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* Today’s drop in ISM non-manufacturing to 41.9 (vs 53 expected) was a clear shock to equity markets. The weakness reported was across almost all sectors: only three reported an improvement in conditions: utilities, scientific services & education. The last time we’ve seen such a big drop in non-manufacturing ISM was directly following the 9/11 attacks, after which the index bounced sharply.

* It’s pretty strange to see conditions deteriorating this rapidly, especially since consumer confidence stabilised last month and  ISM manufacturing actually rose. The manufacturing index is by the way a more reliable indicator of GDP and is still signalling a 2% or more growth rate.

* perhaps the credit crunch can be used as an excuse for today’s weak survey, but interestingly only 14.6% of respondents in the survey said that the financial markets turmoil was having an effect on their financing. So the rest didn’t.

* All in all today’s ISM non-manufacturing report looks like a outlier event and we therfore wouldn’t give it too much weight at this time.

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Ok, so what was that saying again? Oh yes, NEVER FIGHT THE FED.

Well we can’t really say that the market is following that old piece of advice (this time will be different!) as equities have basically gone nowhere despite a massive 125bp rate cut by the FED within two weeks. Everybody betting against assets though under these circumstances clearly has history against him and is therefore likely to regret any asset sales somewhere in future.

So what looks good now? Well in our humble opinion we wouldn’t mind putting on the following trades:

• Short U.S. Treasuries. Let’s get this straight. The biggest debtor to the world is currently paying 3.5% interest on its 10 year borrowings, while headline inflation in the country is running at 5%+. So effectively any holder of U.S. treasuries is currently paying the U.S. government 1.5% yearly to hold their IOU’s. No way.

• Long commodities, especially precious metals.  Helicopter Ben has kept his promise, though we suggest a new nick name: Boeing Ben. These money drops are really gigantic. Don’t be surprised if M3 growth (should we find out what it actually is, since the Fed decided to discontinue its publication) is now running at 15%+ year on year. That means inflation from which commodities should benefit. Precious metals are obviously the age-old hedge against this money printing, but perhaps a bit overbought in the short run. So out-of-nowhere attacks against gold can happen anytime, but are moments to pile in, not out of it.

• Long Equities, specifically Banks & Hong Kong. The problems in the banking sector are huge, the potential write-downs enormous and the fundamentals lousy. So how much worse can it get? Just stay away from Citi, Merrill and UBS as long as the bond reinsurance problem hasn’t been solved, but the rest looks like pretty good value to us right now.  And oh yes, bottoms are never set amidst positive news flow, like tops are never  put in when the news in bad. On a different note Hong Kong has taken a breather along with all other equities markets, but due to the link between the HKD and USD, imports the Fed policy immediately. At the same time the economic environment in Hong Kong is nowhere near that of the U.S (clearly benefiting from the Chinese growth story). So Hong Kong faces huge monetary stimulus in an economy that is booming anyway. The only way out is asset inflation.

• Short Volatility. Can you believe the day-to-day moves in financial markets? Just stepping away for a pee can mean one percent of difference in whatever instrument it is that you’re following. We will get back to boredom eventually.

On a final note: every trade has two sides an differences of opinion make markets. So yes we might actually be only at the beginning of a multi-year bear market, the problems might get bigger in the financial sector, commodities do have a chance to drop significantly when global growth slows down significantly and volatility can just as well mushroom. We just don’t think those are the most likely outcomes currently. If you do, just replace long with short in all trades mentioned above. Happy Hunting!

—— Evening Whiskey is a an irregular update on the state of financial markets and the opportunities it provides by dealingfloor.com. It is not investment advice and not a substitute for your own judgment. When taking on any investment, make sure to have a first aid kit at your disposal that is jammed with tranquilizers and sleeping pills, you’ll need it. History is not a guide to the future, nor is anything else. Any sane person knows that there’s no sure thing except death and taxes. Fortunes are made and lost each day in this arena. If you can’t stand that heat, please stay out of the kitchen.

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European & Asian equity markets took a real beating today, closing at the lowest points of the day, generally down anywhere between 5-7%. The financial sector was the bleeder once again, this because of genuine fear that the Ambac’s and MBIA’s of this world will go belly up and with that create another round of monstrous write-offs on the bank books. At the same time a U.S. recession seems to be a “sure thing” now and people decided that this will have its effect on Europe and Asia. So much for the decoupling theory.

