Converging Crossroads

It seemed at that time as if the whole nation had turned stockjobbers. Exchange Alley was every day blocked up by crowds, and Cornhill was impassable for the number of carriages. Everybody came to purchase stock. "Every fool aspired to be a knave." In the words of a ballad, published at the time, and sung about the streets, ["A South Sea Ballad; or, Merry Remarks upon Exchange Alley Bubbles. To a new tune, called ' The Grand Elixir; or, the Philosopher's Stone Discovered.'"] Then stars and garters did appear Among the meaner rabble; To buy and sell, to see and hear, The Jews and Gentiles squabble. The greatest ladies thither came, And plied in chariots daily, Or pawned their jewels for a sum To venture in the Alley. The inordinate thirst of gain that had afflicted all ranks of society, was not to be slaked even in the South Sea. Other schemes, of the most extravagant kind, were started. The share-lists were speedily filled up, and an enormous traffic carried on in shares, while, of course, every means were resorted to, to raise them to an artificial value in the market - The South Sea Bubble, from Extraordinary Popular Delusions and the Madness of Crowds, Charles MacKay, 1841

Maybe there'll be a day when historians write about today and make vague reference to all of the various bubble sites, bubble broadcasters, and bubble heads. It's so hard to see things for what they are at times when the nation is engaged in delusion. That's what I learned from the book. Commentary like the example below may seem knowledgeable today, but in hindsight I doubt it:

Low interest rates played a huge part in lessening the impact of the recession. Now that the economy is expanding, some worry that higher interest rates may also lessen the benefits of the recovery - 19 April 2002, Dismal-Scientist.com.

It is still not discernible to what extent the interest rate may have been too low, and to what extent the impact of the recession has yet to be felt as a consequence. If it were too low, over-consumption would result at the expense of savings, which would result in new economic dislocations for the market system to contend with.

Here is the correct way to say what the above economist tried to say:

Low interest rates played a huge part in re-inflating the aggregates, by inducing the consumer to borrow more from his future wages and allowing the government room to expand its large debt burden. Now that the aggregates are inflated, some worry that profits won't follow, or that it won't matter they do - Ed Bugos.

Let both of those comments stand the test of time.

Dollar volatility should continue on Forex markets this week and the bond market will have to brace for reports on durable goods orders and housing activity in the US for the month of March, as well as a preliminary estimate for first quarter GDP.

The US dollar had a rough last week, finishing off against all of the currencies over the past five days, including gold. The dollar index put in a lower low in the three-month downtrend that began in February, and came within half a point of breaking what we view as bullish intermediate trend support at 116 (see chart below).

Since landing at the week's low in Thursday's session, the dollar was only able to bounce against gold and yen by Friday.

Gold had 2 down days last week. The first was on Tuesday when the Dow put in a 200-point rally, and the second was on Friday when the dollar rose against the yen. Generally though, gold prices gained only a point against the dollar.

The weakness in yen at the end of the week was reportedly related to expectations it will be talked down by Japanese authorities this week after the G7. The IMF and the Treasury had been jabbing at the Japanese through the press by Friday, specifically, they said Japan's government has to borrow more and its bank has to inflate more. The Japanese fought that claim prior to the G7.

At the time of writing the G7 has finished and there was nothing in the communiqué about the yen or otherwise related to the pre-G7 banter in the media, but the press has already gone to work. Reuters' take is that since there was no public backing of Japan's proposal to cut taxes in June, or for its plans to clean up Japanese banks' non-performing loans, the yen would naturally lose value now, since it needed the rest of the developed world to corroborate the credibility of its plan.

That is the bearish argument for yen. Because the world doesn't approve of Japan's policies the yen should fall in value. Unfortunately, the world is awash in dollars, not yen. The bearish argument for yen also assumes more downside for the economy in Japan than in the United States. This argument has been discounted several times over by the market already.

What the market hasn't discounted is the possibility (probability) that there is more downside in US markets today than in Japan. Nor has the market factored the difference in foreign holdings of government bonds and other liquid assets. And it certainly hasn't even begun to consider that a new bull market in the Nikkei could be around the corner. Yup, the perfect recipe for a surprise reversal in the Yen.

Still, I expect to hear post-G7 comments by politicians through the press in coming weeks that will continue to reflect the West's unhappiness with Japan's policies, and especially as the yen continues to rise. Threats will be made how a rising yen will be bad for the Japanese and world economy. Meanwhile, the rising yen will likely occur coincident with a rising Nikkei, which will be a prosperous development for Japan, at least in the medium term.

