The market has begun its euphoric phase as stocks marched higher despite the rise in energy prices. As we had stated a few weeks ago, many investors are betting the winners of 2005 will continue to be the winners in 2006. All we have to say about that is "not so fast".
The psychology today is the Fed will stop raising rates and everything will be fine. This assumption of course is way too elementary. To think the Fed will stop raising rates, then immediately reverse course and begin lowering rates, is only wishful thinking.
Veteran market watchers know that it takes about 3-6 months for a rate hike to begin affecting the economy. This being said, the medicine from the December rate hikes will not begin to take hold until the March-June timeframe.
For those of you who have lines of credit at a bank know that your interest rates have jumped dramatically. Depending on your FICO score, the interest rate on your credit-line can vary from 6.75%-8.25%. Chances are, the more you have borrowed, the higher the rate.
Many consumers have bet the farm (no pun intended) by pulling out equity in their appreciated home values to fund their overzealous spending habits. Another rate hike or two (3, 4?) will drive rates on credit lines even higher.
Overly aggressive mortgage lenders have sold consumers a bag of goods. When you take into account that approximately 25% of all real estate sold in the U.S. was purchased by speculators looking to make a fast buck, the closing dates on these purchases are fast approaching.
Real Estate (Condos,etc..) purchases made at pre-construction prices 2 years ago will begin to go to closing as early as this March. I know many speculators, and despite their high incomes, some cannot afford to close on the properties that they have speculated on. So, in the next year or so, things could get very interesting.
In addition, it痴 become real clear that there is more supply than demand. Along the Gulf Coast, there is not much demand for $800,000, 1100 square foot condos in hurricane alley.
WHEN WILL THE BLOWOFF END?
The problem with euphoria (as well as panic bottoms) is it can go much higher than anyone could imagine. If the markets can rally sharply despite rising energy prices, what can it do if energy prices drop?
The natural response of course is that the markets will celebrate a sharp drop in energy prices, but no one thought the markets would rally as sharply as they did when oil prices leaped over the $60/bbl mark.
Peter Lee (UBS Technical Strategist) thinks the stock market will shrug off the rise in oil up to $70-$71/bbl. After that, he thinks the market will react negatively.
I am not waiting for the final blow-off, to begin positioning myself on the short side. This week, I began dollar cost averaging into the Rydex Tempest 500 Fund (RYTPX), and plan to continue adding to my position on subsequent rallies.
SPECULATORS SHOULD TAKE PROFITS
On December 21st, I said:
Sorry, but I cannot give specific advice, only general ideas. Any stock ideas would be listed in the IA portfolio. That being said, I did mention if anyone wished to speculate on a year-end rally I would do so using the following:
S&P 500: SPY or SPX calls 3-4 months out on a pullback.
DJIA: DIA Diamonds, or buy a 3-4 month call on the DJI on a pullback.
NASDAQ: QQQQ
By now, you probably have substantial profits in your call option positions on the S&P, Dow, and NASDAQ. I would look to take profits in those positions, add to the Rydex Tempest Fund, and sit on my hands.
