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MARKET TIMING with DECISION MOOSE

Moosecalls

LATEST SIGNAL (09/05/2008): HOLD Long Treasury Bonds (BTTRX, TLT, EDV) through 09/14/2008.

Index Moose provides deeper insights into the current state of global financial markets than simply the best place to put your money.

RANK	ASSET	Medium Trend	Short Trend
1	Long Zero-Coupon Treasury Bonds (BTTRX)	POS	POS
2	US Small-cap Equity Index (IWM)	NEG	POS
3	Cash ((3 month T-Bill or money market fund)	POS	POS
4	US Large-cap Equity Index (SPY)	NEG	NEG
5	Gold Bullion (GLD)	NEU	NEG
6	Latin America 40 Equity Index (ILF)	NEG	NEG
7	Japan Equity Index (EWJ)	NEG	NEG
8	Europe 350 Equity Index (IEV)	NEG	NEG
9	Pacific ex-Japan Equity Index (EPP)	NEG	NEG
	Other considerations
	Fed Check (what the Fed ought to do)	Stand pat	Cut
	Impact of US Dollar on Foreign Equities and Gold	NEG	NEG
	Commodity Inflation Trend	NEU	NEG

Week in Review

SEP 05— The Republicans unveiled their secret weapon this week, a well-spoken female candidate who (a) smiles naturally, (b) doesn’t whine, and (c) doesn’t vaguely resemble a pineapple in a pantsuit. It’s widely expected, and/or feared, that this astounding, and it would seem, previously undiscovered, marketing trifecta could actually induce men (as well as women) to vote for the person. That could be scary for the other side.

But not to worry. In a reflection of the economic times, all four of the major party candidates have public jobs waiting for them should their grasp exceed their reach in November. It’s a situation that highlights the old adage that it is far easier to find a job when you already have one. Indeed, three of the four have made looking for a new job their main job for almost three years, even as their second jobs as Senators continued to pay the rent. They’ve had hands to shake and photo-ops to make. To hell with the Senate. (Even though you and I are on the hook for their salaries, can’t say I disagree on that last point.)

This week, however, we find that fewer and fewer private sector Americans are as fortunate. The unemployment rate hit 6.1% in August, as the economy shed another 84 thousand jobs. June and July job losses, moreover, were upped to 100K and 60K respectively (from 51K each). In all, we’ve lost 600,000 jobs since January.

Since mortgage delinquencies and foreclosures hit a record high in the second quarter, when we “only” had 450,000 job losses to date, it is reasonable to expect that housing will continue to falter in the third quarter. After all, people without jobs tend to default more often than those who have them. Real estate weakness, in turn, applies pressure for further write-downs in bank-held mortgage-backed securities, which squeezes bank capital ratios and their ability to lend. Tight lending leads to further economic weakness.

As noted last week, such pessimism favors bonds, and this week reaffirmed that. Long Treasury prices rose (+2) and yields fell. It was a rather staggering move on the week, however, a move that upon Friday’s employment data release already looked overdone. The ten-year yield fell to a low of 3.54% Friday, before recovering to close the week at 3.66%.

Stocks had the opposite reaction, and were down across the board this week. U.S. stocks were lousy enough, but offshore equities were particularly hard hit. So far, the Dow and the S&P are tenuously holding 3-4 percent above their July lows. U.S. small caps are slightly better off. Meanwhile, Europe, Japan, Pacific ex-Japan, and Latin America all plunged to new lows this week.

Whereas the U.S. may no longer lead the world’s business cycle around by the nose, decoupling in the equity markets is more problematic. It’s arguable that the U.S. is further along in its malaise, has already seen the lows in its equity markets, and is a better value. The problem is that if offshore stocks get really ugly, margin calls usually toss the baby with the bath water, and U.S. stocks could suffer collateral damage.

Back when the experts were calling the July low in U.S. stocks rock bottom for the cycle, recall that I was skeptical. Now that we’re one trading day from re-testing those lows, and several other indices have broken below them, I remain unconvinced.

