Good morning,
It’s the start of the New Year and I believe 2010 will be a challenging year for the economies and the stock markets. Already there are many experts giving their views and forecasts, ranging from a very bullish year to the pessimists predicting the dreaded W to happen in 2010. It seems confusing for those wanting to have a glimpse of what to look for to decide if it is the good time to invest and trade the stock markets. A friend of mine told me excitingly that the stock market will be very bullish because of the steep yield curve. He is right to a certain extent, but it is important to understand the relation before jumping in to buy the shares.
The yield curve is the relation between the interest rate or cost of borrowing and the time to maturity of the debt for a given borrower in a given currency. Basically it has to do with the interest payable on the short, mid and long term government bonds. A normal yield curve pays higher interest for longer term bonds because of the higher expected risk free rate in the future and higher risk because of more uncertainty for longer duration bonds compared with the shorter duration bonds; or opportunity cost of bond holders for holding the longer term bonds. On the other hand, an inverted yield curve can happen if the market's anticipation of falling interest rates causes such incidents. Negative liquidity premiums can exist if long-term investors dominate the market, but the prevailing view is that a positive liquidity premium dominates, so only the anticipation of falling interest rates will cause an inverted yield curve. Strongly inverted yield curves have historically preceded economic depressions. So what can we make of the yield curve to forecast the stock market? Since interest rates affect the profits of firms, higher interest rates will be more expensive for firm to borrow. If the firm absorbs the costs, it will be less profitable; if the firm passes on the costs to the consumers, it can cause the demand to shift along the demand curve and with reduced demands, it will also affect the overall revenue of the firm. Thus we should be buying stocks when the interest rates are low and sell when the rates are high, i.e. buy when the interest rates are declining and sell when the interest rates are advancing. However, rising interest rates may be a sign that the economy in improving and may be a good indicator for stocks, so there are other factors to consider when using the yield for forecasting. One of the factors is the money market yield curve. For US, bills with lesser than 1 year maturity are considered money market instruments and 3 months bill are accepted as risk free rates (what can really happen to US in 3 months?). Thus if the shorter term 3 months rate is higher than its longer dated bills, more money will flow into this risk free returns, draining money away from the stock markets. It’s the same for the difference in spread of the 10 years bonds and the 3 months bill. If the 3 months bills have higher rates than the 10 years bonds, we can expect money to flow into the 3 years bills because the reason for the inverted curve is the expectation that the market is anticipating a recession where federal may have to reduce its future interest rates. It is not the scope of this blog to explain the academic reasons but I am glad to summarize the following considerations:
Buy stocks when: The federal funds rate is declining and; the money market yield curve is positive and; bond quality spreads are shrinking; and the difference between 10 years notes and 3 month bill spread is positive.
Sell stocks when: The federal funds rate is rising and; the difference between 10 years notes and 3 month bill spread is negative and; bond quality spreads are widening; or the 10 years yield is more than 10%. (This is logical since professional fund managers would prefer to invest in lesser risk bond that offers 10% returns than investing in higher risk equities which long term returns are around 9%).
Though I am expecting the interest rates to rise in 2010 which is an indication that the economy is recovering and we should see some correction when it does, the current data seems to point towards a continuing of the advancement of the recent run. The rising interest rate has not reached a level that I will be concerned for the markets to turn south. However, I will be careful with the 10 years bonds and 3 month bill spread and the 10 years yield and will monitor this closely for the overall macro view when KUTE system is applied.
With the overall yearly macro view in mind, let’s see how the weekly macro outlook will be for the first week of the New Year. This week will see some important reports from the labor department for the non-farm payroll, the initial claims, unemployment rates and the ISM report on manufacturing. The cycle trend using the bartel trend is showing a potential continuing of uptrend, but the weekly candle is also not very encouraging with a black spinning top. With the previous week’s thin volume and shorter trading week, I believe that it will be better not to read too much into the candlestick. With the market expectation of the timing of interest rates increase, I am quite sure that the markets will be volatile and trade within a broad range for the next one month. My strategy will again be to buy when it dip and sell at target.
The stocks selected by KUTE for this week are: NOV, NE, PDE, PTI, DSX and CAB.
Diana Shipping Inc. (DSX) is a global provider of shipping transportation services. The Company is engaged in transporting dry bulk cargoes, including commodities as iron ore, coal, grain and other materials along global shipping routes. The company has strong financials with increasing revenue for the last 5 years and both its operating and free cash flows are positive and growing. However, both its weekly cycle trend and candlestick formation are not indicating any buy signal so I will leave this stock alone for the time being.
Cabela's Incorporated (CAB) is a specialty retailer. The Company is the direct marketer of hunting, fishing, camping and related outdoor merchandise. The Company’s products offerings include casual and outdoor apparel and footwear, optics, vehicle accessories, taxidermy products, gifts and home furnishings with an outdoor theme and furniture restoration related merchandise. The Company issues the Cabela’s CLUB Visa credit card, which serves as its primary customer loyalty rewards program. The Company operates through three business segments: Direct, Retail and Financial Services. Its’ next generation store format, multi-channel strategy and seasonal product assortments enable CAB to focus on increasing stores productivity and sales per square foot, and lowering labor costs. Retail operating income margin expanded 240 basis points to 11.6% in third-quarter 2009. Its’ healthy balance sheet viable strategy and improving operating efficiencies offers investors a strong growth profile. It remains on course to achieve its targeted long-term return on invested capital of 12%-14%. Another growth engine is Cabela's Club Visa credit card, which is enhancing brand name and increasing merchandise revenue. However, both the cycle trend and weekly candlestick are not showing any buy signal so this will be another stock I will not be buying this week. One interest note is the monthly cycle trend is very positive and I am consider adding this stock to my 30% of the 30-20-50 rule.
As for the rest of the stocks, I will only be looking at the technical since they were all covered previously. NOV cycle trend is still showing strong upside potential for both the weekly and daily time period. However both the weekly and daily candlestick formations are calling for a sell recommendation, I will not add on to my current position which is out of the money at market open price. Since I cannot be sure of how genuine the candlestick formation can be from the thin volume and short trading week, I will observe the stock and may consider buying if the daily and intra-week candle shows wait or buying signals. NE has the same reading for both the candlesticks and cycle trend as NOV so my decision is the same. PTI weekly cycle trend is flat but its’ daily cycle trend is positive. The weekly candlestick with a white candle showing more bulls last week with the attempt by bears to push the price down but the bulls managed to win the week with the stock closing higher than its’ opening price. The indicator is still a “sell-if” signal waiting for the next period to confirm. Since I do not have a strong buy signal, I will just hold my current position and wait for it to hit my limit order before I decide my next course of action.
PDE weekly and daily cycle trend upside trend is not confirmed by the candlestick formations with the weekly candlestick showing a bearish engulfing and evening star, so it will be better to observe for the next period candlestick before any decision is made for buying this stock.
Have a great week!
Francies Cheng
BBus MAppliedfinance
