Sunday, June 1, 2008

Psychology of the Coming Week's Economic Data

Good morning and good evening to all our weekend readers. We hope our psychology reaches you in good health and good spirits. Last week's shortened three day trading was bullish Tuesday through Thursday, followed by a strange sell off late Friday, so "profit taking Friday" did come true, although very late in the day. The Psychology of the Call team (POTC) witnessed tremendous selling pressure in the final 5 minutes Friday, marked by huge blocks and limits being triggered having to adjust the market up after market close. The Dow Jones Index went from up 28 to down 28 or thereabouts from 3:50 ET to 3:59 ET, then after market close limit orders adjusted the market and the Dow settled down 8 points.
Again, one of the strangest market closes ever witnessed. Institutional funds usually do not trade in the first and last 30 minutes, but this kind of block volume could have only come from a large fund...

What the late sell off means remains a mystery. Could it be a hedge fund in need of liquidity due to a fall out in the bond market, or related to the recent move up in crude oil? Either or both of these scenarios are possible, as it was the last day of the trading month. Here's a visual snap shot of what transpired, but why is the more pressing question. What caused this action/behavior; do you know?

Market mechanics of the upcoming week will be influenced by the looming June 25th FOMC meeting. By looking-forward, our readers begin to understand how and why the market discounts information.

1) Crude oil. With prices backing off from above $135/barrel, and now at $127/barrel, where will they go is the $64,000 question.

Bernanke's Fed prefers to see crude back off before their next meeting, as their charter does not call for creating or bursting market bubbles. Nonetheless, the Fed seems to have their arms tied with the dislocation of rising food and energy prices and the weak real estate market in the face of a weak greenback.

POTC believes prices north of $100/barrel have negative effects on the consumer, so perhaps the psychology of this whole debate is more important than the difference between $115 and $130 per barrel. Some argue that higher prices are a good thing, as the world will be forced to invent alternative sources of energy. But a wise neighbor of mine named Roger recalls the 1972 Nixon gas rationing program with odd & even numbered license plates. Prices at the pump back then in California were incredibly high, perhaps around $2.50/gallon. And what have we learned in nearly 40 years; nothing. Our readers would be wise to monitor crude prices closely this week, since the market is so nonsensical in the short term (1 day - 3 months), but never wrong in the long run, yes? Although POTC does believe this is a cyclical crude oil bubble, we don't see it bursting because of the start of the hurricane season and the speculators that spin with it~ Remember, our belief is the crude oil bubble will burst after the Beijing Olympic starter pistol is shot, and that shot will be heard around the globe in August. Perhaps no category 3 or greater hurricanes hit the Gulf Coast by August either… you decide on the Psychology of that call.

2) A credit/mortgage/real estate crisis, in the face of a weak greenback.
Historically, the U.S. real estate market has been a safe haven for investors, as has the greenback, but neither seem so today. Will Bernanke's Fed realize the problem in real estate is not only inventory overhang and prices, but also and perhaps more importantly tied to the psychology and ramifications of a weak currency?

POTC believes the Fed has lowered interest rates enough and the real estate fall out should take its natural course and shake out all the "weak sisters." After all, in a Capitalistic society, speculation is what drives our freedom of innovation and technology, so why should the government bail out any speculator with lower rates, while ruining a larger portion of society with high gasoline and food prices. A word to Bernake's Fed: raise interest rates to change consumer psychology, before it's too late. Everyone knows crude oil is priced in greenbacks, so it's time for interest rates to rise and burst the crude oil bubble.

3) A precipitous fallout in the 10 Year Treasury market in the face of a struggling stock market. Who's right? We'll find out next week after Monday's Institute for Supply Management's (ISM) data release at 10:00 ET. The volatility will be greater than anything witnessed in the last few weeks. Is the rise in the Treasury Note yield telling us institutional credit market participants know there will be no recession and their spreads have tightened to a point where they're able to liquidate what was worthless paper just weeks ago? Credit market participants are closer to the pain than their equity counter-parts, so POTC sees this bond market sell off as a potentially welcome event for equity investors. Our readers must understand the influence the bond market has on the stock market (S&P 500 Index). Bond market investors are usually better informed, wealthier, older, and wiser than the average equity investor/trader, so be cautious.