You may be wondering why it matters, since we’ve been avoiding U.S. stocks since April 1999 and continue to do so (The S&P was 1358 when we sold it almost a decade ago, and closed this week at 1242. Long term buy-and-hold, anyone?) Primarily, it’s interesting because we’re in long bonds, and lately they’ve been heading in the opposite direction. If stocks do hold their lows in here, and we get a tradable bounce, bonds will probably retreat. If stocks break down, the bond rally should continue.

That the model’s math is telling us rather unequivocally that the bond bet is on makes further damage to stocks the most likely outcome. The Fed Check, however, is closing in on a bullish signal— that the Fed ought to cut rates— but it isn’t there quite yet. Commodities were down big again this week led by oil, and bonds were flying. How long oil weakness will continue, however, is on everyone’s mind.

The Paralympics open in Beijing this weekend, so my guess is that the draconian pollution controls implemented prior to the Olympics are still in place and will be until at least the 17th. That means oil and materials demand in China should be reduced awhile longer, keeping prices low. But then again, we’ve got a string of hurricanes lining up that could disrupt oil and gas production in the Gulf of Mexico and push those prices higher.

Even if oil prices continue to fall, a Fed rate cut is not expected soon by any means. Current inflation data looks too hot and there’s no guarantee further rate cuts would help the struggling economy anyway. We’ve had three hundred basis points in cuts, and market rates are higher now than when we started. Interest rate spreads are high, signaling that the credit markets are still extremely tight.

Were new cuts made, however, it could be bullish for stocks. Meanwhile, the expected delay is bullish for bonds. Remember, when the Fed Check says the Fed ought to do something and it doesn’t, the markets take up the slack. Market interest rates are thus apt to fall, and bond prices rise.

NOTE: The collapse of Fannie and Freddie after hours this weekend, and their subsequent reorganization by Treasury ("taxpayer bailout") should stabilize the credit markets somewhat. Essentially, however, the Treasury is buying up mortgage loans, diluting its "risk-free" image. That reduces the attractiveness of T-Bonds. Prices may not fall, but they will probably not rise as quickly as they might have.

Still, there is no change in the signal. The Moose holds long bonds for another week.

See the week’s detail below.

Shared Assumptions vs. This Week's Perceptions

Individual components within the global market do not interact in a set, immutable way in every context, but certain relationships do exist more times than not. Those relationships form the basis for investors' shared assumptions. Market trends are reinforced when investors’ shared assumptions are borne out by their perceptions. Market trends reverse themselves only after perception begins to alter shared assumptions. By understanding the market’s assumptions, and current perceptions, we can better forecast a potential change in trend.

