The Case-Schiller Home Price Index is just one of the plethora of housing indicators due to be released this week. We bought homebuilders based on low supply and the prospect of high demand. In fact, last week the National Association of Homebuilders released its Housing Affordability Index.

Click to enlarge:

The macro news on the housing industry was decidedly negative. Mortgage applications, housing starts and building permits all fell.

As the obsession with the “falling dollar” continues we have been scouring the globe for a catalyst to stop the decline. Last week, Fitch warned Japan that if government spending is not curtailed it faced a ratings downgrade.

Japanese debt as a percentage of GDP is already the highest in the G7 at over 180%, and the IMF estimates it could rise to 227%. The risk is that a debt downgrade could cause borrowing costs to rise and curb investment. The new Japanese government is in a tricky predicament, as government spending is part of the plan to lift Japan out of recession.

Just when it looked like the prophecies of Nostradamus may be coming true, a white knight, in the form of Warren Buffett, strode in and saved the day. Buffett’s buy of Burlington Northern (BNI) turned the US equities markets from ugly duckling to suave Prince.

The purchase was hailed by the Oracle himself as a “bet on America”. We see it a little bit differently…it is a bet on Asia/China.

The traditional economic orthodoxy suggests that unemployment is a lagging indicator, since firms do not begin hiring until they are sure a recovery has begun. However, the length and depth of this recession has resulted in unemployment morphing into a leading indicator.

Click to enlarge:

While the U.S. equity markets rallied, the U.S. bond market did its best to tell us that economic growth was not going to be what the equity markets expected. Treasury futures held on to that belief as long a they could…until last Friday.

Whether the most recent move in Treasury futures is a correction or the beginning of a new downtrend will only be revealed with time. However, it does present a critical question for investors…

We would expect that of the economy were truly picking up steam (notice the foreshadowing) then railcar loadings would be climbing.

Not only has total rail traffic failed to begin its seasonal upturn, loadings of crushed stone and lumber are falling. These are signs of an economy that is stalling.

The economic data released last week painted an picture that may best suited for the ice cream shop…a double dip. Atrocious employment, weak durable goods orders and falling new orders in the ISM index have us questioning whether the economic pain is really over.

This time last year, we were riveted to our computer and television screens wondering which company would be the next to need a bailout. The policy of too big to fail was in full swing.

If a second round of global economic weakness occurs, the pressure for competitive currency devaluations will rise. The Swiss have already begun to devalue their currency and now we turn to the markets to tell us who may be next. Over the weekend, the G7 met and paid a bit of lip service to the idea of a strong dollar. At the same time, Japan was changing its tune about a strong Yen.

The new Japanese government is intent upon moving Japan away from an export economy. The first step in their plan was to let the Yen strengthen and encourage business to focus on domestic demand. The fatal flaw in this strategy is that major economies are not overhauled in a weekend. Moving Japan from an export economy to one that is driven by domestic demand is a decades long process. Moreover, such an ambitious goal may prove impossible in the age of globalization.

The bond market continues to scream that a slow growth, low inflation economic environment is on the horizon. To illuminate our observation we turn our light on the 2 year and 10 year futures market.

2 Year Treasury Note Future – Daily Chart (Click to enlarge)

The U.S. dollar index has turned at a 61.8% retracement of the September 21-28 rally. This is exactly what is expected if the dollar is indeed starting a new long term uptrend.

US Dollar Index – 90 Minute Chart (Click to enlarge)

As the G20 concludes and the U.S. equity markets decline, the U.S. dollar is playing a pivotal role in both the foreign currency markets and geo-political posturing. Last fall, during the height of the economic crisis the U.S. dollar index broke a 6 year downtrend which began in 2002. As the dollar peaked in March 2009, the U.S. equity markets began to find firmer footing and the year long relationship between the dollar and equities blossomed.

U.S. Dollar Index (Cash) – Monthly Chart (Click to enlarge)

This is from Wednesday September 23, 2009 where I talked about the Fed extending mortgage purchases being a de facto easing.

After shrugging off the first signs of blatant protectionism, the markets have begun to focus on the battle between inflation and deflation. The good v. evil debate was reignited when BoE governor King suggested that reserve hoarding at banks was hindering QE. Moreover, he was concerned that if the banks do not lend then a deflationary spiral may take hold.

However, to date the data does not support his fears. The U.K. National Statistics office released several measures of CPI and on a monthly basis, August CPI was up 1.6% v. 1.8% previous. While below the traditional 2% target zone, the gauge is far from showing deflation.

Despite claims to the contrary the Chinese are savvy capitalists and even savvier traders. Consider the stockpiling of commodities at recent lows and the subsequent sales being made at elevated prices. The trading acumen extends to the Treasury market as well.

To understand the Chinese slight of hand we must first understand the classifications in the TIC data. The country to which a T-bond/note purchase is attributed may not be the country that is ultimately the owner of the security. If a foreign entity purchases Treasury bonds through a British investment bank then the purchase is attributed to Britain.

Beyond the obvious play on an improving economy, the forest products sector may get an additional boost from the sale of wood pellets for energy as the cap-and-trade legislation attempts to curb air pollution. The European Union has already enacted laws requiring 20% of electricity to be produced from renewable resources. Originally these laws were thought to benefit wind and solar companies, but wood has emerged as the cheaper alternative. The key feedstock for wood pellets is softwood pulp and, lucky for us, there is a futures contract we can use as proxy.

Softwood Pulp Futures (Click to enlarge)

Lost among the euphoria that accompanied the S&P 500 climbing above 1000, was lower than expected disposable income. The government response to the economic crisis has been a Keynesian whirlwind of pump priming.

Click to enlarge:

The wildly bullish ISM report not only explains the strength in US equities but it also shows an interesting trend in exports.

On CNBC Friday we spoke about North American Palladium (PAL) as a play on the cash for clunkers program. At the same time the U.S. government was doing some juicing of its own, it was revealed that members of our beloved Red Sox had “unwittingly” used performance enhancing drugs.

The cash for clunkers program has been a remarkable success. In less than a week the program actually ran out of money after dealers sold over 200,000 cars. Politicians know a popular program when they see it and by Friday afternoon had approved another $2 billion for the program. Anecdotal dealer reports have suggested even customers without a clunker are returning to the showrooms. For every customer that trades in a clunker there has been at least one more customer who simply buys a new car.

As gasoline prices inexplicably found a bid we examined the relationship between gasoline and distillate stocks to sales. Using the EIA data we have created an “inventory to sales” ratio for the product sector of the crude market.

Click to enlarge: