Wednesday, September 19, 2007

The Market's Deal With The Devil - Bernanke Sells His Soul

The markets are elated with the 50 basis point rate cut by the Federal Reserve. In as little as a few weeks the stance of the Federal Reserve, targeting inflation, has changed its colors, and now has attempted to put a band-aid on a bullet hole. The change has shown a clear weakness in the Fed and Ben Bernanke. This 50 basis point cut is not going to solve the sub-prime mortgage problems or solve the fear of U.S Banks to lend to the "shadow banking industry", it will take a long time to filter down to the folks who actually need it. The market cried for its latest fix to its low interest rate addiction, and Ben gave in and the party started at 2:15pm yesterday. There will be a price to be paid in the future, and who will actually pay it will be those who can least afford it.

The bet that is now being made is that the Federal Reserve can lower rates and stimulate the economy out of this self inflicted slump before inflation will start to effect consumers in the United States. Inflation is not just a result of the U.S. economy the way it was a decade ago. Inflation is now a global factor, and as much as U.S. consumers have the capacity to leverage up and spend, there are new players in Asia and India that are aiding inflation. The rate cuts are being made with the idea that they will keep the economy in growth mode, but with growth comes inflation. Inflation is a fact of life, it is not the end of the world, but like almost anything in life, when making decisions out of fear there are usually consequences that are not readily viewed in the correct light.

Below is a chart of the U.S.Dollar Index compared to a basket of commodities in the lower pane of the chart. Most commodities are traded in U.S.Dollars, so as the dollar declines in value the price of commodities must rise. As an example, OPEC is reluctant to cut production in order to keep the price of oil high in order to make of for the currency effects of a falling dollar.

Dollar Index vs CRB Index

Some longer term charts of Nickel,Lead, and Copper.




Below is the chart of the S&P 500 Index with the levels based on the opening range marked with the red dashed lines. 1524.10 is the next target, if the momentum continues there could be an attempt at the 1547.77 level. The first pull back after this initial rally will be very valuable in accessing the quality of this rally. It should be on low volume.

S&P 500 Index

The chart below shows the S&P 500 as above with the indicator that shows the percentage of stocks above their 40day moving averages.

The Nasdaq 100 Index, NDX, broke out of a tight triangle yesterday. Calculating the width of the triangle gives a target of 2057.13. Investing in companies with global exposure is a safe bet with a weakening dollar. Technology fits this idea perfectly.

Nasdaq 100 Index

Following some of the currency charts can give a great clue as to the velocity of the dollar decline. It is also helpful to watch the currencies from countries that have a strong commodity base and vast natural resources. They have strong customers in Asia and India to go along with the traditional buyers.

New Zealand Dollar

Australian Dollar

Pimco article worth reading by Paul McCulley.

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