Shared Assumption: Global Economy		This Week
World GDP grew at a record pace in 2007, led by an emerging market boom in Asia. Slower, but still sustainable growth continued in the first half of 2008, as central banks around the world have begun to react to inflation with tighter policies. Problems in the global credit market and US economic weakness are dampening the world outlook in the second half. The IMF lowered its global GDP estimate for 2008 to 3.7% in April. Offshore growth, particularly in emerging markets, is still in the lead, but estimates have been cut substantially. Global growth has helped the U.S. avert recession so far, but still takes its cue from the U.S. The world will slow even more should the U.S. go into recession. Most expect Fed rate cuts since September 2007 to begin improving the U.S. outlook by Q1-09, but the U.S. financial system is still weak, putting the recovery in doubt.		Overseas, the Bank of England and European Central Bank both kept their benchmark interest rates unchanged, as expected. Both mentioned rising inflation and weakening economic growth.
Shared Assumption: U.S. Economy		This Week
U.S. economic growth, once expected to improve in the second half of 2008, is now questionable. The first half was anemic, although we initially seemed to have skirted a recession, data is being revised downward. Unemployment rose to 5.7% in June, up from 4.8% at the end of 2007. Moreover, the price of oil neared $140 a barrel before backing off 10% or so in July. The combination of weak growth and strong energy prices suggests that stagflation is likely. With housing very weak, mortgage finance still poses a danger to the financial system. $1.5 trillion in ARM rollovers come due in ’08, followed by half a trillion in ’09. Growth went negative in Q4-07 (-0.2%), but improved in Q1-08 (+1.0%). Second quarter GDP (+1.9%) benefited from Federal stimulus. Estimates of third quarter (e+1.3%) and fourth quarter (e+0.6%) GDP are lower. The notion that previous Fed rate cuts and government stimulus should have kicked in by September has been moved ahead to January 2009. Credit expansion has lagged during this Fed rate cut cycle, due to the sub-prime crisis, suggesting that growth may be weaker than expected and/or delayed.		The good: ISM services (49.9) and manufacturing (50.6) were better than expected. Factory orders 1.3% weak but better than expected. The bad: ADP employment index had private-sector employment dropping 33,000 in August. Construction spending (-0.6%) weaker than expected. The Federal Reserve's latest reading of economic conditions, which described business conditions as weak across the country. The ugly: Unemployment spiked to 6.1%. After three weeks of declines jobless claims rose last week to a seasonally adjusted 444,000. August auto sales are down 20-26% over last year.
Shared Assumption: Inflation		This Week
Inflation is a growing problem entering the second half of 2008. The 4.1% consumer price increase in 2007 was the biggest since 1990's 6.1%. As the second quarter drew to a close, the CPI was rising at a 4.6% annual pace. PCE, an inflation measure tied to the GDP report, showed prices grew at a 4.2% rate in Q2, up from a 3.5% pace in the prior quarter and 3.9% in Q407. Core PCE (excluding food and energy) rose at a rate of 2.1% in the second quarter. That was lower than the 2.5% pace in Q4, but still above the Fed's comfort zone. The Fed's maximum inflation tolerance is 2%. Gas and food prices, however, have gotten much hotter since the start of the year, adding to inflation pressures. As summer began, gasoline prices set new records, well above $4 a gallon. Problem is, U.S. inflation is rooted in surging emerging market demand for raw materials (oil and metals). This type of "exogenous demand pull" inflation responds to Fed rate hikes with a long lag, and usually only after the U.S. has stopped growing. "Endogenous cost push" inflation is also a recurring problem. U.S. pipeline and refinery outages have constrained U.S. supplies of crude, natural gas, and gasoline at various times, spiking prices.		Productivity of U.S. nonfarm businesses was revised higher in the second quarter than previously estimated, climbing at a 4.3% annual rate in the quarter, up from 2.2%. Average hourly earnings (0.3%) are not keeping up with inflation.
Shared Assumption: U.S. Dollar		This Week
The Dollar is weak, as the U.S. economy has been growing more slowly than the rest of the world. With Europe and Japan slowing in the second half of 2008, however, the Dollar has stabilized somewhat. A weak Dollar tends to support higher commodity prices (which are traded in Dollars). It also provides additional return to dollar investors in offshore assets. Over the long term, it helps U.S. multinationals (US large-cap stocks) become more competitive in the export market. It also worsens U.S. inflation by raising the price of imports, which in turn lends pricing cover to U.S. producers of competing products.		The Dollar (+2.1%) rallied for the sixth week in seven. U.S. growth prospects may be dimming, but so are the rest of the world’s. The trend in the greenback is up medium and short term. It’s up over the last 13 weeks (+9%), but still down over the last 52 weeks (-1%).
