States Facing Deficits in 2010

1. Washington – The state tax collections for Washington is said to be down again. Thus, the state’s budget deficit is said to have increased by about $1 billion. According to the new revenue forecast, it is said that the state will get about $810 million less than what was previously hoped for the next state budget. It has also been said that it will take some time to recover from this situation.

2. California – California perhaps symbolizes the budget crisis because of the massive shortfall that it has faced and the measures the state has been forced to take like worker layoffs and reduction of aids to the university, massive cuts on education and social services. In the last year the state is said to have gone through about $6 billion budget gap. Moreover according to the assumption of the state’s Legislative Analyst’s Office the state may have to face about $20.7 billion budget gap during the next budget.

3. New Jersey – According to reports this state is going to have the third-highest budget shortfall for the financial year 2011, the first two being Nevada and Arizona. There have already been $800 million cuts in the budget. In addition to this, the state’s unemployment fund will have to face about $1.2 billion deficit. This, it is assumed will trigger an increase in tax on the employers.

4. Arizona – Just like California, Arizona too is one of the worse hit states facing mostly the housing crisis. As per the lawmakers, there has been a 30 percent budget gap in this state in the current year.

5. New York – New York is already said to have faced $3 billion budget deficit, which is expected to double by the next fiscal period. As a result Gov. David Paterson delayed payments to schools, hospitals, and cities so as to keep the State finances above water.

Effect of Home Sales on State Budgets

According to the Bureau of Economic Analysis (NAR) in 2009 the median priced home in Washington and California was $336,400 and $548,700 respectively, and the income derived from the sale of a home was $94,748 and $149,564 respectively. In New Jersey the income generated from the real estate industry was $32,463. The median priced home in this state was $360,700 and the income derived was $101,022. The median priced home in New York was $229,100 and the income was $66,785. In Arizona and Nevada the median priced home was $253,600 and $301,100 respectively and the total income derived was $73,369 and $85,633 respectively. However, with the decline in home sales the income of the states too has dropped; negatively affecting state budgets’ top line.

As a result of the deficit, state revenues continue to subside, which will very quickly trickle down to hardships for public employees and a negative consumer demand shift in months to come. In order to cope with this problem, states will have to modernize their revenue system and increase interstate cooperation, but the issues tied to lower revenues may be impossible to ail until employment and consumer demand make sizeable recoveries.

This was a guest post by Jason Holmes. He is a regular writer with Debt Consolidation Care (http://www.debtconsolidationcare.com/) and is also a contributory writer with other financial sites.

The War On Credit

In 1940 America the War had been felt only in reminiscent ripples, by “tweets” on telegraph receivers and two week old newspapers.  Pearl harbor still stood strong and broad on O’ahu’s South Face, while mothers and wives hung close to those on which they’d grown to depend.

Not so dissimilar from those days, we now face threats that only quietly whisper their motives from Asia and Europe. Constructed by years of fiscal white lies and monetary insanity, the body bags have yet to be filled. Municipal governments in China still depend on increasing real estate values, while European banks holding large debts of failing Southeastern states still stand. The United States Economy has “recovered faster than anyone could have imagined” and the S&P 500 at one time had nearly doubled from it’s lows. But still the whispers; 10 year U.S. Treasuries nearing 3% yields, LIBOR trending higher, market technicals showing a shift towards negative confidence, and this weeks economic data hanging in the balance…

Quintessential Indicators

This week is a pivotal moment for the global economy for many reasons, not the least of which are the developing technicals of the S&P 500 (SPX).  Take a look at the QUINTESSENTIAL CHART, THE MEANING OF LIFE, THE TRUTH OF YOUR VERY EXISTANCE below…

Economic Data

In economic news this week we have an immense block of information set to hit the street. Monday we saw that incomes rose by 0.4% in May and consumer spending turned higher by 0.2%. The consumer spending portion was an upside surprise, but it was mostly in the auto sector which tends to be volatile.

Tuesday we’ll get consumer confidence which is expected to stay constant at 63.3, while Wednesday will focus on Chicago PMI, the EIA Petroleum Report, and MBA Mortgage Applications. We’ll be watching the PMI for signs from Midwest manufacturers and the EIA report for signs of further dry storage supply increases. EIA may be fighting tropical depression Alex over traction in the Crude Oil space.

Look for a volatile morning session on Thursday as the Initial Claims , ISM Manufacturing, Construction Spending, and Pending Home Sales reports cross tickers. ISM is expected to drop to 67.0 in the June reading and Construction Spending projected to fall from a 2.7% gain to 0.5% loss in May. Initial claims will be closely watched for signals on the heels of the ADP report from Wednesday; all in preparation for the May Employment situation report on Friday. Also due on the final day of trading this week, will be the Factory Orders report at 10:00 am, which should set the tone for the final hours of trading ahead of the weekend.

Remember it’s all about the S&P 500 (SPX) until we say so! Stay vigilant and nimble. We see this market on the edge of further downward momentum. There is a battle just over the horizon and bombs may well fall when we least expect it. To those prepared and those forewarned…

“Good night and good luck.”

