Fed Statement Day

Once again, the markets have come to the day when the Federal Reserve Open Market Committee (FOMC) releases their statement regarding interest rates and their economic forecast.

What to expect?

Absolutely nothing on the interest rate front. As I have said before every meeting since rates went to essentially 0%, the Fed is not going to raise rates today. That day will wrongly come sooner than later, but not today. Rather, we will hear about the uneven recovery, wages, trade imbalance, employment growth and inflation. Don’t be surprised if there’s mention of Europe and China as well. There’s enough ammunition for both hawks and doves to sell their case.

In the markets, the trend for today is to see a range of plus or minus 0.50% until the 2pm announcement and then a few wilder swings in both directions until the bulls take over the rest of the day. With the current set up, there is a 75% chance of a green day in the stock market based on data since 1994.

In yesterday’s piece, I wrote about how the bulls had a fairly good short-term opportunity right here and needed to step up right away. They did a decent job of that on Tuesday with solid leadership and there should be more upside coming before this little rally peters out and rolls over to the downside again.

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Turnaround Tuesday

Stocks continue to be oversold in the short-term and a bounce is likely as soon as today. It’s Tuesday so don’t be surprised to hear the media focus on this historical reversal day. As I have mentioned before, I do not believe this is the rally to buy or chase. More than likely, stocks will bounce and regain some of the lost ground before rolling over again to what could possibly be the bottom to buy.

I m keenly watching biotech, healthcare, consumer discretionary and financials if we do in fact see a short-term rally. It would be very disconcerting if they either don’t rally or rally feebly. High yield bonds are another sector which bares watching closely. They are oversold and are supposed to rally if stocks do.

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China Again

A few weeks ago, I published a piece about the Shanghai having further to fall. Chinese Market Collapse Not Over

Last night, Chinese stocks saw their largest decline since February 27, 2007, a day I vividly remember as I was running money for a hedge fund in Boston and about to leave for a week’s ski vacation in Utah to celebrate a belated 40th birthday with a bunch of friends. At that time, the prevailing sentiment was that the Asian Flu was cause a 15-20% stock market correction was taking hold in the U.S. I vehemently disagreed and argued for fresh all-time highs over the summer as major corrections typically don’t begin with such volatility and fanfare.

Today, we have another huge rout in China. Our market looks weaker than it did in February 2007, but I still don’t believe the bull market has ended just yet. It is, however, living on borrowed time and the next new high will have to be scrutinized very, very closely.

U.S. stocks are getting short-term oversold and a counter trend rally shouldn’t be far off. This should be a rally to sell into rather than buy, but we’ll analyze that if and when some strength develops. For now, keep an eye on the sector leaders in healthcare, biotech, housing, financials and consumer discretionary. If the major indices see accelerated selling, I would expect the leaders to have a quick and very sharp bout of strong selling that should result in another buying opportunity. On the other hand, it would be concerning if these sectors began to underperform.

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Homebuilders Still Offering Opportunities

The other week, I did an interesting segment with the good folks at Yahoo Finance regarding real estate, housing and the home building sector. You can view it HERE. In my 2015 Fearless Forecast, the home builders were one of my top sector plays for 2015 and they have not disappointed so far, although others certainly have!

Sue Lee, the interviewer, asked me for a few companies which look particularly good. I answered by saying that I would much rather buy the whole sector through an exchange traded fund like XHB or ITB instead of cherry picking. There are a few reasons for this. First, I think the sector is ripe for consolidation, but choosing who are the acquirers and acquirees is above my pay grade. Second, the purest plays in the sector like Lennar, Toll, Beazer, Ryland, Pulte, Hovnanian, Kaufman Broad, etc. actually trade weaker than the secondary plays that support the industry like Mohawk, Aaron’s, Tempur Sealy and Owens Corning.

As I briefly discussed with Yahoo, the tailwinds to the builders are mergers and acquisitions activity and lower input costs to build houses, like raw land, lumber and labor. Higher mortgage rates is the primary headwind. This is absolutely not the same as the housing industry as a whole, which is suffering from high rates and the lowest home ownership numbers in 30 years. Additionally, baby boomers are downsizing and selling, but too many millennials, the organic buyers, don’t value home ownership like previous generations. I don’t know is this cause or effect, but millennials prefer renting or living at home as mortgages have been tough to come by for this group.

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Trouble Brewing Beneath the Surface

The more I analyze, the more I don’t like.

The number of stocks participating in this rally has not been encouraging, but Friday’s action along with today so far is becoming eerily similar to that of 1999. Notice I said 1999 and not 2000. Valuations are nowhere near as egregious nor is sentiment showing much greed, not mention frothy. And monetary conditions are certainly not restrictive.

On Friday, on the New York Stock Exchange, there were almost 1000 more stocks declining than advancing with the major indices roughly flat. Today, we are seeing a carbon copy.

On the NASDAQ, it was equally as troubling or maybe even more so because that index saw all time highs. Three days in row saw essentially new highs with more stocks going down each day than rallying. However, keep in mind that the NASDAQ typically has a negative skew on a daily basis.