Shared Assumption: The Fed		This Week
The Fed is caught between a weakening U.S. economy and sticky inflation. Market-determined longer-term interest rates have been lower than the overnight or Fed Funds Rate (FFR) since 2005, presaging a slower economy. This yield curve inversion, however, was not steep enough to suggest imminent recession. The Fed lowered the FFR from 4.75% in September 2007 to 3.00% in February 2008 -- concerned more that credit problems could cause the U.S. economy to deteriorate further. That ended the inversion, but eventually turned our Fed Check from neutral to bearish, suggesting further cuts would be seen as very inflationary.		The Fed Check (1.04) remains neutral on weaker commodities (-6.1%) and an ongoing bond rally (+2.0%). Will China reignite its demand for commodities once clean air is no longer required? The next few weeks will tell. Meanwhile, the Fed Check’s neutral reading suggests the Fed can stand pat without doing any inflation damage. Futures put a 57% chance of a rate hike by January.
Shared Assumption: Commodities		This Week
Commodity prices bounced off a low in January 2007, due to a warm winter and better than expected U.S. growth, and kept going up all year. Nevertheless, 2007's rally could wane as the U.S. economy deteriorates in 2008. Higher prices have been the result of strong global demand, but a slowing U.S. economy could reduce global growth and raw material demand. Hard commodities (energy and metals) are more vulnerable than soft (grains), which benefit from China's food shortage and the US ethanol craze.		Commodity prices (-6.1%) tanked on possible hedge fund liquidations. Gold (-3.3%) and oil (-7.3%) were among the victims. Oil is now down 23% in 13 weeks, but still up 49% from a year ago. The medium term trend in the CRB sank to neutral (non-inflationary), but the short trend remained negative (disinflationary). The CRB index is down (-17%) over 13 weeks and up (+18%) over 52 weeks.
Shared Assumption: Gold Bullion		This Week
Gold bullion has been on a gradual rise since 2005. While bullion price tends to correlate with overall commodity prices, gold's rally has more closely mirrored the decline in the U.S. Dollar, as central banks replace Dollar reserves (the value of which has been falling) with gold reserves (the value of which is rising.) In doing so, they further reinforce gold to the detriment of the Dollar. When the Fed began lowering rates in late 2007, investment demand for gold picked up steam. The prospect of stagflation, further Fed rate cuts, and low Treasury yields in 2008 prompt a bet against the Dollar.		Gold (-3.3%) slid. A stronger Dollar (+0.7%) and a weaker commodity complex contributed. Bullion is down (-11%) over 13 weeks, but still up (+14%) over 52 weeks..
Shared Assumption: U.S. Long Treasury Bond		This Week
The U.S. long bond (25+ years) is bullish entering 2008, based on the notion of a slowing US economy in the first half. Bonds gradually rallied in anticipation of a slower U.S. economy from May 2006 to mid-2007. Then commercial credit fears set off a flight to quality into Treasuries, even though rising commodity prices reflected inflation danger from the strongest global economy in decades. While either potential U.S. economic scenario (stagflation or recession) should be bullish for bonds, the trend in global commodity prices ultimately measures whether inflation is "under control". Falling commodity prices, then, are essential to rising bond prices.		US 25yr+ Long Bonds (+2.0%) rallied for a sixth week on a weaker economic and equity outlook. Long T prices are up (+7%) over 13 weeks and (+9%) over 52. The 10-year yield fell from 3.81% to 3.66% this week. Cash yields fell from 1.69% to 1.64%. That flattened the 3M-10Y-yield curve this week from 212 basis points to 202. The medium term steepening trend since late May is slowing.
Shared Assumption: U.S. Large Cap Equtiies		This Week
U.S. large cap stocks are bearish entering 2008. They bottomed in late 2002 and rose steadily until 2007, during which they suffered three corrections due to the credit crunch and fears of impending economic malaise. Large caps usually lead small caps when the economic outlook is considered positive, but weak, as it was after 2006. Larger companies are expected to do better than smaller ones slow times. They have more resources and are better able to weather a recession, should one develop. They are more prone to be multinational, making them more competitive globally as the Dollar weakens and offshore economies boom.		US large caps (-3.4%) are taking a close look at their July lows. SPY is down over 13 weeks (-9%), a loser over 52 weeks (-15%), and has gone nowhere for three years. The markets, the tape, and the Fed all confirm that a bear market has been underway since October. The Moose has been avoiding SPY for years and continues to do so.
Shared Assumption: U.S. Small Cap Equities		This Week