We tend to agree with those bears saying that a rate cut (50bp is well priced in for the end of this month) and fiscal stimulus won’t do the job to restore confidence. So what will? Because something always does. Don’t get us wrong, we don’t necessarily say that today has been the low in the equity markets, but boy, the masses are surely pricing in an Armageddon scenario now. And although this time can always be different, we have heard calls of Armageddon too often in the past to take it seriously.

So what can save this market? We kind of liked the idea posed by Jim Cramer. Throw a bucket of sand on the heart of the fire: the bond insurance cos. One way to do this is for the government to guarantee (part of) the exposure these firms risk defaulting on, get the exposure off their books to new kid on the block Berkshire Hathaway and solve the issue once and for all. No more speculation that huge write-offs are around the corner for the world’s banks, which can easily trigger a short-covering rally that drags along the broader market.

Now obviously such a bail-out will have people screaming “moral hazard!” and the likes, but realistically speaking such a move would at least prevent a deflationary bust scenario (just ask Japan what a hassle that can be). Although the (hyper) inflationary scenario might not prove to be a proper solution either, bringing along its own disastrous problems, in today’s over-leveraged world it will be the easier way out for those who currently run the central banks and treasury departments.

So if we had to forecast as to what it’s going to be, a deflationary collapse or a reflationary boom, we would put our money on the latter. The good news of that is that asset prices (amongst which equities) are therefore likely to bounce significantly once -and for whatever reason- confidence returns. The bad news is that these assets might not be able to increase in real terms (accounting for inflation) on a longer-term basis as they will continue to decline on a relative basis to real assets such as gold & silver.

Whatever it may be. These markets separate the boys from the men. Crisis provides opportunity. Good luck with your investments in these tough, yet interesting times.

—— Evening Whiskey is a an irregular update on the state of financial markets and the opportunities it provides by dealingfloor.com. It is not investment advice and not a substitute for your own judgment. When taking on any investment, make sure to have a first aid kit at your disposal that is jammed with tranquilizers and sleeping pills, you’ll need it. History is not a guide to the future, nor is anything else. Any sane person knows that there’s no sure thing except death and taxes. Fortunes are made and lost each day in this arena. If you can’t stand that heat, please stay out of the kitchen.

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Sentiment in worldwide equity markets continues to be pretty pessimistic and not many other asset classes seem to be able to offer relief. Except for government bonds ofcourse, which continue to be well bid in these circumstances.

On the subject of govvies, we think that you are absolutely out of your mind if you are buying them at these levels (European ten year government paper is yielding 4% and U.S. treasuries are 3.86%). If you subtract headline inflation from these yields you are basically left with nothing and that’s not even taking taxes into account. No thank you. We’d prefer to put our money elsewhere.

So where is elsewhere then? Short-term deposits don’t look like too bad a bet if you’re as uncertain about what the future will bring as the media are right now. We are a bit more adventurous though and don’t mind some volatility. Therefore we’re looking at the stuff most people aren’t considering right now: the financial sector.

Sure, banks are in trouble and the reasons for those troubles are front-page news every day. But boy, look at those yields. Pull up the Belgian/Dutch bank Fortis for example. Based on Bloomberg data on the consensus view amongst the 23 analyst that are following the company, Fortis is currently trading at 6.7x 2008 earnings (dividend yield 7.5%) and 5.9x 2009 earnings (dividend yield 8%). Now consider this. What if we buy some shares @ 17.75 (today’s close) and at the same time buy some puts December 2008 strike 18 below this position for which we pay approximately 2 euro. Next year we’ll receive about 1.30 dividend which pays for most of this put protection, leaving us with a net investment of 18.45 per share. Since we’re owning the puts, we’re effectively hedged at 18 and downwards till the end of December 2008, our downside risk is effectively 0.45 per share, about 3% from our entry level. In return we’ll get full exposure to the upside in Fortis, should -after the fact- the current financial crisis turn out to be yet another great buying opportunity. In the mean time of course we could write some shorter dated calls to improve our averages. Not too bad a bet we’d say and one that can be copied in a lot of financial companies out there.