Sector leadership has been fine, but the majority of sectors are no longer bullish. In fact, the semiconductors closed down slightly on Friday while the Nasdaq 100 index saw fresh 2015 highs, up 1.5% on the day.

Smart money traders went from being net buyers a few weeks ago to net sellers last week. Historically, they take months and quarters to go from one end to the other. Schizophrenic behavior to say the least!

Given the aforementioned concerns, I still do not believe the bull market is over nor do I think stocks are headed for a double digit correction. I do, however, continue to believe that the upside is capped by 500 Dow points and the downside is 1300 points. Not exactly the greatest risk/reward ratio.

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Chinese Market Collapse Not Over

I remember the outrage when the government sought to pull off TARP in 2008, first buying troubled, illiquid assets from the big banks which then morphed into outright capital injections into the banks. When QE was announced, the calls were equally as emotional, not to mention the myriad of special Fed programs designed to provide liquidity in the financial system when there was little.

I can only imagine what those naysayers believe now regarding China.

This is not a new topic here, but I do want to reiterate my own analysis about the collapse in the Chinese stock market. I have seen interesting comparisons to China’s stock market right now and ours during the crash of 1929 period. For now, they seem to line up very nicely and suggests further downside. However, a note of caution; eventually, all market comps break apart.

The Chinese are not experienced in dealing with the pitfalls of an almost free market financial system, but they are certainly smart enough not to make the same mistakes we did to cause the Great Depression. It does seem, however, that they believe they can manipulate their way back to a bull market in stocks, something our government learned was impossible in 2007 and 2008.

After the Shanghai Index peaked on June 12 and began to spiral lower, the Chinese government started a series of measures to curb selling. They shelved all IPOs. The 21 largest brokerages created a consortium to inject money into stocks. When both failed, the government prevented large shareholders (5% or more) from selling any stock for six months. As all this unfolded, hundreds of non state owned, non blue chip companies requested that their stocks be suspended from trading until volatility subsided. At last count, those companies numbers roughly 700.

Market bottoms do not end with increased manipulation and a lack of liquidity. There are billions, if not trillions, in pent up selling demand waiting to be unleashed if and when the Shanghai begins to function semi-normally. Just like the Bank of England and Bank of Switzerland learned, you can’t ultimately prevent investors from selling no matter how hard you try.

I would also argue that had they left the free market to determine price, the Chinese market might have crashed like ours did in 1987, but the bottoming period would already have begun. Now, with the Shanghai down 28% from high to low and the smaller indices much more, it looks like that market is ultimately headed at least 5-10% lower than the lows so far, if not a whole lot more this year.

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Another Bad Deal… Iran

We woke up this morning to learn that the big western nations struck a deal with Iran to lift the economic embargo in return for nuclear concessions. In life, I have always tried to avoid rewarding bad behavior. Once you start down that path, it never ends. Just look what happened in this country with the S&L crisis, Orange County, Long-Term Capital and Bear Stearns. Talk about moral hazard! While Lehman Brothers put an end to that, look at how far we had to go as well as the consequences to break the rewarding of bad behavior.

I remember when my daughter was two and my wife and I were with her at Wal-Mart. She wanted this little toy on the shelf and we said “no”. As we approached the register, she threw herself on the ground and start kicking and screaming about the toy. Everyone looked over to see if this cute this girl was being beaten. Incredibly embarrassed, my wife and I tried desperately to calm her down, but she just kept screaming about wanting that toy. As hard as it was, my wife and I started to walk away and not turn our heads to look back. Although it seemed like minutes, our daughter leaped to her feet after about 10 seconds, stopped crying and ran straight for my wife’s leg to hug. Lesson learned. Don’t reward bad behavior.

While the same can be said of how the EU is treating finally Greece, the country has the option to go play on their own. Iran, on the other hand, is a total head scratcher to me. We know the regime sponsors terrorism. That’s a fact. We know the regime has been building an offensive nuclear program. That’s a fact. We know the regime oppresses freedom and choice. That’s a fact. And we know that the regime is about as brutal towards women and human rights as any country on earth. That’s a fact.

Why on earth would President Obama want to strike a deal with the likes of the Iranian regime? I am our friends in Saudi Arabia aren’t too happy! Why give the Iranian regime access to the energy markets and allow them to rebuild their economy? I don’t think anyone really believes that their government will actually use that money to help their own people. Are we naive enough to believe that Iran will actually curtail their nuclear ambitions? Aren’t we just giving them money to eventually funnel to terrorists in the Middle East to fight against our allies?

As I sat and read various analyses today, one particularly resonated well with me by Martin Armstrong. The Iranian deal is yet another attempt by the Obama administration to punish Russia. Until now, Russia has been the main supplier of natural gas to Europe. When the Crimea crisis hit, there were fears that Russia would halt sales of natural gas to Europe, which by the way, never happened. Now, Iran will have the opportunity sell their natural gas reserves to Europe and try to squeeze out Russia. Russia, in turn, has been solidifying and strengthening its relationship with China in the energy markets. Neither are sympathetic to anything the U.S. does and will only hurt us longer-term.