U.S. small-cap stocks are bearish entering 2008. They bottomed in early 2003, rose into mid-2007 and have been slipping since. Small caps begin to under-perform as the interest rate level rises and the economic outlook weakens. Smaller firms have fewer resources and less access to low cost capital, and thus are less able to weather a recession, should one develop. Moreover, small cap companies are less apt to be multinational, which can become more competitive globally as the Dollar weakens.		US small caps (-3.0%) sank this week. They’re down (-3%) over the past 13-weeks, and down (-8%) over the last 52. That’s still better than large caps. The Moose has avoided small caps, although at the moment, they’re the best of a sorry lot (equities).
Shared Assumption: European 350 Equities		This Week
Like U.S. equities, European stocks are bearish entering 2008, They bottomed in early 2003 and rallied into 2007 before rolling over. Dollar investors in European equities benefited from a strengthening Euro during that bull run. Financials comprise two-thirds of the capitalization of the 350 largest companies in Europe. Without understating the importance of nascent markets in New Europe, this suggests that the four-year rally in (Old) European stocks was rooted more in favorable interest rate and currency trends, than in a high-tax, extended-vacations industrial renaissance. Low interest rates and a strengthening currency are particularly profitable to the banking industry. The first allows improved margins, and the second attracts new offshore money (petrodollars). The ECB is expected to hold rates steady in 2008, but the prospect of weaker U.S. demand might cause them to ease. A stronger Euro means oil (bought in Dollars) is becoming cheaper in Europe, which also reduces the pressure to raise rates.		European stocks (-6.7%) resumed their swoon, as a weaker growth outlook in Britain and Germany, and a staggering euro continued to weigh. IEV is down (-20%) over 13 weeks and (-24%) over 52. IEV is bearish short and medium term, thanks to slowing European growth and inflation fears. The dual threats of a US recession and credit worries also remain on the continent.
Shared Assumption: Japanese Equities		This Week
Japan's equity markets rallied nicely from early 2003 into 2007, then followed global equities and rolled over late in the year. Entering 2008, the market is bearish, and the carry trade has begun to unwind. (The carry trade borrows Yen at very low interest rates in Japan, converting those Yen into a foreign currency, and investing that currency, often on the margin, in offshore assets that have a much higher expected return than the original borrowing cost. Success depends on (1) low Japanese interest rates, (2) a weakening Yen, and (3) rising asset values abroad.) The BOJ raised interest rates from 0% to 0.5% in 2007, the Yen strengthened, and investment markets outside Japan began to falter. The Yen put in its first annual gain versus the dollar in three years, as global equities tanked amid political and economic uncertainty.		Japanese stocks (-4.0%) resumed their free fall this week. The Japanese consumer is weak and inflation is on the upswing. The government is in disarray. EWJ is down over 13 weeks (-18%), and over 12 months (-20%). Slower growth in both Europe and the US, and the unwinding carry trade led stocks in export-driven Japan to their worst first half since 1992. The only good news: the Yen has weakened against the Dollar lately, improving the outlook for Japanese exports.
Shared Assumption: Latin American Equities		This Week
Latin America is a resource-based region that rode a wave of higher commodity prices in 2006-07, particularly in oil and base metals. Latin American equities were an attractive investment until fears of slower global growth in 2008 and less demand for raw materials. A leftist political surge in 2006 was symptomatic of the region's capitalist economic success (or excess, if you're a socialist). While expropriations of private property in Venezuela and Bolivia did not initially portend economic collapse, if global economic growth does cool, mismanagement and lack of investment capital in state-owned industries will hasten the region's decline.		Latin American equities (-9.4%) got killed on weaker commodities this week. Weaker commodity prices and a stronger Dollar zapped equities in the resource-rich region. It’s been a tough quarter. ILF is down 26% over 13 weeks, all but wiping out what was once a stellar 52 week performance (+1%).
Shared Assumption: Asia ex-Japan Equities		This Week
Pacific ex-Japan stocks are bearish entering 2008. They bottomed in early 2003 and rose through most of 2007, turning south as the prospect of global growth cooled. Dollar investors in the region's equities benefited from a weaker Dollar during that period. The Index is comprised of Australia, New Zealand, Singapore and Hong Kong (China for non-Chinese investors)-- the more developed economies and financial centers in the Asian region. As the US credit crisis ebbs and flows, so will nervousness in the Asian financial centers.		Pacific ex-Japan (-8.1%) also got massacred this week. The index is heavily weighted in banking, and the global trend toward higher interest rates, and the spreading credit crisis have taken their toll. The region is down over 13 weeks (-22%) and (-22%) over 52. EPP is negative short and medium term and to be avoided.

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