Even disaster creates opportunity.

—— Evening Whiskey is a an irregular update on the state of financial markets and the opportunities it provides by dealingfloor.com. It is not investment advice and not a substitute for your own judgment. When taking on any investment, make sure to have a first aid kit at your disposal that is jammed with tranquilizers and sleeping pills, you’ll need it. History is not a guide to the future, nor is anything else. Any sane person knows that there’s no sure thing except death and taxes. Fortunes are made and lost each day in this arena. If you can’t stand that heat, please stay out of the kitchen.

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What started off as a promising day in Europe ended in a disaster after HSBC stated that it was going to use $45b of its capital to bail-out its two Structured Investment Vehicles. Another round of “de-risking” took hold of the financial sector, dragging along the general market. Crude oil kept hovering around the $100 mark to make matters worse and bond yields dropped another few pips to underline the flight to quality. Equity markets headed for last week’s lows (which already coincided with the lows last seen in August).

All in al sentiment continues to be negative, shaky at best.  Nevertheless some optimistic points can mentioned as well:

• Central Bank helicopters were put into the air again. Both the European Central Bank as well as the Fed indicated that they’ll be pumping cash into the system to prevent the money markets from getting into trouble towards the end of the year;
• Shop Sales the day after Thanksgiving came in better than expected at an 8.3% gain, indicating that people are still willing to pull their wallets when the discounts appear high enough.

From a technical perspective it continues to be the case that most equity markets are “oversold” and the same basically goes for the bulk of the stocks within them. Oil on the other hand is “overbought” and so is the Euro (and Gold).

Could it be that sentiment is too one-sided?  Doug Kass (over at TheStreet.com) has some interesting observations:

• Net long hedge fund exposure has plummeted. Like bank trust departments in the early to mid-1970s and mutual funds in the mid- to late 1990, hedge funds are today’s most dominant investors. According to Ed Hyman’s ISI Survey, hedge funds’ net exposure has dramatically dropped from a near record high of 61% to only 42.7%, the lowest level in over four years.
• Individual investors, too, have turned to the exits. According to the AAII survey, individual sentiment is now as bearish as at the intermediate low of summer 2006 and at the primary low of March 2003. Small investors put-buying and short-selling has risen parabolically over the last month.
• Consumer confidence makes new lows. In fact, confidence is now at the lowest level seen since the other real-estate-induced recession in 1992.

Bottoms are never made when the facts are good. Tops never occur when the flow of news is bad. We are inclined to take advantage of the current environment to get good value investments at a discount.  If you’re not sure what good value is, just follow these five simple steps.

—— Evening Whiskey is a an irregular update on the state of  financial markets and the opportunities it provides by dealingfloor.com. It is not investment advice and not a substitute for your own judgment. When taking on any investment, make sure to have a first aid kit that is jammed with tranquilizers and sleeping pills. History is not guide to the future, nor is anything else. Fortunes are made and lost each day in this arena. If you can’t stand that heat, please stay out of the kitchen.

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Dealingfloor.com has been up & running for well over a year now the time has come to re-think the content of the site. We’ll be taking a two-week holiday & hope to return afterwards with fresh ideas for the future. In the mean time please feel free to send us your suggestions as to what you would like to see more of (or less of) . info@dealingfloor.com.

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- The most important story of the week has been the continued weakness in commodities in our view, with oil breaking out to a new low, followed by the precious metals. We believe commodities are trading at deeply oversold levels, from which a significant bounce is likely to occur. There is quite some speculation on the net, and even in main stream media, that this commodities weakness was somewhat staged to the benefit of the upcoming U.S senate elections. This case is made amongst other here.

- The Dow Jones reaching a new all-time high was headline news this week and suggests that equities are back in the spotlight again for the average investor. We agree with the observations that this is somewhat a “phony high”: although the Dow Industrials managed to break-out to new all-time highs, this is defenitely not the case for broader benchmarks such as the S&P, Nasdaq and the majority of European and Asian markets. Nevertheless, the attention for this event did support investor confidence, as is displayed in the high readings once again of the AAII investor sentiment figures. This sentiment figure has been a pretty good contrarian indicator over the past few years and we don’t think this time will be any different. The time has come to lighten up on equity exposure in our view, especially now that broader based equity indices are moving into technically overbought regions and are trading at the upper ends of their trend channels.

