Reality Bites…

Yes, reality is not pretty when it one is forced to see it. Today the market got a good hard look at reality and it was not a pretty sight.

Since March 17th the markets have advanced on nothing more than speculation that everything will turn out ok. That the economy is not as bad as some were claiming it would be, and that the market sell off was over done to begin with. Ever since that date in March the professional analysts and media have been claiming the market declines were over, the bottom was in, and it was a great time to be buying stocks. But, we never once changed out tune, it was a bear market rally, period.

Many new investors of the stock market don’t understand or grasp what a bear market rally really is at its core. Therein lies the reason that once they fail, the market sells off violently. Too many people get hooked into believing that they will miss out on something big if they are not buying stocks as the media and the pros keep making claims that the bottom had been achieved. And as each passing day the market advances, it makes more and more people feel as if "the market is getting away from them", and then they begin to chase it to get in. Euphoria of an advancing market, and the wanting to get in it, is what gives us our bear market rallies.

When the bear market rally comes to an end, the selling begins to grow as those who were buying on ‘hope’ start to suffer losses and throw in the towel. Not all at first, but increasingly they will sell into the market to take what they can of their investment before it is lost. Once reality hits them that the pros and the media might have been wrong then selling really accelerates further.

So what was the reality that hit the bulls in the back side? Two things. First was the FOMC minutes today, that was the most important. And in their statement they lowered their growth forecast for the United States yet again. The numbers they released today are now in line with our own predictions we made many months ago regarding the economy.  But, we already know that the Governments data is usually about 6 months behind in their projections. The data today was of no surprise to us, but it sure was a surprise to the market.

Here again are the highlights of the FOMC minutes:

*MINUTES OF THE APRIL 30 FOMC MEETING: MOST FED OFFICIALS VIEWED APRIL RATE CUT AS ‘CLOSE CALL’

- Signals no more rate cuts even if economy contracts; says the substantial easing of monetary policy since Sept., the Fed’s liquidity efforts [TAF, TSLF], and the fiscal stimulus package should help to support economic activity.  "Moreover, although downside risks to growth remained, members were also concerned about the upside risks to the inflation outlook, given the continued increases in oil and commodity prices and the fact that some indicators suggested that inflation expectations had risen in recent months.  Nonetheless, most members agreed that a further modest easing in the stance of policy was appropriate to balance better the risks to achieving the Committee’s dual objectives."

- Notes add that economy may be ’severely disrupted’, financial conditions better, but still fragile, concerned about upside inflation risks, signs inflation expectations had risen. Saw rising restraint on consumer spending.

- Food, energy pries to keep boosting overall inflation.
- Raises 2008 jobless forecast to 5.5-5.7% from  5.2-5.3% previous  
- Adjusts 2008 GDP growth forecast to 0.3% -1.2% from 1.3%-2% previous, and 2009 to 2%-3% from 2.1%-2.7% previous
- Raises 2008 core inflation forecast to 2.2-2.4% from 2%-2.2% previous, Total Inflation forecast to 3.1%-3.4% from 2.1%-2.4%

I still stand by my prediction that the GDP will go negative this year. Unemployment will continue to climb and will meet my predictions of 5.4% soon. And it appears likely that that number will rise further on the still accelerating housing and credit implosion issues. The Feds are still behind in their recognition of how far this is going to go, well, maybe they do know but don’t want you to know it. They would rather have you keep pouring your money into IRA’s, 401K, etc. in order to keep the markets propped up. They want you to fix the problems that their policy actions created, and at your expense!

The market got a glimpse of reality in that if the FOMC says they expect the economy to grow even slower then their last forecast then things must be getting worse. Gee, ya think? Anyway, those doubters started selling and that is what ended the bear market rally today with strong conviction.

The second part of today’s sell off was oil. Prices of oil continues to go skyward, almost parabolic now. And the debate rages as if it is speculation or supply and demand that is causing the price to rise. I feel it is a mix of both, demand is increasing globally, and the ‘fear’ of prices going higher is actually driving them higher as people keep buying future contracts up. It creates a cascading effect.

What if oil were to suddenly break its parabolic rise? A temporary euphoria will set in, but it won’t last long as oil IS in a multi decade long bull trend. Oil will never reverse in price, it will only have periodic pullbacks. There is one scenario that would drive oil prices into a long bear trend, and that is a deep global recession, or a US depression.

Back to stocks… the talking heads are once again pounding the table saying that stocks with foreign exposure will continue to do great. Keep buying large cap stocks with heavy foreign assets they say. We say no to that theory. Economies all over the world are beginning to weaken and some are actually beginning to fall at an accelerated pace. The big growth countries that everyone has been talking about (Brazil, Russia, India, and China) have been turned into a bubble as money has been pouring into those equities. And their economies grew at such a fast pace just as the credit bubble did, and their economies are poised for a bursting in the near future. So, as the United States economy falls deeper into recession, so to does many other world nations. With the collapse of the credit availability, so to goes the economies.

