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    - Interim Update 29th October 2014

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The Fed

With the Fed's infamous "tapering" now complete and its latest round of QE having ended amidst vigorous, congratulatory back-patting, the main questions -- in a world where the actions of the monetary central planners are far more important to the markets than anything else -- revolve around when and by how much the Fed will hike its targeted overnight interest rate (the Fed Funds Rate). Rather than paying attention to the opinions of various commentators and economists we think it makes sense to look to the market for answers, bearing in mind that the market's answers will vary from week to week.

The market's answers regarding the timing and extent of the coming Fed rate-hiking program are contained in the prices of Fed Funds Futures (FFF) contracts. Of these contracts, the most interesting and most useful at this time is the one that expires in December of 2015, because this contract tells us what the market expects to happen to the Fed Funds Rate next year.

The December-2015 FFF contract is currently priced at 99.475 (see chart below), which implies an average expected Fed Funds Rate of 0.525% in December of next year. This, in turn, implies that the market is expecting at least one, but no more than two, 0.25% rate hikes during the second half of next year (the current price of the July-2015 FFF contract suggests that there is almost no belief that the Fed will start hiking the Funds Rate prior to the middle of next year). This expectation didn't change by much after the latest FOMC statement was released on Wednesday 29th October, as the implied expected Fed Funds Rate in December of next year was about 0.45% at the close of trading the previous day.



The market's belief that there will be only one or two 0.25% rate hikes between now and the end of next year is consistent with the Funds Rate guidance emanating from the Fed's leadership, but is at odds with the economy-related commentary of the Fed and almost all mainstream analysts, economists and other pundits. The popular view is that the US economy is doing fine and is likely to get even better, but if this is true then why is Zero Interest Rate Policy (ZIRP) still in place and predicted to remain in place for at least another 12 months? A good economist would, of course, understand that ZIRP cannot do anything other than hurt the economy (at its core it is nothing more than a means of transferring wealth from savers and the productive elements within the economy to financial institutions and carry-trading speculators), but most people and all senior representatives of the Fed believe that it helps to support a weak economy. Therefore, the pertinent question is: If it is true that the US economy is no longer weak, then why is ZIRP still expected to remain in place for a "considerable time"?

Euro-Zone and G2 Monetary Inflation

The ECB snapped into action this week and published euro-zone money-supply figures for September. According to these figures and as illustrated by the following chart, euro-zone TMS (True Money Supply) rose by 6.4% over the 12-month period ending 30th September 2014. This is 2014's highest year-over-year (YOY) growth rate and makes a mockery of the deflation fear being expressed by financial journalists and the ECB itself, but is roughly unchanged from where it was a year ago.

At a time when private and public sector debt is at dangerous levels a 6.4% monetary inflation rate might not be high enough to generate the "price inflation" that Mario Draghi and most other Keynesians mistakenly believe is needed, but the euro-zone is presently not close to genuine deflation.



With September figures now in hand for the euro-zone we have been able to update our chart showing the G2 (US plus euro-zone) monetary inflation rate. The result is displayed below.

As a leading indicator of major economic trend changes and/or global financial crises, the G2 monetary inflation rate has been more reliable than the US and euro-zone monetary inflation rates in isolation. The G2 monetary inflation rate has flat-lined at around 7% over the past year, which is not far from its lows of the past 5 years but is still a few percent above the levels that preceded the 2000-2002 and 2007-2008 crises. All things considered, we would take a decline to below 6% as a clear-cut warning of impending crisis.

The Stock Market

US consumer confidence hits a multi-year high

A 29th October Bloomberg article contained the following comments on the latest Consumer Confidence number:

"Consumer confidence advanced in October as Americans enjoyed further price drops at the gas pump and the job market continued to improve. The Conference Board's index climbed to 94.5 this month, the highest since October 2007, from a September reading of 89 that was stronger than initially estimated.

"The consumer confidence index was really big as everybody's been concerned about what the pullback in the stock market means for holiday spending," John De Clue, the Minneapolis-based chief investment officer for the Private Client Reserve of US Bank, said in a phone interview. "When you approach this time of year you're looking at a wall of money to be spent or not spent, and it looks like now the fall in gasoline prices is going to offset that.
"

So, according to John De Clue* it's good news that consumer confidence in October of 2014 is as high as it was way back in October of 2007. Has he forgotten that in October-2007 the US stock market was at a major peak and the US economy was within two months of entering an official recession?

Like most other indicators of the general public's sentiment, consumer confidence is a contrary indicator at extremes. Confidence is always very high at important peaks for the economy and the stock market, and confidence is always very low at important bottoms for the economy and the stock market. While a high level of confidence doesn't guarantee an important peak, it is a prerequisite for one.

