The New Year is here and I hope you are ready. We come into the turn with some of the lowest bearish sentiment we’ve seen in years. What I love about economics is they do an incredible job of projecting the last 12 months on the next 12. In 2007, they told us the sub prime mess was contained and probably would stay contained in 2008; 2008 turned out to be a disaster so that was projected into 2009. The year 2009 turned out to be a pleasant surprise. Naturally, we already hear whispers 2010 will be a boom year.
I’d like to know exactly what they are basing that on.
Logic dictates that since the SPX has retrieved 50% of the losses with the NDX well over 61% that we are actually back to levels last seen in the latter stages of the 2002-07 bull market. It’s true; we are actually above August 2007 spike low levels in the NDX. But you should ask yourself how we were up there in the first place.
You know I’m not big on fundamentals but we did build much of that bull market on a house of sand and that’s putting it diplomatically. Now the patient heals with an infusion of liquidity and we are going to have to find out if he can stand on his own. There are many demons out there and a big one is a factor the Fed can’t control. The Fed might rule the short end of the curve but the long end is ruled by market forces. Sooner or later potential homeowners must pay up to borrow money and banks themselves may end up having to use some of that Tarp money they seem intent on returning to give savers motivation to invest.
The technical landscape is hinting that several charts are setting up to move in a way that is contrary to continued bullish activity for the stock market. One is the copper chart, and the other is our good friend the U.S. dollar. We’ve hit a long term channel line in copper but the daily action is right at the 261-day window (see chart below). If it’s going to reverse, this is a good place for it. If it is going to reverse, January will already not be a repeat of last year so forget about projecting the last 12 months on the next. We know that copper is one of the best advance warning systems for recession. We don’t need recession to get a new perspective. All we need is an intermediate term pullback to get the recovery to stall. Copper is in the 330 handle. The 200-day moving average in about 265. That is a 20% drop and really enough to cause some indigestion without creating long term technical damage to the chart. At the point in time any pullback doesn’t respect the 200 do we concern ourselves with double dip recessions.
You can see from the long term monthly dollar chart (below) how the action may interfere with forward progress in the stock market. If you looked at an hourly chart, you’d likely take a long trade based on these candles. But think about it, these are not hourly candles but on a huge monthly scale. These lines have the predictive power of 80% accuracy. So don’t take it as the gospel but rather what the high probability can do this year. If you think about it, the dollar reversal and 261-day high in copper do support each other with the information we have right now. What this particular chart is telling us is we could get a rally in the dollar that could end up testing the mid 80’s. How long would that take? If we get a spike this sequence could complete by the end of the 2nd quarter but if it is a slow boat you’ll see the converging lines don’t meet until late in the year.
But if these lines have 80% predictive capability, it shows us that neither deflation nor inflation is going to be a major factor this year. It is and has been my contention since we hit that 38% area for the first time in November 2008 that as long as prices stayed below 38% serious deflation would not be a problem simply because once 38% is taken out most prices get a fast track to 50% or the 61% retracement. Since the majority of the loans taken out this decade were when the dollar was prices in a range from 92.50 back in the middle of 2004 to about 76, you can see why that might present a problem.
Now if we avoid the bottom which takes us to the 3rd rail of hyperinflation, we have a year where the dollar is not a distraction to the recovery, but certainly would get in the way of the rally.
The bottom line here is as far at the charts go, if copper takes a break and the dollar continues higher, we have two conditions that were absent for the majority of 2009 when market put in one of it’s rally years in history.
Overall, a dollar that stays out of the way means we could have a real vanilla year. In the past two years we’ve had action followed up by reaction. Nobody who is not part of the perma-bull crowd really expects markets to continue in 2010 the way they rallied in 2009. On the other hand, in order to avoid a 2008 scenario we need to avoid a crisis. IF the dollar stays in the middle of the range, we can avoid a currency crisis. That would be one less problem to worry about.
So I’ll end where I started. Here is an intermediate view of the long bond. You can see that 2009 was a rally year in spite of what you are hearing in the media right now. But the last five weeks have not been kind. We begin 2010 on a warning parallel line which is the last guard at the gate to the uptrend. Odds are the line prices rest upon right now eventually will break but it looks like we should have some upward testing first. I understand that prices were much higher earlier in the year and this is leading to the sentiment that thinks 2009 was a lousy year for bonds but the second half of the year was spent in a normal range. Technically, we are still fine but if prices break the June low the landscape will begin to change and we still have some territory to cover before we get there. This chart is here to give you an idea of how close we are to entering a new phase of higher interest rates. We are inching closer to that reality and I think we’ll eventually get there.
Summing all of this up, 2010 can be a big dud in the overall scheme of things. If the dollar were to materialize the way it is setting up we could see two major moves this year. I think it can be a year characterized by wild swings but no real net progress in either direction.