Slowly through each wave of rise and fall, markets are revealing where the capitals are concentrating. The market leaders are no longer US, Japan, nor Europe, but Brazil, India, China, and Taiwan.

US market is facing heavy pressure again today. S&P 500 has broken support at 1080/1085, and then 1065/1060. The technical pictures are simply getting worse and worse. However, that is not so for Brazil, India, China, Taiwan, and other southeast Asian markets. They are far above July low by some 10%. The good news is that I believe these market leaders are not forecasting a repeat of depression, or a serious bout of recession. The bad news (for more mature markets as to emerging markets) is that the better days are not for us.

Going forward the stock markets will be increasingly selective. Given the extremely low interest rate environment, there are LOTS of hot money trying to find a home. But it’s probably not going to be in S&P 500.

Misc Observations On Financial Market

Just some more data points on this crazy markets:

  • Have you heard those radio ads on TreasuryDirect for buying US bonds directly? I listen to business channel on radio when driving to work everyday. Never heard that kind of radio ad before. Maybe US bonds are really unwanted and required special advertising these days from public. And US Fed is not alone. California bonds are also in the ad too.
  • I have never seen Xmas tree decoration this early in the year. The first week of October, Macy is already filled with Xmas merchandise. Unbelievable. Halloween is barely here, and Macy is already selling for Xmas? I’m guessing there will be quite a lot of things on sale this year.
  • Have you got your Wii yet? I tried to buy Wii at several stores, and they always run out of stock right in the morning of the day on sale. I think Nintendo Wii is going to have a really good Christmas. If you stock up on Wii, you can probably make some 10% to 15% reselling them on Ebay during Christmas, I guess.
  • The precious metal markets are truly scaring me. Yeah, my portfolio is at all time high. I’m just nervously waiting for the fall to come, just like night is followed by the day. My wild guess is that HUI goes to 459, and then comes back down to 357, correcting some 20%. It appears that there are so much more money NOT in the PM, missing the biggest rally so far. Most of the best market timers that I’m aware of are missing this rally. There goes the best technical analysis down to the drain. There is a reason that I don’t want to time the market so much. I just know that I’m not that smart. If the smart market timers cannot time it, then how can I time it? My guess is that HUI will become so painfully high for people who miss the rally to suck them all in, and/or correct to a value so grudgingly high that few will take up enough shares.
  • As far as I can tell, the band of day traders from 2000 are back in fashion. These day traders are trading China stocks, plus all the high volatility & high momentum stocks. And many more are leveraging their house, and making a killing in trading. Since not everyone can be rich, eventually I am guessing that it will be resolved. Watch out. Everything is alway happy, even if it’s one minute right before the top of the market.
  • I listened to the financialsense.com radio over the weekend. Robert McHugh is stating out my biggest fear for this great country USA. He believes that bond yields will not be going up next year for the benefits of housing market because Federal Reserve will be monetizing the US debts by printing money to mop up the excess of US treasury bonds. That makes a lot of sense to me, and that’s what I would do to save the housing markets if I’m the Federal Reserve. But that’s just NOT the decaying path that I want to see for this great country. Such actions are simply making everyone to pay for the sins from house flippers. When I commented last year about the real losers when the housing market bursts, few people seem to understand what I wanted to say. I think as time goes on, possibly forward by another 6 or 7 years, it should become all very clear.
  • Crude oil is going crazy too. Looks like $4 per gallon will be here sooner than I think. Inflation will transfer the wealth from middle class to the upper class. The short-sighted Federal Reserve thinks they’re doing the country a service, but higher inflation eventually will make big changes in the political arena globally. Poorer people from inflation won’t be happy. And vote they will. I only pray that we will have smart leaders like Ron Paul, instead of Hilter-like leaders. The history has shown that the mass cannot tell a good leader from a bad one. They will demand changes, whoever that can provide to them.

In any case, it looks like phase two of the gold bull market is here or almost here, thanks to Bernanke to kick-start it by cutting 50 basis point. Sit tight. The roller-coaster is going to get wild, both up and down.

My Thoughts on the Current Market

I have written this post, before I leave for the extended vacation. I just want to leave and recap my thoughts on the markets for anyone who is interested. I have not been posting much on the market, but I do watch things daily.