Our attempt to isolate Putin has been a disaster and this Iranian deal will be even worse. Russia is not North Korea or Cuba. It’s so interesting that the Obama administration is totally hands off on every international situation, but when it comes to Russia, they want to play hard ball. I think ISIS is a lot more worrisome and dangerous than the Russians.

This is a bad deal through and through. Who is next on the deal front? North Korea? How about Hamas?

Searching for winners?

Domestic defense is one sector that should benefit long-term as the rest of the Middle East will be seeking to increase its capacity to fight a war. And the usual European suspects will likely benefit. France for sure. You would think a company like Schlumberger or Halliburton could also see some long-term upside from the deal, but I doubt either would be a huge needle mover.

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Reboot Greece

Since the latest “crisis” in Greece unfolded in the markets almost two weeks ago, I continued to offer that China was the real problem, but Greece was dominating the headlines. Greece doesn’t really matter in the grand scheme of things, economically or market-wise. And even though they struck an absolutely horrific deal for their country, stocks will rally in the short-term because the uncertainty is lifted.

Who in their right mind would agree to more tax hikes, more austerity and more pension cuts in a country spiraling out of control in an ongoing depression? The “deal”, once again, just Band-Aid’s the problem and kicks the can down the road. Greece needs D-E-B-T R-E-L-I-E-F, not more of the same which hasn’t worked since day one.

I have said this for years so you’re probably used to hearing it, but Greece needs to leave the Euro, default on their debt, issue drachmas and reflate without much in the way of imports. In other words, as the cable and PC telephone reps advise, they need to reboot. I keep hearing how Iceland is “different” because they have their currency, but I don’t agree. It’s similar. As bad as it got there, the recovery fromĀ  depression was sharp and steep and the world loaned them money again less than five years later.

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Q3 Stock Market Scenarios Unfolding Nicely

Last week after the Dow plunged 350 points and began to bounce, I offered the two most probable scenarios for stocks, both of which included new multi-month lows before any real rally would begin. Stock Market Scenarios for Q3

My conclusion was, “just because we saw extreme readings on Monday doesn’t mean that the ultimate low was seen. I would argue against that. Monday’s snowball day was an important piece, but far from the final piece. Wash out readings like I listed above typically do not coincide with the final low. There is usually more constructive work to be done by price.”

Below is the chart I included with the the green (more bullish) and orange (less bullish) scenarios.

Today, the chart is starting to show signs of a potential low in the green bullish case, right on schedule, as you can see below, but it’s too early to offer more comments until I see how sentiment behaved so far this week. One thing is certain; the stock market will need much better internals to mount any significant rally, meaning that the number of stocks rallying and declining needs to shift to the bullish side along with the volume on each side. For months, it has been neutral at best or slightly on the negative side.

While the markets and media are singularly focused on Greece, everyone’s eyes should be on China which is a much, much bigger issue.

Care more about how the market reacts to news rather than what the news actual is. Watch for spikes in bearish sentiment to set the stage for another leg up in the bull market. The bull market remains old and wrinkly but very much alive.

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Rip Off the Band-Aid Greece

As the early tally in Greece showed overwhelming support for the NO camp, meaning they wanted to reject more austerity, markets around the globe braced for another round of strong selling. As usual, the pundits got it wrong. Almost every single interview I watched or read had the vote almost a dead heat. “Famed” investor Wilbur Ross laid a huge egg in not only predicting a YES vote, but also positioning his portfolios for it and then trying to rationalize that the overwhelming rejection of more austerity wasn’t as it seemed because “only” 60% of the country voted! The U.S. hasn’t seen 60% of eligible voters turn out for a presidential election since 1968!

Put yourself in the Greeks’ situation. Each and every bailout has come with more severe measures. Their economy continues to spiral in modern day depression. $266 billion in bailouts since 2010. Their debt/GDP ratio has climbed from 150% to 175%. Unemployment has soared to 26% overall and more than 50% in the under 30 market. Greek banks are essentially insolvent and almost out of cash. They have been closed for more than a week with no sign of reopening anytime soon.

Who would really vote for more of the same, but worse?

This process of kicking the can isn’t working and won’t work in the future. If the Troika (ECB, IMF, EC) really wants to bailout Greece or help them, there’s only one solution. Debt relief. Greece wasn’t able to pay its bill when this whole mess started and those bills continue to increase. At the same time, as the economy shrinks month after month, tax revenue declines which make the Greeks even more unable to pay their bills. Debt relief is the only solution if the Troika wants to keep Greece in the Euro.

However, with outright debt relief comes moral hazard. What would the Troika do with Italy, Portugal, Spain and France if and when they fall on harder times? Won’t they want the same treatment? And we all know how the northern countries including Germany, Austria, Belgium and Finland feel about living fiscally responsibly while the others do not.

I will repeat what I have written many times before. Greece should rip off the Band-Aid and leave the Euro. Circulate those drachmas sitting in the vault. Devalue the currency. Recapitalize the banks. Reflate. While the economy would likely plunge deeper into recession in the short-term with imports next to impossible, it should also begin a strong recovery sooner without the insurmountable debt anchor. Just look at Iceland. Less than five years removed from default, the world started loaning them money again.

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