Refer to our twitter and rss feeds by clicking on the links in this sentence to see how you can stay in the loop whenever DS makes trades or publishes analysis.

It’s no secret that the entire China Renminbi “de-peg” issue, as defined by the U.S. White House, Obama, and “Tiny Tim” Geithner, was a complete sideshow to draw attention from domestic financial policy that has carved a handsome crevasse into the foundation of our country, formerly referred to with common adjectives such as “strong”, “unwavering”, and “solvent”. The currency was pegged to our currency and if it were un-pegged it would effectively levy a major tax on all of the American families who have traded down from Whole Foods to Wall Mart as we learn to live on fewer incomes and more humiliating job titles. Why is that Rob? Well sports fans the equation is simple: Cheaper goods = Chinese goods. The single and solitary reason that President Obama and Treasury Secretary Geithner had any stance on the issue, was due to European pressure to hard-line China into a gentle revaluation to make German goods more able to compete. And now that the Euro is nearing 1 to 1 parity with the USD, it seems that all is well in Whoville…

Well not quite, because now that no one cares China has played it’s middle child syndrome role to a “t” and obeyed the oldest son’s sustained pleas. Sure the Yuan will revalue, but apparently it will be capped around +1.5% in 2010, and still managed by central China. So is a managed float really a float? Well is a bear Catholic? Not really… in fact they don’t really belong in the same sentence. Exactly.

So sure the second largest economy in the world suddenly feels the need to float it’s currency because it runs a major current account surplus and is ending it’s stimulus fueled domestic spending; which would force it’s currency higher, or in the case of a pegged currency, keep exports competitive but cause inflation to run rampant as prices increase and wages stay stagnant. Make no mistake, China may be a middle child but they made the de-peg decision for themselves and it means nothing to the economic recovery there or anywhere in the World. Still, we’ll probably see some self proclaimed credit groping out of Washington in the near future by idiots who have no idea how to spell current account surplus, much less the name of the intern who wrote the speech they delivered on the subject. (Of course, that’s only after they zip up from railing the heads of global Petroleum giants.) This is why markets rallied early as bulls shot blanks, meant to be live rounds, over the bow of U.S.S. Permabear but ended in negative territory.

This week we’re going to see some serious pain from the housing reports on Tuesday and Wednesday where economists expect a rise to 6.2 million and a fall to 400,000 annual units in the Existing and New Home sales reports, respectively.

We’re getting towards the middle of 2010, and eventually we’re going to have to hear something from Bernanke to prep markets for the inevitable day when the U.S. economy has to sell the xbox, leave the parents’ basement, and in the words of a wise man, “get a job sir!” Many of us forget what it means for the large financial institutions that manage our cash to actually pay interest on borrowed money, but the day will soon arrive. The same folks who approved all of the crappy mortgages that you didn’t pay, because you didn’t actually make what you wrote on the application, are going to have to start paying their own rent as well. Yes, the event I’m so jovially alluding to is the Fed Funds Rate announcement from the Federal Reserve, and we’ll hear it on Wednesday.

Otherwise this week is going to be in the hands of the traders. Lucky for you, you’re reading this so you’ll have a jump on that as well. Check out the chart below for a look at the S&P 500 (SPX)… THE ONE AND ONLY QUINTESSENTIAL CHART NECESSARY FOR ANY EQUITY TRADES UNTIL WE SAY SO!

As regular readers know, we endorsed “short” positions relative to the S&P 500 and Crude Oil and a “long” call on the VIX following our proprietary trades to open said positions on Friday, May 28. As you can tell from the chart above, we called the next leg down to new six month lows correctly, but sentiment reversed and we called for investors to exit positions before the next big leg up on June 10.

I’m going back on the line now to call a true and magnanimous move lower on the S&P 500. Sentiment is waning as the truly negative effects of a floating Renminbi are becoming realized ahead of two sure to be nasty reports this week on the U.S. housing market. The MACD histogram (blue bar chart below main chart) has peaked, RSI is back above 50 and out of “oversold” territory for the first time since May 1st, and the SPX has followed a string of anemic trading sessions with a hugely volatile Monday session that ultimately ended lower.

Normally, we like to use the “simple moving average” (SMA) to chart trendlines for resistance and support of prices, but due to a drastic sentiment shift we’re more comfortable with the “exponential moving average” (EMA) trendlines, as seen in Green (200 day) and Red (50 day) above. The 200 EMA and 50 EMA have both served as resistance  and are nearing a bearish cross amid the slew of other red flags facing the U.S. equity market.