- Bond markets have been relatively strong over the past months resulting in lower yields across the board. We believe the strength in bond markets will be relatively short lived, as the long term bond trends are pointing down. We therefore wouldn’t be surprised to see yields edging up again shortly (triggered by a bounce in commodities?)

- On the currency front we’ve seen some interesting moves this week. Firstly the commodities currencies (CAD/AUD) have been relatively weak against the USD & EUR for obvious reasons. However, they have not managed to clearly break their short-term uptrends (unlike commodities). This might be an indication that money continues to flow into these commodities countries even on dips in prices.
The other big theme was the renewed weakness of the Japanese yen, which made a new low against the USD and flirted with new lows against the EUR. This might indicate that the piling into the yen carry trade simply continues. From a technical point of view though, the yen seems pretty oversold and therefore runs the clear risk of bouncing significantly when a sudden news fact shocks the bears (What about the BoJ getting more hawkish?)

- Real-estate continued to perform well this week, supported by the idea that the Fed is more likely to drop interest rates in the near future than it is to carry on raising rates. Considering our view on commodities & bond yields, which are likely to rise in our opinion, we would be surprised to see real-estate benefit under these circumstances.

- So our tactical short-term conclusion is to take money off the table in equities, bonds and real-estate and put some of that money to work in commodities (mainly energy and precious metals).

Opinion only, never investment advice. We urge you to read the disclaimer at www.dealingfloor.com.

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The Technical picture of the S&P 500 Index looks a bit troublesome: on the short-term time frame that is. The index has basically recovered to its May-high but now seems to hesitate to break through that level. Since the Fed didn’t prove to be the catalyst to push the S&P through 1330 resistance, we think the short-term path of least resistance is probably lower.

A break below 1310 would be needed in our view (the short-term uptrend line) in order to start speculating that a possible double top formation in the S&P is being set. But at this stage, that’s too early to call.

The longer-term picture in the S&P is an interesting one. On the one hand the long-term uptrend is still in place, which indicates that once 1330 is cleared, we could easily see the index move towards 1360. On the other hand, the long term momentum indicators and volume are starting to show some serious problems which might be indicative of the S&P being in the process of making a top that will open the door towards levels in the 1250 area.

Conclusion: Short-term we would anticipate a correction towards 1310, below which 1250 would be the longer-term target to focus on. A break above 1330 on the other hand is a positive, generating a buy signal for a ride to 1360.

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The recent dip in crude oil has brought the commodity back to the lower end of its mult-year upward trending channel. This together with an oversold reading in the RSI-indicator leads us to believe that crude has seen most of its downside and is likely to turn (sharply) higher in the short run. We are looking for a pullback toward the $70 area, possibly new highs in due term.

The argument for a weak oil price (slowing economic growth, diminished geopolitical tensions) are now too wide spread in our view and therefore demand a contrarian approach. We’re picking up some contract around these levels and add on to our long gold position (see last week’s trade idea)

Please note that our disclaimer applies to all thoughts from www.dealingfloor.com. They are opinions only, never advice. If you can’t handle that, please ignore these posts and surf to another place.

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Gold is currently flirting with its 200-day moving average. Further the metal seems to be testing the lower end of its long term upward sloping trend line. Should gold be able to find a bottom anywhere between $580-$590, we think it will prove to be an excellent buying opportunity. From a longer term perspective gold seems to be moving within a symmetrical triangle pattern, which generally displays a pause within the long-term trend.

With commodities in general and precious metals in specific now making headlines in a negative sense (remember how different that was only a couple of months back?) we are definetely inclined to start thinking contrarian. The long-term fundamentals behind the gold bull market haven’t changed in our view (see our February post for more on the fundamentals).

What will trigger the bounce? Oh, more chaos coming out of Iran, a not-so-orderly decline of the U.S. dollar, a continuation of global loose monetary policy or just ordinary short-covering. Pick whichever one you like. What the risk is? Another round of global anti-inflation talk (AND action) coming out of the G10 or sudden out of the blue institutional sponsorship for what Steven Roach has to say.

No Guts No Glory. We’re piling into gold around $585. Stops below $575. Target for the bounce $620+.

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