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Welcome Back My Friends . . .

. . . to the show that never ends, we're so glad you could attend, come inside, come inside:

>

With the Summer officially over, the masses of traders, fund managers and corporate honchos return to their trading turrets, offices and desks, ready to kick it out for the last four months of the year.

What's on their minds? Here's a quick overview:

Bullish

• Its no coincidence that Crude Oil is at a 3 month low and the indices are at a 3 month highs.

• The biggest North American Oil find in a generation may add further pressure to Oil prices;

• Performance anxiety is a powerful factor that could draw more players into equities;

• We are 7 weeks away from the best seasonal period for equities;

• Mortgage prices have slipped to 5 week lows, perhaps providing a respite to the floundering housing market;

• The major trend in the equity market since June is upwards.

• Bond rally seems to have ended; Rotation away from fixed income into equities is possible;

• Recent economic data puts the Fed on hold at least another 2 months;

• Earnings period is over, with most S&P500 companies reporting better than expected;

• With the summer over, Momentum is with the Bulls.

 

Bearish

• Much of the good news is baked into stock prices already;

• Since the mid-June low, the SPX has rallied nearly 10%;

• Markets have rallied on decreasing volume and breadth;

• Complacency has returned, as the VIX reachs 3 month lows;

• The American Association of Individual Investors (AAII) reported there are now only 25.84% bears, down from a peak of 57.8% on July 19;

• Markets are enetering the most dangerous 2 month stretch of the year;

• The economy is slowing significantly; Employment has trended downwards:

2004: 175,000/mo
2005: 165,000/mo
2006: 140,000/mo
Past five months: 119,000/mo

• Forward Guidance out of many companies has been weak;

• Q3 warning period is a few weeks away;

• Earnings gains have been concentrated in the biggest companies; The bulk of firms beneath the SPX are struggling;

•  Despite lower rates, Mortgage purchase apps fell to their lowest level in August since 2003;

• Retail sales are slowing;

• Inflation remains ever present;

Neutral/Unknown?

• What will returning traders do? Fear missing a run and jump into the fray, or take advantage of higher prices and hit bids ?

• Will the political control of the House of Representatives flip in November ?

• How will the situation in Iraq, Lebanon and Iran impact consumer sentiment -- and spending ?

These are the elements worth watching, as we return to what is often the most interesting part of the calendar -- back to school, end of Q3; year end Holidays, and 4th Quarter.

Tuesday, September 05, 2006 | 06:49 AM | Permalink | Comments (41) | TrackBack (2)
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Comments

Lots of food for thought. Makes my head spin. the indicators that jump out for me are:
BULLISH
1) which way is oil really headed over the next few months
2) how do we get a handle on something like performance anxiety. Sounds like it could be very important
3) what factors will impact rotation out of cash - it would be great to see a chart showing the flow of major asset classes over time and what trends are at play.

BEARISH
1) what will happen when volume and volatility return
2) which way the AAII bearish sentiment moves
3) inflation

Posted by: trendwatcher | Sep 5, 2006 7:45:48 AM

Excellent lay-out.

Posted by: Eclectic | Sep 5, 2006 8:16:54 AM

Barry,

Your readers may be interested in this recently issued press release from the United Nations Economic and Social Commission for Asia and the Pacific (UNESCAP):

http://unescap.org/publications/detail.asp?id=1166

UN report warns Asian governments to prepare for financial downturn – (31 August 2006)

The United Nations Economic and Social Commission for Asia and the Pacific (UNESCAP) today warned the region’s governments to reduce exposure to the impact of a sudden or unexpected market downturn, urging a mood of protection and preparation rather than the celebratory atmosphere of current prosperity.

Asian countries have to stay alert despite the lull in financial markets recently, says UNESCAP in a new report, The Calm Before the Storm? Managing the Risks of an Asia-Pacific Financial Downturn. “There are a number of new emerging risks which may lead to more stormy weather ahead,” the report warns, citing possible interest rates hikes in developed countries, oil price shocks, housing market overheating, and investor overreaction and contagion.

The region evokes bitter memories of the Asian financial crisis in 1997 but notes that countries of the region “are now in a stronger position to handle turbulence.” Governments have improved economic policies, depend less on portfolio flows, and have bigger foreign reserves and better banking sectors.