Take 5 minutes and look into SDS (UltraShort S&P 500), DTO (UltraShort Crude Oil), and VXX (Short Term VIX). We like using www.stockcharts.com to chart these vehicles and suggest our readers use it as well. It’s free and has a lot of technical indicators for your convenience. (And no we’re not even getting a cut for that plug, it’s just a solid chart service…)

Stay vigilant and keep stops tight if you want to dabble at these levels… For the record, we are most certainly dabbling in those very names as of this morning. Be sure to stay current on all of our positions and trading moves with our free Twitter service that tracks DS Lead Analyst Robert Eberenz’s trades in real time by clicking on the follow button under the DS_Shoutbox tweets in the right sidebar…

Fingers on the trigger boys!

Factors Affecting WTI Spots

The BP Gulf spill, gasoline demand reaching 3.5% yoy, prices at the pump at $3.00, refinery capacity above 89%, Cushing, OK crude storage dwindling to 14 million barrels, tankers holding countless barrels off the coast, OPEC members breaking quota, unrest in Iran, and sovereign default contagion in Europe have been on the radar of “black gold” speculators for the past two months. These realities are the extension of maturing trends over the range bound past two months, but only one has significantly altered WTI Crude prices. A casual deduction might blame oil’s price destruction on a stronger Dollar, due to the recent flight from all things Euro. Contrarily, we see default risks in the EU and retrenching speculation creating the vacuum through which industrial commodity prices, most notably Oil, will fall.

WTI Continuous Crude Oil Spot Chart

In January we correctly called a bearish trend reversal in Crude Oil prices and predicted the fall to $70 / barrel. Our prediction seemed far fetched at the time, while Crude was trading near $80, but we were right then in identifying the speculative forces surrounding crude oil. Now discounting for newly developed sovereign default risks in the EU and the effects of a plummeting Euro on the price of all industrial commodities, we foresee a very similar reversal the second time around.

Technicals

The MACD peaks have continued along the negative sloping trend line, congruent with a bearish wedge reversal, while recent events regarding the Greece bailout have had direct impacts on the price of the WTI continuous Crude Oil spot price. In April, the WTI spot reached the $87 mark in intra-day trading three times, but each time closed lower and weaker than the last. The Relative Strength Index (RSI) now reads below the neutral 50 mark, suggesting that momentum has reversed and bearish sentiment is now leading prices.

Greek Contagion

Wedensday, April 28 through Friday, April 30, Crude Oil climbed near it’s yearly high of $87 on rumors that led to PM Papandreou accepting a 110 billion Euro bailout from the EU on Monday, May 3. On Monday, the price of crude again reached it’s $87 high intra-day, before closing just above $86.

Greek Bond Spreads to German Bunds, 2yr & 10yr Maturities (April 22, 2010)

So why did crude oil sell off in the wake of this “stability” in the EU? We would argue that the situation surrounding the Greek debt crisis is now anything from stable, and has in fact grown to an unstable monster that could drown much more than just Oil and EU stocks. We don’t claim to have any inside edge on the contagion risks of defaults in the EU, but we do trust a certain Mohamad El-Erian, of PIMCO’s total return bond fund, the largest bond fund in the world. El-Erian appropriately warns, “it is far from assured that this program will forcefully counter contagion risk,” as seen in the recent chart (left), compliments of Business Insider. In the time since this chart was built Greek yields have rocketed even higher, where on May 5, 2010, Greek 1o yr spreads over German Bunds rose to above 700 bps, putting the headline yield on Greek 10 yr bonds above 10.5%.

Austerity measures in the form of  pension reductions, bonus cancellations, and job cuts are planned to cut Greece’s budget by 13 billion Euros, in exchange for EU loans at 5%.  Naturally, markets don’t like the deal, since the EU is absolving Greece’s bad debt at a loss, where the interest on the loan to Greece is half that of the market yield for 10 yr debts.

So how are the Greeks taking the medicine? We’ll let you judge for yourself in this week’s DS Video, compliments of CNBC, covering the the budget cut protests.

The Future of Crude

At this point it isn’t crucial that the EU break up for Crude Oil to fall to $70 or below. 2010 gasoline demand is trending towards 3.5% as prices at the pump average above $3/gallon in the U.S., but leading indicators seem to be topping, as the ISM non-manufacturing new orders component trended lower and retail sales are narrowing closer to 2% yoy for April. The past 12 months have been an atmosphere of loose money and speculation, while globally growth has recovered due to stimulus packages and corporate spending supported by higher equity valuations. All in all, we see global energy demand near it’s peak, given (Quantitative Easing) QE cooling in China and European weakness due to Euro-zone cost cutting.

Our analysis supports the position that Crude Oil spot prices still reflect a great deal of recovery linked speculative forces. Further, moderate gains in demand for crude and distillates are countered by the bulging supply of U.S. inventory and OPEC member countries producing above quotas, partially to fund stimuli plans and state bailouts of their own (e.g. Dubai World).

The only recent game changer for Crude Oil has been Greece and the ensuing sovereign default contagion risk. We are playing this risk using crude oil, because the volatility allows for large price swings to capture gains with positive correlation to the situation in Europe. Finally, the ceiling for WTI spot prices is a firm resistance level ($87), and therefore much safer than the erratic behavior of direct EU crisis plays (e.g. Greece, Spain, Portugal Bonds, the Euro, Euro Equities, etc.). Specifically we like DTO (Powershares DB Double Short Crude Oil ETN), since it’s generally liquid enough for our taste (500k-1 million volume/day), and tracks -2x the WTI Crude Continuous Spot.

