Sunday, September 23, 2007

The Week Ahead

The markets are at a divergence. There will be several different and conflicting camps that will move the markets in different directions.

The Slowing Economy Argument: These traders see the latest employment report as being the final nail in the coffin of the latest expansion. The slowdown stared about a year ago when housing started to slow. It continued with the first quarter GDP number and ended with the net loss of 4000 jobs last month. This group of traders will attempt to drive the market lower by selling shares short and selling long positions. There are two underlying trends that play into this group's arguments. The first is this expansion has been going on for awhile and all expansions end at some point. The second is the housing market, which many have said is "bottoming" but which in fact as a record high inventory level at a time of constricting credit markets and tightening lending standards.

The Soft Landing Argument: This crowd was cheered by the Fed's decision to cut 50 basis points last week which is stimulative because it lowers the cost of money. This argument is bolstered by the size of the rate cut and it's timing, which came as the credit markets were in a slump. There is also the very strong position of US exports which have shown a good increase over the last 6 months and the strong world economy whose demand is bolstering US exports. Finally, there is the cheap dollar which lowers the cost of US exports.

The Inflationary Crowd: The Fed's rate cut lead to a big sell-off in medium and long-term US government debt and a spike in the price of gold. However, the biggest impact was felt in the forex markets where the dollar took a big hit and where the consensus among traders was dollar negative. Because most commodities are priced in dollars, the dollar's drop is largely seen as inflationary, leading to a bidding-up in dollar denominated commodities.

It is still way too early to know who will win the battle of market direction. My guess is we are going to see a ton of cross-currents over the next month do battle with each other with no one emerging as a clear winner for a while.