Macro economic picture

  1. Housing bubble has finally popped. In my second post on this site, back on April 8th, I have indicated that housing bubble may pop in mid-2006, based on the studies of bubbles in the book of Why Stock Market Crash. Back in April, the signs were not that clear, but after June/July, it became increasingly clear that bubble cannot be pushed higher.
    Associated with the housing bubble in the mortgage market, 1 trillion out of 9 trillions mortgage will be reset next year. This will increase housing market inventory further, while Fed cutting interest rate next year will help the market somewhat. However, if you think a slow-motion market can finish its correction in a mere 3 months, you got to be joking (did David Lereah at NAR or Greenspan f*rt?). Even a super-fast volatile sector like precious metals couldn’t finish its correction in less than 2 months. I think the correction or crash in housing market will last for YEARS, about 5 to 6 years to be exact until 2011/2012 in my best guess. Possibly with the later 2 to 3 years to be flat or slightly up (0% to less than 3% range annually).
  2. US economic growth is slowing down. And the biggest culprit is the housing market. I believe that although you may not see a headline recession due to all the economic fudged reports and skewed media, a US recession could be here already. By recession, I mean any actual growth rate that is close to 0% or slightly negative.

With the above macro picture, I believe that in the short to intermediate term (now to end of 2007), this is probably what would happen:

  1. US central bank will print like crazy, with money supply increasing probably at 8% annually or above. This is to drive money back towards into bond, housing, and stock markets. However, they cannot control fully where these additional money supply will go. A higher bond market, which translates into a lower interest rate will alleviate anyone who wants to refinance their ARM into fixed rate loan. But I believe that a 2002-style of yield crashing will NOT happen this time around, due to the growing diversification of $US around the world. In the short term however, stock markets may from time to time experience the jubilating rallies due to the extra shower of newly minted money. I tentatively believe that the secular bear market in stocks is NOT over, at least on the inflation-adjusted basis.
  2. Due to the slower or zero growth, Fed and big brokerages will try to keep a lid on the commodity and precious metal markets. A slower “growth” in USA is definitely a negative for base metals, steel, cement, energy producers. But they will also continued to be supported by the Asian demand (or the Chindia, China+India). My guess is that the stocks of these commodity may go into a range trading, but a bigger trading range of maybe some 30% peak to bottom (on the average) in 2007. This trading range allows the secular bull market in energy to catch their breath. Some may outperforms others, such as uranium. I think the bottom range of these stocks are around here. While it is possible that selected few of the raw commodity price may either go on and make new highs, or trade with a slight bullish tone.
  3. A slower US growth means lower short-term US interest rate, and lower $US foreign exchange rate. This is bullish for precious metals. The rallies in precious metals may or may not be capped, and/or range-bound, due to their counter-party in the oil world, but saying that the bull market in precious metal market is over is probably wishful thinking for PM bears. Overall, starting from mid-2006, to maybe end of 2007, it could be a time for the general commodity markets to catch their breath before launching UP further.
  4. I begin to see signs of energy inflation making its way into agricultural commodity. I believe that 2007 will probably be the year of stellar return for agricultural commodities, IF not already in 2006. Many agricultural commodities are breaking new highs (corn & wheat, and guess what, meat from animals is “corn”-based). Eventually these prices will get passed down to the final food product. I think Fed will have a hard time managing the inflation numbers going forward. first, it was energy. Then it was core rate. And then it will be FOOD. This inflation fire simply CANNOT be put out, and will continue to rotate and spiral upward from one physical thing to the next. Why? It all goes back to the root of evil, Fed printing money. To think that you can print money, and still be able to contain inflation, is simply insulting and ridiculous. On one hand, Fed wants to appear to be an inflation fighter; on the other hand, Fed WANTS inflation to save the housing market and all the USA debtors.
  5. There could be a short war like the one between Israel/Lebanon in early 2007. I won’t bet any money on it. But the macro picture of commodity inflation, or relative lack of natural resources usually leads to wars in which precious resources are the target of grab. If such war happens, it will support both oil and gold prices.