Disclosure: Long DTO Over the Next 2-4 Weeks

In short, the charts are begging for a pullback in every equity index from the S&P 500 to the German DAX, but earnings and economic indicators are giving no reason to sell. Most analysts agree that the good news is mostly baked in to the run up in stocks, but sellers have left the building and buyers keep coming out of the woodwork.

The saying goes, “all good things do come to an end,” but this time it’s difficult to find a bear argument anywhere. We have been negative on the market for most of this year due to a series of long term issues facing the global market (e.g. rising interest rates, sovereign defaults, and asset bubbles in China), but this orgy will continue until the data gives it a reason to stop.

Here we’d like to focus on a few indicators related to the S&P 500 that will show just how over-bought markets are, and why investors should be taking profits at these levels. (See chart below…)

SPX 6 month chart, including RSI, MACD, Bollinger Bands, 50 day SMA, 200 day SMA

First, let’s begin with the RSI, or Relative Strength Index, which acts as a price momentum metric, and is marked by the blue circle at the top right of the chart. If the RSI is above 70 or below 30, the underlying instrument is said to be “overbought” or “oversold”. The RSI is currently at 78.29, well above the “overbought” mark, and is effectively higher than at any point over the last year. What’s more interesting, is that when you compare the absolute value of the RSI gap above and below the 70 and 30 levels, the RSI is farthest from 50 during any point in the sell-off as well. The most “oversold” day of the market crash in October 2008, according to the RSI, was on October 10, 2008, where the RSI closed at 22.88, or 7.18 below the crucial level of 30.

As we all know October 10 was not the end of the selling  during the bear trend, so the 78.29 RSI on Wednesday may not spell out a peak in this bull cycle, but it puts the stock rally in perspective. It is important to note that the RSI met similarly high levels in January and November of 2004, during the last recession’s recovery. Still, the S&P 500  recovered the %20 from 1000 to 1200 over a period of 18 months in 2004-2005, rather than the recent 9 month recovery over the same span.

Turning to the Bollinger Bands, represented by the green lines above and below the price chart, we can again see a technical signal of an over-excited market. The Bollinger Bands, developed by John Bollinger, show the range of two standard deviations above and below the 20 day simple moving average of the underlying security. Traditionally prices move within these bands and many times change directions when they near the two standard deviation border in either positive or negative territory. Recently the SPX has risen precipitously along the lines of the upper band and on Wednesday closed outside the upper band. While this can occur and not signal a major trend shift, as in mid February on the downside, it is a mark of extreme irrationality for a close to occur outside the bands at the end of a long and sustained trend.

Saving the simplest observation for last, the price of the SPX above it’s respective 50 and 200 day simple moving averages (SMA) is unsustainable and congruent with other short term peaks during the current bull cycle, and until the pullback in February, the S&P 500 had closed below it’s 50 day moving average only briefly before charging higher. These two facts combined tell us that the rally has shown weakness when negative news presents itself, and that during periods of overwhelming optimism the prices have generally moved above their moving averages by magnitudes similar to now. The SPX is trading 6.5% above it’s 50 day SMA and 12.9% above the 200 day SMA, and has traded above these magnitudes above trend for nearly 30 days.

All three of these technical observations are evidence of strength in the S&P 500 and large cap U.S. stocks, but should also beckon reason for concern. Short term developments may yet sustain the unprecedented rally in equities, yet the realization of rising interest rates, further uncertainty via European insolvency, and outlandish imballances in Chinese fiscal policy will serve as negative catalysts to sentiment in the U.S. and abroad. Take this chance to survey the risks facing your portfolio as markets forge ahead towards thinner ice and greater imbalance.

“That will never happen to this country.”

- Timothy Geitner in response to suggestions that the U.S. Treasury may one day lose its Aaa credit rating.

Perhaps inspired by Niall Ferguson’s dramatic Financial Times piece, “A Greek Crisis Coming To America“, we see today as a prime opportunity to recap our short U.S. Long Term Treasury position and share our argument for why you should buy more TYO (Direxion 3x Bear U.S. 10 Year Treasury ETN).

It’s not every day you hear about nations going belly up, yet this “new normal”, coined early on by PIMCO’s bond master Bill Gross, has even professional analysts spinning deep under water and starving for air. So what is the new normal? Bill Gross claims it’s an investment environment where risk/reward relationships come back towards historical standards and where inflation eventually mucks the lions share of investors’ profits. Now, Niall Ferguson describes it as a world where the U.S. government ranks 6th on the IMF’s list of nations in need of cutting expenditures. According to the report, the United States must cut government outlays by 8.8% over the next 10 years to remain “financially stable”.

