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Hedgers Update, Blowing Bubbles and Utilities and Black Gold


The bear is least until May.

I have not updated you on the positions of hedgers since mid-December so I thought it would be a good time to do so. The market has started off the year in unconvincing fashion. Sector rotation has been the key to this market. As you know, I like to operate on the old adage 'buy when you can, not when you have to.' This simply means that it makes sense to 'buy low sell high.'

My firm recently added a partial position in the oil group via the exchange traded fund, XLE. While not a call on the price of oil per se, we must note that the prices of commodity stocks usually lead the price action of the commodity itself. I happen to think that oil has larger upside than downside from a longer term perspective, so we are dipping our toe in the water on substantial early year decreases. Why? See the two charts below. One is a graph of a weekly poll of bullish sentiment by Bloomberg users. Note how the world seems to loathe the price of oil (buying opportunity) and that the price of oil on a weekly basis is putting in a positive divergence (it is less 'oversold' on a weekly basis). Also, oil stocks have a price/earning ratio of 9.5 compared to 16.5 for the S&P 500, not to mention their wonderful cash flow and balance sheet characteristics. See the charts.

Bloomberg Oil Bullish Sentiment Poll

Weekly Oil Price vs. Weekly RSI (Relative Strength)

What about the hedging community? Well. The hedgers continue to lean against the crowd and stay short the S&P, NASDAQ, and Dow Jones and are slightly long the small-cap Russell 2000. See those charts below. Keep in mind I don't know if they are hedging against a move lower in the S&P (this is what I believe they are doing) or hedging against gains. I doubt they are hedging against gains because if they were trying to defer gains into 2007, they would have already covered, not added to the short position. I don't think any commentary is necessary as they speak for themselves. One last thing, my firm nets out the electronic 'e-mini' contracts into 'big' or 'open outcry contracts' as electronic trading has become more and more prevalent.

Commercial Accounts vs. S&P 500

Commercial Accounts vs. NASDAQ 100

Commercial Accounts vs. Dow Jones Industrial Average

Commercial Accounts vs. Russell 2000

What about the bubbles I've talked about? There are four I will feature here. I mentioned all through 2006 that there was a bubble in copper and it would burst...and it has. See the chart below, courtesy of Ned Davis Research, that overlays the NASDAQ bubble (moved forward in time to overlay over the price of copper). It is strikingly similar.

NASDAQ Bubble vs. Copper Bubble and Burst

In 2005 and 2006, I stated I thought there was a bubble in housing and housing shares. I believe it has burst. I also noted that I thought that companies would begin to write down land holding and eventually would lose money on an operating basis. This is indeed happening as Centex (CTX) and KB Homes (KBH) announce awful results today. Note that their balance sheets are now over leveraged (what isn't over leveraged these days?). I think consolidation in the industry is likely and I would be surprised to see some builders go bankrupt as airlines have. They have many similarities (lots of leverage, awful balance sheets and cyclicality).

NASDAQ Bubble vs. S&P Homebuilders Super Composite Bubble and Burst

What other bubbles exist around the world? The two most glaring are the parabolic nature of China and Vietnam. I compare these against the NASDAQ bubble as well. I know one thing. I have never seen a parabolic move end in pretty fashion. From the tulip mania of the 1700's to today, greed at tops is usually greeted with losses afterwards. See the charts below.

NASDAQ Bubble vs. Ho Chi Minh (Vietnam) Index

NASDAQ Bubble vs. Shanghai (China) Index

In sum, I think the name of the game in 2007 will be sector selection. Just see the chart below of the Philadelphia utility Index. It shows a weekly MACD (trend following indicator) with a negative cross at the same time the weekly uptrend line has been broken. I take two things from this chart.

1) It usually precedes a negative move in equities.
2) It usually suggests a bear market in bonds.

Note that last week I opined a bear market was upon us in bonds as bonds tanked last week. The bear is here, I think, at least until May. My firm is positioned in short-term high, quality bonds for now but will re-evaluate later in the year. More on that tomorrow.
No positions in stocks mentioned.

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