The fact Treasury Notes have fallen and yields have risen to the highest point since January of this year must be monitored, as these short term swings must be respected. Remember, bond investors are more sophisticated, so POTC asks you to closely monitor whether the 10 Year Note stays above 4% after the ISM data is released on Monday at 10:00 ET. If it does stabilize, or if the yield actually rises (bonds sell off), then there could be a concussive ripple effect and move up in the S&P. The opposite is true as well.

Starring in the face of two of the most important economic indicators - Institute for Supply Management (ISM) on Monday at 10:00 ET and Employment Report on Friday at 8:30 ET - will reveal where the equity and bond markets stand, or fall. How the market reacts to stable, strong, or weak data will be fascinating. And finally, how will the talking heads begin to discount the data with the looming June 25th Federal Open Market Committee (FOMC) meeting?

Historically and ironically to many market participants, weak economic data caused the bulls to celebrate, since that meant the FOMC would lower interest rates. In theory, lower interest rates make money/loans cheaper, and businesses borrow more and the business cycle has a fundamental reason to expand.

Today though, the FOMC has a difficult paradigm to address. The weak greenback and rising food and energy prices are a direct result of their low interest rate policy. Quick Psychology: If the economic data comes in below forecasts/estimates, which we will give you later in this piece, POTC does not see the bulls behaving their usual self. The bulls will look at the weak data and realize a still lower fed funds rate will only mean higher crude oil/gasoline prices. Potentially disastrous you say, but not so fast. Remember Roger? He also said maybe this time will be different and the cyclicality of history, which should have never repeated itself, could finally be solved through a serious effort toward a combination of alternative energy R&D and a different clan of D.C. lobbyists. POTC agrees with Roger. We will add that the world in 1972 was more influenced by the U.S. than today. The demand for oil is no longer only a U.S. phenomenon and this will force the U.S. to finally reinvent energy. If this were to happen, the market mechanics would discount crude oil well into the future, therefore a stabilization of current levels or rising prices may actually turn out be a good thing. POTC will never be monolithic in our views, as the markets are deep and dynamic. We'll call it as we see it, as there are always two sides to the market, ole!

Monday, June 2nd brings us the greatly anticipated Institute for Supply Management (ISM) data at 10:00 ET for the month of May.
Prior reading for April was 48.6, now the consensus forecast is between 48 and49. The ISM
is hugely important in institutional circles and carries a rating an A- for market moving significance, courtesy of our friends at The prices paid component (ppc) in April came in at a nose bleed 84.5. Only in 1995 and 2004 did it spike to the high 80's. Is this the triple top breakout nobody sees coming? You decide. That is why monitoring the price of crude is so critical today, because of its huge cause and effect relationship on short term market mechanics. The ISM is trustworthy and considered to be one of the best leading indicators of the economic cycle. Expect tremendous volatility after this number. Rather than fathom a guess whether the number will come in stable, strong, or weak, we'll just leave you with this Quick Psychology: The S&P will react violently up or down from 10:00 ET to 10:05 ET, usually the first 5 minute reaction is met by an equal and often times stronger opposite reaction. So if any of our readers are trading S&P futures, please remember our advice and wait until 10:05 ET and trade against the herd, as their first reaction to the data has historically been wrong.

Monday's close will dictate direction trading until Thursday, barring any unforeseen geo political events, out of step Fed moves, a greater than $10 move up or down in crude oil, or the Euro-ization of America.