Were this the early 1980′s where the 10 year Treasury Note carried a yield near 16%, the talk of insolvency would be merely a footnote to the effective borrowing cost of the U.S. Government. However, contrary to 1981 the current 10 year yield is just shy of 3.7%, which happens to be lower than any point in any year from 1962 to 2003.

So why the low yield, why the high demand for U.S. Treasuries? The argument that treasuries have served as a safe haven from stocks doesn’t hold weight, because global equity markets have surged since March 2009. We all know about the $1.6 trillion U.S. deficit in 2009, the $2 trillion Fed balance sheet, and yesterday’s announcement of tax breaks to hiring businesses; all of which must make it more difficult for the U.S. government to pay it’s bills into the future. According to Ferguson this is just the beginning, since China, the largest holder of U.S. treasury paper, has cut T-bill purchases from 47% of the total issued in 2006 to 5% in 2010.

Who’s buying U.S. debt?

To be blunt, we don’t know. The fact is, it doesn’t really matter. No one SHOULD be buying it, so the fact that they are only increases the potential for us to profit from their ignorance. Take a glance at the TYO chart below.

As noted in the visual, TYO’s handle is sitting right at the 50 day simple moving average resistance line, which bottomed at the beginning of February for the first time. Also, the MACD in the histogram below the chart shows a “bullish” cross potentially occurring in the next couple sessions. We’re putting long term money in this vehicle, since it’s the closest thing to a sure thing.

Either (a) you don’t believe our position that U.S. debt will be devalued and that the recovery will unravel or (b) you believe everything we say. In scenario (a) stocks will do well as bonds suffer and this vehicle will at minimum retain it’s value. In scenario (b) S&P and Moody’s downgrade U.S. sovereign debt in the next two years and the recovery fails to pick up speed, causing for a exodus of money invested in all U.S. Dollar assets, especially U.S. Debt.

The choice is yours…

Happy Trading

Fundamentals

Crude supply rose by 5 million to 330 million barrels in the past two weeks, still above average market high water mark levels. Despite a large draw from the 375 million barrel supply peak in May 2009, refiners are voicing their concern by halting production capacity just above 81%. Crack spreads are increasingly narrow as weak consumer habits choke the profitability of refiners and discourage production managers from adding to the more costly finished good stockpiles (i.e. gasoline, distillates, etc.). When crack spreads rise alongside prices, refiners benefit from higher gas prices by increasing their margins. However, stagnating crack spreads near all time lows signals weaker consumer demand for final petroleum products, forcing refiners into slowing production to keep spreads at current levels. In short, higher oil prices are hurting refiners and consumers in an environment where end demand for energy is not responsible for price gains.

Graph of brent crude oil spot price vs. European gas - oil crack spread, January 2010

International Energy Agency (IEA) World Oil Demand

The fundamental global price function of supply and demand should be respected, but IEA have recently been misstated by oil hawks. The International Energy Agency has predicted global demand for oil to begin at 86 million barrels per day (mb/d) in Q1 2010 and finish Q4 near 87 mb/d. While these estimates may have risen from earlier expectations for weaker demand, the upward price momentum has been baked into stocks.

IEA Wolrd Oil Supply 2010

The 2010 mean demand estimate of 86.3 mb/d compared to December global supply of 86.2 mb/d, on an unexpected rise of 270 kb/d, suggests that supply is gaining while demand growth, rooted in non-OECD developing Asian countries, is less than stable. Also important are upside supply surprises from the OPEC 12, which prove that there are incentives for the cartel member states to raise production levels at these prices.

Sentiment

Rooted in U.S. equity values lie traders’ economic sentiment. Crude oil prices are historically volatile during periods of uncertainty, where the commodity reflects market participants’ confidence in the economy as a whole. Bullish sentiment has been on the rise for much of the previous year, as traders have been talking up the potential for crude to hit $90 per barrel. This optimism has been rooted in the manufacturing expansion in the second half of 2009, GDP expansion in Q3 and expectations of expansion in Q4, and global demand upgrades by the IEA mentioned above. Though mainly, there is the $144 per barrel price hemorrhage of July 2008 fresh in traders’ minds and expectations for a lasting economic recovery in 2010. These factors have combined to create a short averse commodity trader’s market, where resistance levels have remained weak as rallies occur.

As you may have already guessed, we consider prices to be floating on a thick layer of froth, aided by the mentality that oil will continue a sustainable rise, despite the 130% rally from February ’09 to January ’10. The catalysts necessary to cause this confidence shift are simply the reverse arguments of price inflating factors that are now being proven overblown.

First, the manufacturing recovery has outpaced most expectations, as ISM Manufacturing Surveys show positive forward indicators of growth, inflating expectations to levels where the probability of upside surprises is greatly reduced. Second, the manufacturing sector has contributed largely to GDP expansion in Q3 and is expected to carry the U.S. economy towards +3% growth in 2010. Future disappointments from the goods producing sector would not only implicitly hurt oil, but would indirectly lower crude prices as the forecasts for broad based economic growth are revised lower. Third, the IEA estimates for Global demand for crude oil are overblown and supply is increasing more rapidly than predicted. All the while, a public announcement from China proclaimed that QE in response to the economic recession is now being reversed, causing the market’s expected rate of energy consumption to be revised lower.