The growth of Asian countries in recent years has been, in many ways, due to demand for products from the United States. With demand slowing down as we go further into our recession, so to does our buying of goods from those countries, and subsequently their GDP begins to decline. At the beginning of the credit implosion, the housing implosion, and the economic deterioration of the United States everyone was scurrying around to where they could put their investment dollars. And they flooded the stocks and ETF’s of foreign nations. But, just as our markets are imploding, so to will theirs when their economies weaken in tow with ours. You see how this all fits together now? It becomes like a nuclear reaction, once it really gets cooking, it is hard to stop it.

Today’s sell off was confirmed with high volume. For the first time in a long time we had high volume all across the board as reality was taking hold and people realized that they had to sell. The consumer is going to contract much more in the coming months, corporate earnings will decline further, and P/E ratios of stocks are suddenly way over priced again. Well, for our long time readers you already knew that.

(S&P 500 – Daily Chart #1)

(S&P 500 – Daily Chart #2)

(Dow Industrials – Daily Chart)

The bear market has resumed. The question is how long will it play with support and resistance levels before its next move down? From a fundamental and technical point of view, it is only a matter of time before the market does make its decent into the rabbit hole. I would expect to see some gallant efforts over the next few days to try and rally the market. But, it will be an exercise in futility as I see it right now. There is no catalyst present at this time to say the market will be able to correct from this pattern.

News on the wire tonight:

JAPAN:  IMF SAYS BOJ’S EASY MONETARY POLICY "APPROPRIATE"; JAPAN’S ECONOMY IS HEADING FOR A SLOWDOWN; YEN STILL UNDERVALUED FROM LONG-TERM PERSPECTIVE
- Sees Japan’s GDP growth at +1.4% in 2008 and +1.5% in 2009

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MORE TROUBLE AHEAD? THE DANGER OF CREDIT DEFAULT SWAPS – EUROINTELLIGENCE IN A NOTE TO CLIENTS
- "Are credit default swaps – financial instruments that insure against non-payment of interest – the next subprime? The Naked Capitalism blog has dug up a Bloomberg story, quoting a BNP Paribas analyst, as well as Eurointelligence contributor Satyajit Das, saying that there is ticking time bomb. Andrea Ciccione from BNP Paribas has done the maths, and concluded conservatively default of over $150bn. Altogether about $1.3 trillion is at risk. Das makes the point that CDS are going to complicated the financial crisis, saying that this may well freeze up the financial system. Ciccione in particular fears counterparty risks from hedge funds, who have written many CDS. The crisis could be triggered by a rise in bankruptcies from their previously low levels, as global growth slows down. (The point is you don’t a long and deep recession to produce a scary scenario. A mere return to normal is all it takes.)"

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CHINA: APRIL IMPLIED OIL DEMAND +3.7% Y/Y; YTD +5.6% Y/Y

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NEW ZEALAND:

2008 BUDGET: NZ ECONOMY TO SLOW SIGNIFICANTLY; GDP WILL SLOW TO 1.5% IN YR TO MARCH 2009; BUDGET WILL NOT LEAD TO RATE HIKES
- NZ GDP growth will be 2.3% in 2010 and 3.2% in 2011
- NZ income tax cuts are fair deal for all
- Tax cuts will start on Oct 1
- To raise tax thresholds, effective tax cuts of between NZ$22 and NZ$55 a week when implemented.
- More NZ income tax cuts to follow in 2010 and 2011
- The tax cut package is worth NZ$1.5B in 2008/09, NZ$2.3B in 2009/10, NZ$3.1B in 2010/2011.
- NZ spending allowance cut to NZ$1.75B from 2009, capital allowance to stay at NZ$900M.
- The NZ budget will increase GDP by 2.3% in 2008-09
- NZ to alter international tax rules to exempt offshore earnings for NZ based companies.
- NZ sees inflation at +3.2% in March 2009 yr, +2.8% in March 2010 yr.
- Treasury sees 2008/09 govt operating surplus at NZ$3.1B, 2009/10 surplus NZ$3.0B
- Sees March quarter 2009 90 day bills at 8.5%, NZD trade weighted index at 68.6
- Sees March 2010 yr GDP +2.3%
- Jobless rate to rise to 3.7% in 2009
- NZ jobless rate will rise to 4.4% in 2010
- To hold "Tap Tenders plus scheduled bond sales

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AUSTRALIA: MAY CONSUMER INFLATION EXPECTATION: 5.2% V 4.3% PRIOR (HIGHEST READING SINCE OCT 2005)

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OIL: NYMEX CRUDE MOVES TO A NEW RECORD HIGH ABOVE $135.00

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JAPAN: JAPAN’S 3 LARGEST REITS ARE EXPECTED TO REPORT DECLINES IN THEIR NET PROFITS – NIKKEI

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JAPAN: APRIL MERCHANDISE TRADE BALANCE: ¥485B V ¥739BE; ADJUSTED: ¥609.2B V ¥770BE
- The prior trade balance was ¥1.11T and the prior adjusted was ¥770B.
- April trade surplus -46.3% y/y
- April exports +4.0% y/y
- April exports to US -9.1% y/y

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JAPAN: JAPANESE TECH STOCKS: NIKKEI BUSINESS DAILY POINTS OUT THAT 7 TOP CHIPMAKERS WILL CUT CAPEX BY 21.8% IN FY08

I’ll try to answer some of the questions asked of me in tomorrow mornings pre market report. Have a great night and see you in the morning.