Tuesday, June 3rd brings us Auto and Truck sales at 00:00. This data is hardly of any market moving significance. With gas at around $4.00/gallon, POTC finally sees auto industry psychology being forced to change. Building more economical models like the Toyota Prius makes sense today. This long term business decision is solely based on the recent spike in gas prices, so POTC believes if the entire auto sector turns to fuel efficient cars, perhaps they will be fooled as the greenback strengthens and gas comes back to $2.00/gallon. Tuesday will follow Monday's close, so please, please, please do not underestimate the importance of the ISM data when setting up your Tuesday trades late Monday.

Wednesday, June 4th brings us the Institute for Supply Management Services (ISMS) data at 10:00 ET for the month of May. This data is non-manufacturing related.
The prior reading for April was 52, now the consensus forecast is between 51 and 52. Anything above 50 shows business cycle expansion, so forecasts are optimistic. Please remember the prices paid component (ppc) plays a significant role here as well and is troubling. Although there are no forecasts for the ppc, it has been inching up, directly reflective of highly priced crude oil. April's ppc came in very high at 72.1 and only once in late 1995, after hurricane Katrina did it penetrate 75. Will the ISMS come in between 51 and 52 as forecasted, but get derailed by the ppc? We surely think so. Remember; this is an election year, so the sitting elephant administration wants no donkeys moving into 1600 Pennsylvania Avenue. Therefore the question of how much control or manipulation the government actually has over these data sets is valid, no? Just as our advice to traders regarding Monday's ISM, wait until 10:05 ET and trade against the herd, as early money is usually wrong. There will be volatility after this data release.

Thursday, June 5th brings Initial Claims for Unemployment for the week ending 5/31 at 10:00 ET.
The prior reading came in at 372K, now the consensus calls for 370K. The Alice Cooper schools out for summer effect will show up here, and the number will come in strong. IF the number comes in north of 380K files for unemployment, the bears will be in control of the market until the bloodiest hammer of them all, this leads us into Friday's Unemployment Report.

Friday, June 6th is the long and greatly anticipated Unemployment report for May at 8:30 ET.
The prior reading for April came in at 5.0% unemployment, now the consensus is calling for 5.1%. IF this number comes in above 5.1% the bulls will be stampeding over themselves. IF this number comes in below 5.1% the doglike, carnivoran bears will look like more like baby cubs as they stagger into their holes with their five non retractile claws.
If you are not properly diversified going into this number, meaning that you’re exposed too long or too short, POTC urges you to take half your position off the table. The Unemployment report wields the biggest and bloodiest hammer for good reason, as jobs are the foundation of an economy. In a rising unemployment environment, the economy and consumers suffer from all angles, and the wheels could come off. Do we think this will happen? Absolutely not, but is there a chance if the FOMC doesn't raise rates and strengthen the greenback, knocking down oil? Of course.

POTC is more bearish than bullish. There are positives:
1) Election year;
2) GDP fails to signal recession;
3) Treasury Market sell off;
4) Extreme pessimism in the Michigan Consumer sentiment (contrarian indicator eventually).

However we feel the positives are outweighed by the negatives:
1) Rising Unemployment;
2) Crude oil fails to break down;
3) Rising food prices;
4) Weak greenback;
5) Uncertainty what the June 25th FOMC decision will be, and regardless of what it is, uncertainty that the ship can maneuver through what looks like a "Perfect Storm".

The Psychology of the Call team thanks all our supporters around the world for returning to read our insights. Please follow the 11 Commandments and use the 7 Psychological Pillars. We would dearly appreciate it if you helped us spread our psychology to your friends & family. Please email, copy, print, and Facebook wherever possible. Our goal is to help, not harm; share our insights, based on many years of experience at the highest level of US Financial Institutions.

A happy and healthy June to ALL! We leave you with a little relief music video:


Anonymous said...

I can't stand it. The Nixon odds/evens was in Feb 1974.
Please have your cracked staff
fact check. Sam

Anonymous said...

Sam, Dude, Chill. Lie down before you hurt yourself!

Anonymous said...

Perhaps "Sam" was around then?

Anonymous said...

Sam.. we were wrong, you were wrong..