Wrapping up, Q4 earnings results seem to be less positive than Q2 and Q3, where specific results from financials and transports have so far bode badly for animal spirits. Further write downs from JP Morgan (JPM) & Citi (C) on credit card defaults and foreclosures have pushed the consumer’s recovery further down the time line, while CSX Corp. (CSX) reported lower transport volume, dampening the spirits of bulls citing manufacturing growth during the period.

Technicals

While fundamental analysis and sentiment shifts are both worth pointing out, the technical support to one’s argument is always most crucial to a high conviction trade. Glance over the visual below, then we will discuss the technical signals in more detail.

West Texas Intermediate (WTI) Crude Spot Price (NYMEX Crude)

The bearish wedge pattern is a classic technical pattern, where market prices for an underlying security increase over a period of time, but growth between peaks shrinks while growth between troughs is sustained. In this cycle, the Moving Average Convergence to Divergence (MACD) graph and histogram show weakening moving average momentum, as depicted by the downward sloping trend between peaks on the MACD
sub-chart. While the wedge has been forming for some time, two further technical signals support now as the turning point for crude prices. The first signal comes from the 50 day simple moving average (sma) at $77.50, which prices broke beneath more than once in futures markets on Monday, before the WTIC closed higher at Tuesday’s close. The second and most convincing sign came when the MACD histogram broke below zero, marking a bearish cross. Had trading momentum led to higher price levels and an MACD reversal above the most recent rally peak in late October, the bearish wedge would not have formed and crude prices could have consolidated to move higher. Instead, we saw a perfect lower peaking reversal to complete the bearish wedge and seal this call.

The WTI continuous spot, charted above, closed at $79.32 on Tuesday and will allow for a better entry point for oil shorts on Wednesday. We own the PowerShares Double Short Crude Oil ETN (DTO) and added to our position at $79 dollars. The vehicle attempts to provide 2x inverse price movement compared to the WTI crude oil spot.

We are setting a price target for the WTI spot at $70, where we will take profits from our DTO position and reassess our position.

Disclosure: Long DTO

The oil issue has been speculative to this point. It's hard to argue against 90 dollar oil when we saw 145 in July 2008, but the fundamentals aren't congruent with the price growth we've seen and this trader finds it easier to argue FOR $60/ barrel oil. Crude supply in the U.S. remains high, at 330 million barrels, while gasoline demand remains week and imports are rising. Crack spreads for refiners are reflected in their output averse management of facilities, where capacity utilization rates have stagnated at 81.3%. Refiners are the effective buyers of crude and the capacity numbers are sending signals of distress. The IEA's world demand predictions for 2010 were recently raised from the current 2009 level of 84.9 Million Barrels / Day (mb/d) to nearly 87 mb/d by 2010 Q4. (It should be noted that predictions for Q4 2009 global demand at 85.5 mb/d overshot the actual level of 84.9.) Rate hikes in China this week will calm the giant and should increase the likelihood of U.S. rate hikes in the first half of 2010.

Rate hikes will cool speculative trades and pull a significant amount of upward speculation out of Crude, as they increase capital holding costs and the risk of trading on margin. Softening Chinese growth will also cool global supply and demand speculation, with respect to crude, in an equally bearish development for the commodity.

The Consumer

Earnings season may present upside risk to short positions, which is why our stops have been tightened on our SDS and SCC positions. SPX might make it's way to 1200 where a lot of traders are calling the next Fibonacci resistance level, but momentum seems to be sputtering as earnings have begun.

The December Retail Sales report showed -0.3% growth combined with the revised higher 1.8% November rate, and makes it difficult to gauge buying sentiment moving into 2010. However the negative growth in the month of Christmas will leave many scratching their heads, and suggest that energy prices are playing a bigger role in retail sales than previously thought.

All in all, crude seems to be weakening, even on the backs of solid earnings from Intel, which should have been interpreted as positive to the overall economy. In after hours trading Intel traded up around 0.8% on a 0.55 EPS report vs. 0.34 EPS expected. Granted the day saw some sour economic fundamental data from the previous mentioned reports, but the market response was weak for a 62% profit beat.

Financials

Markets are becoming tougher to surprise at these levels and we could see more weakness from the banks. Soc Generale (SCGLY.PK) had an awful quarter in France and the U.S. regional First Midwest Bancorp (FMBI) missed the -0.07 EPS consensus by 76 cents, at -0.83 EPS. If regional financial problems due to MBS and the potential for more mortgage pain continue to show their fangs, financials could sell off through earnings.

Financials are the guts of the recession and will surprise many at how fast they can lower the tide for all. JP Morgan (JPM) will answer questions in this category on Friday, where weakness from the best in breed lending giant would create malignant concern in the banking sector at large. 