    *It was difficult, but we resisted the temptation to make fun of this name.

NYSE margin debt remains below its February peak

The NYSE margin debt figures are always published with a lag of about one month, which is why the September figures have only just been published. The latest figures show that although margin debt rose by a smidgen in September, it remains 0.4% below the all-time high reached in February of this year. Given that major peaks in margin debt have a history of occurring prior to major peaks in the stock market, the fact that NYSE margin debt hasn't yet exceeded its February-2014 high is consistent with the possibility that a major stock market peak occurred in September. By the same token, if NYSE margin debt were to exceed its February high it would be a sign that the equity bull market probably had at least a few months to run.

The relationship between margin debt and the stock market is discussed in the article posted HERE. The following chart was taken from this article.



In broad terms, the relationship between margin debt and the stock market can be worded as follows: Regardless of how much leverage there is, everything will appear to be fine as long as leverage continues to increase.

Current Market Situation

The US stock market's rebound continued over the past three days, in the process enabling the S&P500 Index (SPX) to get within 1% of its 18th September closing high and the NASDAQ100 Index (NDX) to test its September high (see chart below). The NDX looks set to make a new high for the year, but ideally -- as far as our outlook is concerned -- a new high in the NDX will not be confirmed by new highs in the SPX or the Dow Industrials.



An important SPX level to watch over the next two days is the September closing price of 1972. An October close above 1972 would be evidence that the September-October decline was a bull-market correction and not the start of a bear market. The SPX closed at 1982 on Wednesday 29th October.

Regardless of whether we are dealing with a bull-market correction or the first stage of a new bear market, a short-term top is likely within the coming seven trading days and a test of the October low is likely within the next month. Consequently, we consider the next several days to be the optimum time to be establishing or adding to bearish speculations such as SSO put options.


Gold and the Dollar

Gold

The US$ gold price reversed lower after reaching its 50-day MA last week. The decline accelerated on Wednesday of this week after a few positive words on the US economy in the latest FOMC statement prompted the liquidation of some speculative long positions in the gold market.

Gold appears to be headed for another test of support at $1180. Almost everyone expects that this support will soon give way, which actually makes it more likely that the support will continue to hold for now. That being said, quadruple bottoms are even rarer than triple bottoms, so another successful test of the $1180 support level within the coming several days would increase the probability that this support will be breached next year.



Gold Stocks

Tax-related selling pressure affects junior stocks more than senior stocks. There is evidence in the price action that the first round of tax-related selling pressure in the gold sector ended on Monday 27th October.

Evidence of tax-loss selling was apparent on Monday, when a 0.5% decline in the gold price was accompanied by a 4.5% decline in GDXJ and a relatively minor 1.3% decline in the HUI. That Monday was probably the final day of the first round of tax-loss selling became apparent on Tuesday, when a flat gold price was accompanied by a 4.2% rise in GDXJ and a 1.7% rise in the HUI. GDXJ was down a hefty 7% on Wednesday, but this was due to a mini-panic out of all things gold-related.

The first round of tax-related selling pressure stems from 31st October being the financial year end for many hedge and mutual funds. The second and final round will occur in December due to retail investors in the US and Canada taking losses ahead of their 31st December financial year end.

The HUI is working on its 9th down-week in a row. As mentioned in the latest Weekly Update, this means that the HUI is now so oversold that all it will take to signal a reversal is a daily close above the 20-day MA (the blue line on the following chart). Over the remainder of this week, that means a daily close above 190.



The Currency Market

In the last two TSI commentaries we noted that the Dollar Index had improved its chances of making a marginal new high (in the 87-88 range) before ending its short-term upward trend. There was a further increase in the probability of such an outcome on Wednesday 29th October, with the Dollar Index moving up to minor resistance at 86 and our preferred measure of US equities relative to European equities rising to a new high for the year.

Next week is shaping up as a likely time for short-term reversals in multiple markets, including the currency market. Specifically, next week is shaping up as a likely time for short-term highs in the Dollar Index and the US stock market, and short-term lows in gold, the gold-mining sector, the T-Bond and the euro.

Updates on Stock Selections

Notes: 1) To review the complete list of current TSI stock selections, logon at http://www.speculative-investor.com/new/market_logon.asp and then click on "Stock Selections" in the menu. When at the Stock Selections page, click on a stock's symbol to bring-up an archive of our comments on the stock in question. 2) The Small Stock Watch List is located at http://www.speculative-investor.com/new/smallstockwatch.html

Chart Sources

Charts appearing in today's commentary are courtesy of:

http://stockcharts.com/index.html
http://www.barchart.com/

 
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