However, technically, while the dollar has been moving to its breakdown level, it has yet to break down. This week's economic news could either turn out to be just bad enough to do the trick, or it could be good enough to recover some bullish sentiment in the dollar. The stock market is an enormous factor. The bulls have been able to hold on to Tuesday's stock market gains (this is written just prior to Monday's down day), but outside of Johnson & Johnson as well as GM on the surface, the other Dow components (half of the Dow has reported now) have reported rather poor earnings news for the first quarter.

The broader market starts to report this week, and we expect Dupont, Disney, AT&T, and 3M to report for the Dow. 3M recently upgraded the street's expectations, which is apparent in the performance of its shares since and before then. 3M is scheduled to report before the others, so the bulls may set the tone by tomorrow. Unless the good news is already factored into the share price, which it could be after a 25% gain so far in the new year, at 34 times trailing earnings and 22 times forecast 2003 earnings. 3M shares have been one of the Dow's best supporters since the bear market began in 2000.

If bulls can take out last week's high on the S&P (1133) they'll have reversed the run on stock prices that began mid-March. On the Dow, that resistance figure is 10400, which is the prior week's high, or the last lowest high in the five week down trending sequence. There is little reason to suspect that they'll accomplish anything but a run at those levels, and perhaps marginally through them at best.

Threatening their confidence, besides the bad earnings news from WorldCom and Ericsson on Monday morning, or the prospect of a yawn at 3M's earnings news, is that several Dow components are still swimming in deteriorating technicals, such as Boeing, Citigroup, GE, Honeywell, Microsoft, SBC Communications, AT&T, Wal-Mart, and United Technologies. Outside of the latter 2, the rest are already in established bear markets. Both Wal-Mart and Home Depot have been weak in recent weeks, and the durable goods report due this week could set the tone in the retailers just ahead of their reports expected by late May. In that sense, the fate of the retailer's shares and the dollar are probably intertwined this week. In fact, this morning (Monday) Wal-Mart is down a good chunk of change ahead of the durable goods number.

Pushing bull's confidence along besides the promotion of 3M's upcoming quarter, is bullish momentum in American Express, Disney, GM, Johnson & Johnson, Coke, McDonalds, Morris, and would you believe JP Morgan shares have been making a comeback. To be sure, I'm not sure whether that's bullish or bearish because there's lots of resistance at these prices for the stock. However, analysts expect the company to earn almost $3/share by the end of 2002, which would essentially represent a recovery of the last decade's earnings power.

But I would be very cautious about buying any bank stock (let alone this one) when the broader market is likely to take a turn for the worse, along with the dollar and interest rates. Their forecasts could all easily be, well, lowered.

A potentially bullish factor for gold in coming weeks is that China plans to open its 1st ever gold exchange in May. The country's foreign exchange reserves have swelled with dollars in recent years and they're confidence in the Yuan appears to be on the rise.

In other words, they may prefer to redeem some of those dollars in gold rather than support the Yuan.

In the short term, the gold market is probably going to continue to be sensitively averse to any bullish winds for global share markets or the dollar. A break through 116 on the dollar index could be enough to send gold prices through $312, however, while 108, or last year's low on the dollar index, would send them into orbit.

We've reached a point where gold prices and the dollar are both threatening primary reversals, in opposite directions of course, on the long term charts. The momentum has overall been shifting, and continues to, in favor of gold, right up until last week, and despite Reg Howe's honorable defeat (or so it seems) against the BIS et al, as of last week.

I suspect the break out will come just as the dollar index caves through those levels (as mentioned above). Gold shares have already been simmering in anticipation, but they too have refused to continue their advance beyond the higher high made in most of the indexes last month.

As you know, however, it isn't just gold and the dollar that have reached a cross roads, technically. So has the bond, which has been threatening to break down out of a one-year top, and oil prices, which now threaten to bust out of a 16 month bear market.

Not to mention the CRB, that is consolidating this year's gains near the last lowest high in its one-year intermediate downtrend - a reversal point. A break out above early April's high is all that it would take to set in motion, or confirm, a new bull market in commodities.

Outside of any Yen machinations or upside earnings surprises this week, we continue to see general equity weakness undermining the investment premium on the US dollar, and aggravating pent up inflation imbalances in the US economy. Moreover, we continue to favor the yen as the currency most likely to surprise investors in the weeks ahead, on the upside, along with gold.

That's how we're reading the markets this week.