Disclosure: Long SDS, Long SCC, Long DTO (see: DS Portfolio)

While Alcoa is only one company, the firm is symbolic of the U.S. manufacturing sector as a whole and it’s profits are directly affected by the prices of input commodities, primarily petroleum products and aluminum ore.  Below is a 1-year chart of the S&P 500, annotated according to AA earnings results vs. estimates. (Click chart to expand in a new window)

As shown above, the S&P 500 has rallied from the announcement of AA earnings following each of the past three quarterly announcements. The once discarded industrial giant has found new importance over the past year in financial markets as it foreshadows the industrial earning power of the U.S. The recent two quarterly results beat estimates, while the Q1 2009 results were very near the street’s consensus at the end of a period wrought with massive earnings let downs. All in all we see the first three AA quarterly results of 2009 as better than expected.

Naturally, Alcoa can’t dictate the earnings of an entire economy, but the two factors causing the firm to miss earnings will be applied to bottom lines as earnings season picks up in the following weeks. These factors were higher energy and aluminum ore costs combined a weaker U.S. Dollar. The macro economic message heard on Wall Street highlights real revenue destruction from a weaker domestic currency and the negative cost effects of higher oil.

The following two charts show the trend of these two factors of production below in the form of the USD index and the WTI Continuous contract.

Referring to the charts, the cost of petroleum based inputs to production and the devaluing of the U.S. dollar during the months of October to December 2009 are both evident. Immediately, traders and investors have begun applying heavier weights to these parameters when running their earnings models. Will this trend be the thorn in the side of earnings to bring the first season of the recovery where earnings miss more than beat estimates?

In our opinion the dollar has held it’s ground fairly well over the past month and may see a short term appreciation on interest rate concerns, while we view crude oil as overbought and due for a pullback. We follow the Moving Average Convergence Divergence technical series, as it has been highly predictive of price cycles in the many securities, mainly crude oil, over the course of the recovery, and see crude oil particularly overbought with respect to this statistic.

Whether earnings season is a make or a break for stocks relies on more than the results of just one firm, yet the manufacturing recovery story has remained the golden goose of 2009 and will not benefit from the implications derived from a negative AA earnings card.

Disclosure:

Currently we are short Crude Oil (DTO), short Consumer Services (SCC), and short the S&P 500 Index (SDS).

(By Clicking on the DS Portfolio tab in the navigation bar above, readers can follow the current portfolio held by Diamond Slice partners in real time.)

The December Non-Farm Payroll report dropped traders' jaws as if they had witnessed a clown showing up to their eight year old's birthday party slurring and cursing through rosy cheeks soaked in cheap bourbon… not a pretty picture. The news on the street last week was that non-farm payrolls could end up in positive territory for December, yet they fell 85,000 from the revised 5000 gain in November. The headline unemployment rate remained at 10.0% for the month, due to 650,000 job seekers giving up the hunt and thus decreasing the total size of the labor market. Had those 650k continued their job search, the unemployment rate would have reached 10.4%. While the U.S. equity market initially sold off in reaction to the data, the day ended in positive territory as markets continued data mining for positive news. This tells us that now may be the perfect time to start adding to your short positions… or the worst. Crude oil has hovered at a major crossroads for the last three sessions and will have to make up it's mind this week to continue a rally past its previous highs or retreat back into the $70/barrel range. Perhaps even Mr. Wizzard Blankfein is rethinking the situation heading into week 2 of 2010. 

Monday

-Demand for 3-Month and 6-MonthTreasury bills will be closely watched during the 11:30 AM auction, but debt markets will certainly wait to make a call on the day until the 10 Year TIPS bids begin flying at 1:00 PM.

-The 10-Year TIPS are "Inflation Protected Securities", which do basically what they say they do. An interest rate is derived when they are issued and the principle on the obligation is adjusted for inflation over it's life. These investments become popular with institutions and individuals during times of expected inflation and will be closely watched. The last 10 Year TIPS auction on October 5, 2009 saw the high yield at a record low of 1.510%, reflecting the record bid/cover demand ratio of 3.12. Demand for most longer maturing Treasuries has been weakening in recent auctions and may lift yields of the TIPS above the previous record low. A higher yield on the 10-Year TIPS will signal that lessened demand for treasury debt has outweighed inflation fears, while sustained low yields will argue the case of inflation hawks.

Tuesday

-Store salesreports from ICSC Goldman at 7:45 AM and Redbook at 8:55 AM will begin foreshadowing where sales are headed in the post-holiday season.

-The International Trade report at 8:30 AM is forecast to show a widened November trade deficit at -35.0 billion USD in November, from -32.9 billion USD in October, corresponding to recent reports from china that trade to and from the communist giant is improving.

-In debt markets, we will also see Treasury auctions of the 4-week Bill and 52-week Bill at 11:30 AM, and the 3-year Note at 1:00 PM.