The report cautions that “as Asian economies are becoming more integrated into the global economy, they also face a higher risk from the constantly shifting global environment.” It calls for governments to focus on controlling inflation and debt, improving banking regulations, and monitoring complex financial products.

“Countries in the Asia-Pacific region must improve regional cooperation to lessen the impact of financial market volatility,” the report says, recommending strengthening existing regional cooperation schemes by making more funds available against disruptive capital movements, ramping up regional surveillance of country policies and extending these schemes to more countries.

*****

Posted by: Anonymous | Sep 5, 2006 8:34:09 AM

Bullish-ELECTION IN NOVEMBER

Posted by: Neal | Sep 5, 2006 8:34:51 AM

Heya Barry,

Love the EL&P reference! And always the thoughtful analysis :) You rock!

Posted by: Idaho_Spud | Sep 5, 2006 8:43:14 AM

I must concur. Thanks Barry.
also agree election is important but bullish or bearish?

Posted by: doh! | Sep 5, 2006 8:48:53 AM

Bullish because all possible instruments of influence will be brought into play to build a positive image of the economy. The current administration needs a positive element to campaign on, and since the economic picture remains confused, it is possible to color and sway the positive picture.

Posted by: Neal | Sep 5, 2006 9:01:33 AM

CAT is raising prices 5%. The CPI is up 3.875% (Jan-July) vs. comparable period a year ago.

Goldilocks is letting herself go.

Posted by: Craig H | Sep 5, 2006 9:19:13 AM

I'm sure any interest rate releif is psychological. These lower rates translate to about $30/month per $100k for 30 yr fixed instruments. Even less after deductibility. The marketmay be headed higher from the mere pressure of more people trading, trying to justify that trading.

Posted by: Robert Coté | Sep 5, 2006 9:44:29 AM

The potential good effect about the mortgage rates now is that at least some people who went into adjustables over the past few years haven't lost all chance of converting to a decent fixed rate. Depending on how many can afford to convert, that could reduce one of the risk factors that people have talked about overall- the dreaded effect of rate resets in a rising rate environment.

Posted by: Royce | Sep 5, 2006 10:12:32 AM

I question how real that jump from ARM or Option-ARM to fixed is for people who bought in the last two years.

1. If you could afford the fixed, would you really have gone with the ARM/OptionARM in a rising rate environment

2. Do people really understand this early how bad their situation could get a year out from now? I don't think the average homeowner (and esp one that top-ticked the housing market last year) has any real concept of interest rates and/or ARM resets.

Posted by: T | Sep 5, 2006 10:58:32 AM

Bearish

1 Auto Sales down to 10 month low.
2 Light Vehicle inventory (domestically made) up 20% at 64 days of inventory vs 53 days of inventory last year.
3 North American Q4 production plan down 8.2% from year ago.

Posted by: Josh | Sep 5, 2006 11:08:51 AM

What / where was the biggest oil find in a generation ?
I haven't heard about it .. ?

Posted by: jimmy | Sep 5, 2006 11:09:11 AM

Another thing to keep in mind with the mortgages is that folks would have to be paying the 100% LTV for just under 2 years to even have 3% equity. For 5%, 10%, 15%, and 20%, the people would have to have paid for 3, 6, 8, near 11 years respectively. How many mortage companies are going to want to take someone on a 30-year fixed with 15% equity - say the house appreciated by 10% in 3-years? Add on top of that the 50 to 100 basis point difference between the current ARM and a 30-year, and many folks aren't in a position to do it. It isn't like the banks weren't being flexible with housing expense to income ratios tolerated at up to 40%. In the end I think the latter, housing expense to income, is a far greater factor than LTV.

Posted by: M.Z. Forrest | Sep 5, 2006 11:19:51 AM

can someone point me to either the filing or an article discussing the filing where WaMu admits to using a faulty interest rate to price something like $30B in option ARMS. Did I dream that this happened or did it actually happen and I just can't find the material? thx.

Posted by: joe | Sep 5, 2006 11:24:40 AM

Like Jimmy, I'd like to hear about this oil find

Posted by: Wayne S. | Sep 5, 2006 11:27:54 AM

Update - nw=ew finf=d is by Chevron in Gulf of Mex 275 miles soutwest of New Orleans

Posted by: Wayne S. | Sep 5, 2006 11:31:40 AM

From today's WSJ:

"Chevron Corp. and partners Devon Energy Corp. and Statoil ASA announced today the first successful oil production from the region, a 300-mile-wide swath of the Gulf that lies below miles of water and deep within a bed of ancient rocks geologists call the lower tertiary. The company said the well sustained a flow rate of more than 6,000 barrels of crude oil a day during the production test."