With all of the above thoughts, here are my specific predictions:

  1. On the stock market, it will take a short fall about right now, marching even higher, and then take a big 20%+ fall probably sometimes in the first half of 2007. What’s after that really depends on how much Fed intervenes into this market. The stock market could slowly keep marching higher after the big fall, but again, on an inflation-adjusted basis, the return will be unimpressive.
  2. On the bond market, 2007 should be temporarily good, due to cutting of interest rates and potential recession. Beyond that, especially if commodity markets pick up steam, it will be terrible.
  3. On the commodity market, I’m guessing that it will be ranged bound in 2007 generally speaking. Gold may even have another dip later this year. While Wallstreet may not want to put money into the commodity stocks, it does NOT mean that the actual commodity prices will not march higher.
  4. On the real estate, the hopefuls of 2007 to be saved by the interest rate cuts will be surprised by many more new companies whose ARM mortgages reset in 2007, and cannot refinance their ways out. I believe that bond yields will refuse to go down too much due to elevated inflation rate, and a weaker $US. Same thing in 2006 will be replayed again in 2007, with inventory starts to increase in about March/April, and then all the way to October/November. Certainly, it will be different from 2006. It’s just bigger inventory all the way. That will further sack the housing price. On the other hand, rents will keep climbing higher at +6%. In 2007, people’s mood will be worse. Renters are not happy because rents are up. Home owners are not happy because the wealth effect is in the reverse gear. And more things will be more expensive as time goes on.

My sincere apology if I have depressed you. See, I truly wish that the world is a better place to live for everyone. But the world will be what it will be, and the market will do what it does, irrespective of your or my personal opinions. The world will change if collectively we all change and set it back on the right course. But before that happens, which eventually it will for certain (cycle of political activism comes AFTER lower living standards), I will make my advanced purchases of my commodity that I need in the future. Maybe it won’t do as good as a 5.25% 1-year CD (as my thought indicated, could be ranged-bound), but at least I “lock in my price for commodity” whether the price will be lower or higher, it matters less.

I highly suggest you to click on all the hyperlinks in this post to research any related topics further. I’ve pull together various sources for you if you want anything more in-depth.

Invest To Hedge For Inflation

According to the Efficient Market Hypothesis, the stocks are always fairly priced. Whatever information and news will be reflected by the stock price almost immediately. The current market capitalization of a given stock to the entire market is the best allocation percentage using all available news and information. This is the philosophy of the passive index investing.

Using the spirit of efficient market hypothesis, a person can invest to hedge inflation of his or her expenses by studying his or her expense budget. Using my budget as an example, my total expenses including property tax, but excluding income taxes and charity contribution is $3805 per month. I categorize expenses roughly into the followings (please refer to the table of my budget):

  1. Food: $360
  2. Car: $45 insurance + $40 maintanence = $85
  3. Housing: $1270 mortgage + $165 HOA + $225 property tax = $1660
  4. Communications: $16 local + $7 mobile + $20 long distance = $43
  5. Energy: $45 electricity+ $55 gas + $135 gasoline = $235
  6. Utilities: $25 water + $13 trash + $17 cable = $55
  7. Medicals: $127
  8. Travel: $220
  9. Consumer Staples/Clothing: $100 (baby) + $300 wife’s + $80 cash + $100 misc = $580
  10. Education: $440 preschool

Here is the summary table:

Expense

Amount

Percentage

Food

360

9.5%

Car

85

2.2%

Housing

1660

43.6%

Communication

43

1.1%

Energy

235

6.2%

Utilities

55

1.4%

Medicals

127

3.3%

Travels

220

5.8%

Consumer Staples

580

15.2%

Education

440

11.6%

So if I want to hedge against the inflation of my expenses, I would invest in accordingly the related industries. Of course, you may also want to consider the input factors into a particular industry along with that industry. For example, to hedge against your costs of airline tickets, you definitely want to consider the cost of gasoline energy that goes into airplanes. And for calculating your investment for housing costs, you should take out the mortgage, but do include the rent. Mortgage itself is already your investment into your own housing.At last, you don’t need to over-hedge your expenses. If you assume an operating margin of 10% (or stock return of 10%), you only need to invest $43 * 12 months / 10% = $5160 in the communication industry. If the overall revenue of communication industry grows, most likely so will your expenses and your investment profits.