Wednesday

-MBA Purchase Applications at 7:00 AM will start the day, as the previous 3.6.% weekly gain will be the number to beat. Last week 30 year prime mortgage rates rose to 5.18% and muted the mortgage application strength rooted in refinances, as widespread rate hike speculation intensifies.

-The EIA Petroleum Statusreport will get a lot of attention this week as oil finds its way above the high water $83/barrel mark or below the psychologically significant $80/barrel level. Distillate inventories have begun falling due to cold snaps in the U.S., while the IEA has upped OECD global consumption forecasts for 2010, supply shipments to the Cushing, OK continue to rise, and refiners keep capacity below %80. The Moving Average Convergence/Divergence technical indicator (MACD) and corresponding histogram is signaling that the price/barrel of crude will pull back from these levels, but a big draw in inventories would give the price a further boost higher.

-At 1:00 PM the 10-Year Noteauction will confirm or dis-confirm speculation that interest rates are beginning to rise with the market rate yield on the Note finding support at 3.8% as of Friday's close. We predict that coupon rate will be higher than the past two 10-Year Note auctions' 3.375% coupons, while the high yield "tail" on the auction will foreshadow demand for Thursday's 30-year Bond offering. In December the high yield tail was 3.448% compared to the 3.375% coupon, showing that demand for the debt weakened as the secondary market began trading the contracts.

-The Fed's Beige Bookwill get a lot of attention on CNBC and in headlines, as unfortunate interns pour through the minutia of economic window dressing, already released to the public through economic data reports. This report at 2:00 PM should be expected to provide an optimistic boost to U.S. markets.

-The Treasury Budget, also at 2:00 PM, is expected to show a $-92 billion deficit, down from the $-120 billion in November, and suggests that Treasury support programs may be receding. A deficit greater that $-92 billion will suggest that the Treasury is not withdrawing from support roles, as they have announced is their intention.

Thursday

-Retail Sales will steal the limelight Thursday at 8:30 AM, with a consensus estimate of 0.4% growth for December compared to a 1.3% gain in November. This is a number which could get beat, since vehicle units sold in December grew, chain stores posted gains and rising fuel prices will give a boost to the statistic. Be careful of where you stand ahead of this number if you have short positions exposed to retail names.

-Jobless claims(8:30 AM) should stabilize near the 435,000 initial claims level, according to Bloomberg economists, and will hold more significance following the surprisingly negative Non-Farm payrolls drop in December.

-Import and Export prices (8:30 AM) will add color to Tuesday's U.S. Trade Deficit report, but will mainly be watched for signs of inflation in the domestic market.

-In October, Business Inventories rose by 0.2% for the first time in 14 months, and are expected to have risen at a similar rate over the November 2009 period, in the report released at 10:00 AM. Rising inventories are a positive sign that retailers are more confident moving into a recovery cycle, but foreshadow an end to the higher profits from low inventory carrying costs.

-At 1:00 PM the most important, but perhaps least publicized, 30-Year Treasury Bond auction will commence. The pricing of this security, which is most closely tied to the 30 year Prime Mortgage rate, will define investors appetite for long term government obligations and the expectations for mortgage rates moving forward. The market priced this Bond's Yield at a recent high of 4.7% at the close on Friday, and suggests that the previous two month's 4.375% coupon at auction will be forced to rise. The high yield tail on this security has averaged above the coupon over the past two auctions, and should be closely watched in relation to the auction coupon here as a gauge of 30 year interest rate sentiment.

Friday

-Kicking off a big day of data, the Consumer Price Index (CPI) is expected to show barely 0.1% m/m change in consumer prices at 8:30 AM, compared to the 0.4% growth in November. Yet gains in commodity prices over the month and reports from the ISM Manufacturing survey, suggest that input prices surfaced as price increases for consumers in December.

-Empire State Manufacturing cooled towards the zero growth mark in December but is expected to grow at the 13.0 level in January at 8:30 AM. A disappointment in this figure will be negative for goods producing firms with business in New York.

-Industrial Production (9:15 AM) is forecast to show a 0.6% increase in December, compared to 0.8% growth in November. Given strength from the ISM Manufacturing report, this number will likely meet its estimate.

-Finally capping off the week, Consumer Sentiment for the first half of January (9:55 AM) will show just how confident individuals feel moving into the new year. The statistic measuring consumer spirits is expected to rise to the 74.0 level after falling to 72.5 at the end of December, which would mark the highest level since January 2008.

Recapping the forecast for the week, we see potential for this rally to roll over and correct given the gains we've seen, but we are suggesting that stops on short positions are tightened as there has clearly been a desire to buy companies throughout the first major week of trading in January 2010. Crude oil is overbought according to technicals (RSI and MACD) at the $83/barrel level and looks to be meeting resistance as the dollar has found support amidst the gains on the S&P 500. Generally the only names pushing markets higher over the past week were energy names and a pullback in Crude this week would greatly weaken all asset prices. However, we see several upside risks to short positions this week as economic data continues to show moderate levels of growth as explained in this Weekly Spectrum outlook.