"Chevron and Devon officials estimate that the recent discoveries in the Gulf of Mexico's lower-tertiary formations hold more than three billion barrels' and perhaps as much as 15 billion barrels' worth of oil and gas reserves. If the industry succeeds in finding 15 billion barrels of oil, it would boost the nation's current reserves of 29.3 billion barrels by 50%."

Posted by: joe | Sep 5, 2006 11:33:29 AM

It's been mentioned before but the situation with option ARMS and other "unconventional" mortgages is complicated by the fact that many of them appear to have fairly severe early payoff penalties and/or are full-recourse: Difficult to refinance and default involves more than loss of the house; a lien still exists against other assets and future income.

As I understand it the Fed has also made it clear to member banks that they want to see fewer unconventional mortgages originated in future. The promised Fed guidance on the matter has yet to be published I believe but I suspect member banks have gotten the message and will not only tighten their own loan practices but are likely to more closely monitor loans originated by mortgage lenders who must get their money from those banks.

If a homeowner has already bought more house than they could afford or normally qualify for it's not clear to me they can get out from under at all.

It is also not clear to me what the total burden of unconventional and underqualified borrowers is when totaled up thus I don't really have a sense of how large the problem is writ large so I'll only add that I have removed virtually all mortgage backed securities from my portfolio. Do not know if that is a smart or dumb move but do not view reaching for yield as wise in this environment. JMO.

WRT the major domestic oil find, the maximum current estimate of the field is 15Gb which is about 3 months world energy consumption (all sources) and it is not clear recovery would be considered economically feasible, but I believe there was an even bigger find in Kazakhstan fairly recently so there is obviously still new oil to be found. Regardless I assume we are talking some years before anything from a new field comes online.

Overall I am neither bullish nor particularly bearish; the current market simply strikes me as possessing rather poor risk/reward qualities to the point I am willing to pay some (potential) opportunity cost by hedging and increasing cash.

Posted by: RW | Sep 5, 2006 11:59:15 AM

Great analysis, Barry. Takes a rocket-scientist's mentality to factor down. In light of current situation, do you foresee any change in your end-of-year call?

Posted by: jcf | Sep 5, 2006 12:06:04 PM

Bearish:

Layoff announcements up 76% in August.

WASHINGTON (MarketWatch) -- Announcements of job reductions at major U.S. employers rose by 76% in August, only the second increase this year, according to a monthly survey conducted by Challenger Gray & Christmas released Tuesday.

http://tinyurl.com/rd4hu

Posted by: m3 | Sep 5, 2006 1:37:16 PM

Jeff Saut talks about huge liquidity injection by the Fed last week in his latest Commentary. I see gold liked that news.

Posted by: Mark | Sep 5, 2006 1:40:45 PM

As Mark said, Jeff Saut comments on the liquidity injection.

FTA: "... the Federal Reserve added $36 billion to the nation’s money supply (M2) last week. This is not an unimportant point, for under the guise of “tight money,” fostered by higher interest rates, the Fed has recently been increasing the money supply. Unfortunately, Greenspan & Co. did away with the broader-based M3 money supply figures, so it is difficult to calculate the leverage the Fed is introducing into the economic system. Suffice it to say, if M2 increased by $36 billion M3 should have increased by a greater amount. Whether this liquidity injection is in response to the worrisome real estate environment is unknowable, but our real estate research team is clearly worried..."

Posted by: Mike | Sep 5, 2006 2:19:14 PM

Would this extra liquidity be to prevent a real estate collapse or to keep that collapse from spreading to a more systemic risk?
At first glance, it looks like this would protect large lenders but leave the folks with resetting ARMs with re-fi penalties as high and dry as ever.
If enough individuals get in trouble as it looks like will happen, this could become a big enough political issue to impact the economy.

Posted by: kevin_r | Sep 5, 2006 2:56:37 PM

and don't forget , in March , Pemex announced a 10B barrel field in the Gulf of Mexico , Noxal 1 , that may be bigger than Cantarell

Posted by: ECR | Sep 5, 2006 3:27:55 PM

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