Dow Over 12,100: Pressures Not Sustainable

by: Bill Cara

There is a widening credibility gap between a U.S. Administration that points to a Bull market as evidence that all is well in the American economy and the many confused capital market traders who can’t understand why prices are so high and going higher. I’ll bet there isn’t a single major broker-dealer in America whose research from a month ago indicates that the DJIA would be above 12,100, heading north. And all the ones I read, which are the biggest firms, all foretold a lower $USD and a higher precious metals price.

Is this a conspiracy to suck retail traders into taking greater risk, or is it truly the case where Wall Street is as confused as the rest of us?

I don’t believe there is a conspiracy here, but I do think the market has been pushed off the rails.

CNN ran a "news special" about "broken government" in which they made the case that a strong majority of Americans (all stripes) believe that govt is failing them. You can take these polls with a grain of salt, but I think there is an underlying concern today that govt has moved too much into the capital market arena, and that consequently, prices are not acting normal.

This is debatable, but many of us feel that way.

Equity prices – up +113 Dow points as I write -- are moving higher, I believe, because traders think oil prices, interest rates and other inflationary costs will decline. This is the continuous rhetoric coming from Talking Heads. Lower cost and/or higher productivity, as you know, give rise to higher earnings and to PE multiple expansions.

But are higher PE multiples sustainable? And, are earnings likely to grow at close to the same double digit rates of the past two or three quarters?

I don't think so because corp earnings will be hurt by rising costs and economic "headwinds" -- as Bank of Canada governor David Dodge alerted us, but which are being ignored in the U.S.

Moreover, there are other dynamics at work, particularly with respect to energy costs. I believe that the G-7 nations stopped replenishing strategic oil reserves in order to create a glut of oil that would break the high oil price, but in the long term they have to be flat in their net trading of oil.

And, I believe that central bank rates are lower than they ought to be relative to money supply growth and inflation levels. In addition, I believe G-7 nations are selling gold heavily to make it appear that fiat currencies are stronger than they really are.

So, when all is said and done, you can say that I see the black hand of government involved in this price rally in equity markets. These pressures are not sustainable.

What the price rally has played into is the trader tactic I laid out a couple months ago, which is that traders continuously raise their stops, and hold onto their put write positions. Furthermore, as more call writes are being put on at this point, the market itself will close out the long positions, which ought to be at excellent profit levels.

The only thing that concerns me at this point is that too many traders still believe that there is a natural glut of oil – that double digit earnings growth is possible because the economy is cranking along nicely but not so fast that anybody is using energy (lol), which supposedly explains the glut of oil around today.

During this uncertainty regarding oil markets, which leads to a lack of bids in the precious metal markets, I think that gives the central bankers ample opportunity to sell gold for maximum effect.

So I am watching the $USD rallying, which is consistent with confidence that the Fed will not drop rates, and could even raise them, at this week’s meeting. But, if the Fed doesn’t drop rates, how do we have PE multiple expansion? And, how is the credit bubble issue being addressed?

When in doubt, it’s best to do what you think is the right thing. In my case, I’m sticking with the precious metals, consumer staples and the (still outstanding) put writes on stocks that have prospects for hanging in with this rally.

But more than anything, I’m focused on the Sell button and on raising stops. My mindset is strictly defensive.