the current oil bump is really being driven on the Nigerian and Russian supply disruptions rather than war fears. I think Nigeria is baked into the cake already so keep an ear out for a change on the pipeline status to time a move back down on oil.

The dollar will be in play this week after a big 5% drop last week and any combination of ECB tightening or Fed loosening will drop it below its 50 dma of 85.64 and we could be on the way to testing new 5 year lows around 80! The problem is that the Fed is in a no win situation and probably has to keep tightening, no matter how much we suffer…

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If the markets head down today I buy nothing unless they turn up but today is the last day of the month and many strange things can happen so I wouldn’t read too much into a rally either but it would be very encouraging if we can shake off global concerns.

I was going to say I like PD in this environment but so do a lot of people now that the Falconbridge trade is off. I guess the analyst at Prudential read me column on Friday because they upped PD to overweight today and the stock is already up 6% in the pre-market. Those $80s for $2.25 are going to look like a real bargain today but I’d sell on the morning bump as N is going to get competing bids. Hopefully PD will be smart enough to let this one go and get back to work.

We got out of COH a little early as Barrons gave them a nice article over the weekend but I wouldn’t be comfortable holding that kind of gain into tomorrow’s earnings anyway.

SNKD is buying Israeli firm FLSH for a 13% premium, not too bad and both stocks should benefit but SNDK will now take a little on the chin every time a bomb goes off near MSystem’s offices but it’s a great play for both companies.

TWX is cheap enough to take the Oct $17s for .40 as I’m expecting and upgrade on the whole sector. There should be heavy resistance right around $17 so I would want to have an itchy trigger finger on this one.

VIA is very strong now that they have trimmed down and I think the Nov $35s are a great value at $1.30.

Record heat is causing the grid failures I predicted 2 weeks ago but not having electricity doesn’t stop people from finally going to HD, LOW or BBY for fans and air conditioners. BBY (9/12) Dec $50s are $2.80 and should be stopped out at $2. HD is one hurricane away from $40 so I like the Sept $35s for $1.10 while LOW (8/21) Sept $30s aren’t bad at .75.

In Friday’s comments I mentioned Pfizer would announce a new CEO and it says a lot about the drug industry that they chose their General Counsel to run the company. I like it as our unfortunate reality is that litigation is a bigger concern to big pharma than curing cancer and this shows that Pfizer has their priorities in order.

XOM got an upgrade from JPM and I will be picking up some $67.50 puts if they dip below $1 as I think there will be some profit taking later in the week. There is also an appealing spread play of the Sept $70s for .80 and waiting to pick up the Sept $70 puts for under $1.

I eagerly await WFMI’s excuse for this quarter’s earnings but they are a little too beaten up already to bet against them.

AQNT is out tomorrow and I think the sell-off had nothing to do with them, just following techs straight down. Money is coming back into this sector and I think .11 (+10%) is a very low bar for earnings expectation as revenues should be well ahead (+25%) of last year. Google, Yahoo and Microsoft’s reports clearly show that the pie is growning and Aquantive has a nice service niche to that market. It is risking a wipeout but the Aug $22.50s for .75 are a nice gamble.

Tomorrow is time for recent IPO BKC to put up or shut up. It will be very interesting to have something to compare MCD to now.

Something very strange is going on with CEPH which is losing 2 weeks worth of gains in the pre-market. I don’t

EK has a nice low bar too and the Sept $22.50s might work well at $1.10.

ELN earnings should be no great shakes but outlook should be great. Best bet is to buy it for $14.94 and sell the $15s for $1.40.

ERTS will be a big pointer for that industry tomorrow.

Be very careful out there today!

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Google Spread of the Month:

Here’s what’s happening with Google: They slipped under the 200 dma back on the 20th and are trying to consolidate for a run back up. The Friday jump was based on a rehash of old news regarding a click fraud settlement where it turns out Google will only pay $30M in cash to the legal sharks who pushed the case while actual advertisers affected will get a whopping $3.80 per $1,000 credit on future ads.
http://biz.yahoo.com/ap/060729/google_click_fraud.html?.v=2

Don’t even get me started on this BS from the advertisers point of view but this is a very legal way for Google to pay off the victim’s lawyers to take a settlement that amounts to 4 tenths of a cent on the dollar – and they don’t even get that in cash! Meanwhile, if you’re a Google shareholder – Yay!

Also, this was the traditionally slow 2nd quarter so we should be expecting great things from the stock, hopefully great enough to justify a p/e that’s creeping back to 60. Last time Google took a dip I maintained that it needed to retest $330 in order for it to break $450 and make a serious run at $500. You need every single non-believer out of this stock to make that kind of run with a $120Bn S&P listed company. Look at MRK and PFE and the false starts they had until they finally got a nice bottom test to build on in the fall.

Right now Google is nice and rangey between $380 and $420 but it is in mortal danger of a nice $50 correction if it slips below $380. The daily chart says slightly oversold but the weekly chart says look out below. I’m not sure the fund flow can get much worse for an S&P staple without the whole market turning down so there’s an interesting play to be had by buying the Jan $430s for $22 and selling the Dec $450s for $12.25 which gives you a 50% refund on your call and a $20 + 1 month spread between you and your caller. If we assume current premiums persist then Google would have to be around $410 on December 15th for you to be in the money.

So IF Google opens above and stays above $380 and the Nasdaq breaks 2,100 – I enter the Jan $430s with a 3/10 position and wait to get $14-15 on half in December $450s then wait on the other half for a nice move up (treat it like a trailing stop order). We’ll check up on this as the week progresses.

As a risky side bet, I take a 2/10 position on the Sept $440s at $2.75 (but only if the conditions are met!) as a $20 drop brings me down to $1.25 while a $20 rise brings me to $6 (apx and only if it happens soon!). In both cases I’m betting on Google to get a little giddy but then pull back to at least $380.

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IBM is in a very similar situation having just recovered from a nice test of a mortifying low of $73, only the second time since 2002 it’s been that low. Same rules as Google with an eye on the 50 dma at $77.50 but the $80s are only .25 for goodness sakes! The stock has gained $5 in 2 weeks and has a forward p/e of 12. If this trade doesn’t work I’d be willing to double down on September…


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