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September 14, 2008

Weekend Review

The markets seem to be loading us up with mixed signals these days, and I have to admit to being a bit baffled by the ability of stocks to grind higher in the face of the continued erosion of our credit system. I suppose there is still an underlying belief in the government's ability to hit the reset button and allow for another expansion. Perhaps traders are betting on a rate cut next week, but frankly I'd be quite surprised by such action. While I believe the next move will be a cut, not a hike as the Fed would have us believe, it is simply too early to play that card. The next rate cut will be done for political reasons, and there is nothing politically compelling at the moment. Apart from a market crash scenario, I would expect the next cut to come out of the January meeting under staged pressure from the new president as a tactic to gain favor with the public.

There is a lot to review this weekend, so let's dig in. Commodities finally seem poised for their first significant countertrend rally. As postulated a couple posts ago, the dollar index popped above 80 for a nice fakeout move and then tanked, and we're seeing this action in conjunction with oil test the $100 level.

oil chart

Both gold and silver are significantly oversold at the moment, supporting the idea of a countertrend rally in commodities being upon us. A rally back into their recent consolidation zones would be a reasonable expectation.

gold chart

silver chart

Friday's strength in mining shares certainly supports this idea.

stock chart

If oil were to put in a close below $100 or the dollar to recover sharply from Friday's drubbing, I would hesistate to commit further to a countertrend rally, but at least the parameters for this play are clear-cut.

Equities, on the other hand, are not providing such a clear near-term picture. The technical view is a bit hazy at the moment, so let's approach the market from a psychological point-of-view. One of the drivers behind the late-week strength in stocks, I believe, is anticipation that a Lehman bailout will produce another BS rally. Keep in mind, though, that Lehman has substantial counter-party obligations to meet on Monday morning. Bernanke and Paulson are working triple time this weekend to find money that can back up these obligations. What do you think will happen to stocks if the bald guys are unable to engineer Lehman financing?

Let me draw a picture for you:

stock chart

Even if financing is found this weekend, I would not expect the market to hold up much past the FOMC meeting, especially if my read on no change in policy is correct. I feel quite comfortable with my current short position, and if no news of a financing deal has hit the wires by this evening, I will probably increase my position via S&P 500 futures tonight.

It's going to be a thrilling week.


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