PeakTrader.com

[arthur]

The Federal Reserve knows that sustainable growth is optimal growth (i.e. the optimal balance between labor and leisure with neither strain nor slack utilizing other inputs). So, living standards rise at the fastest possible rate. The U.S. economy expanded at over 4% real annual growth over the past two years. The long-run trend is 2.7% real annual growth. When a large economy expands too quickly, then it always compensates by expanding too slowly (e.g. a boom/bust cycle). Consequently, the Fed wants to see slower growth.

Unfortunately, the Fed typically "overshoots" its target (when stimulating or slowing the economy). Nonetheless, the Fed wants sustainable or slower growth. The FOMC (where Fed policy is set) will continue to tighten the money supply, until it reaches a neutral stance. It's uncertain where neutral is in terms of the Fed Funds Rate. However, the table at the bottom of this article may indicate that the current 3.25% Fed Funds Rate may still be quite accommodative.

Normally, a pick-up in employment slows productivity growth, which lowers earnings growth (and supported by the data over the past year). Also, employment tends to lag. A slowing economy will slow earnings growth even further. Firms may report greater uncertainty about future earnings in July, when earnings season begins. Consequently, that may trigger a sell-off in the stock market, or at least create greater volatility.

The chart below is a NYSE Oscillator daily chart over the past four years. The NYSE Oscillator has a high positive correlation with SPX (S&P 500). The levels, movements, and relationships of the MAs (moving averages) have excellent predictive powers. This chart shows 15 out of 16 times that the 20 day MA (in blue) rose above zero and then pointed down, the MA fell below zero and stayed below zero for at least a few weeks. Consequently, this chart suggests SPX will fall or become more volatile in July.

SPX may not rise above the low 1,200s (i.e. 1,200 to 1,206), where there are several significant resistance levels, until it falls much lower. SPX has lower open gaps at 1,174, 1,143, and 1,138, which it may close this summer. Currently, there are no upper open gaps. There are many support levels in the 1,180s (including two congestion areas). The 10 month MA is at 1,181 and the 80 month MA is at 1,173, which may work together to provide strong support. The multi-year 50% Fibonacci level is at 1,161. It's uncertain where SPX will find support, with so many support levels. However, it may be best to buy SPX puts on SPX bounces, since the downtrend may continue in July.

Mon is the 4th of July Holiday. Important economic reports next week include: Tue: Factory Orders, Wed: ISM Services, Thu: Unemployment Claims, Fri: Nonfarm Payrolls, Hourly Earnings, Unemployment Rate, and Wholesale Inventories. The weekly oil inventory report is Thu, at 10:30 AM ET (because of the holiday), which should move oil stocks. Also, the G-8 Summit starts Wed. Next week is a light earnings week with only one notable earnings report from AA on Thu. Jul options expire in two weeks.

There may be excellent trading opportunities with SPX Jul puts (particularly, during options expiration week, because of time value decay, which provides greater leverage). Also, oil stocks, e.g. AHC OXY and OIH may become more volatile (a slowing economy should be negative for oil prices). PPH IP X AMGN and RMBS are relatively undervalued. TLT may fall further this year. GOOG has the potential to fall to the 220s after earnings Jul 21st (Aug 270 or 260 puts may be cheap). Also, there may be excellent earnings opportunities, using leverage, with Jul options the week of expiration.



Effective Fed Funds Rate on May 1st Annually, since 1982:

Tightening or Easing Cycles

Tightening
1982-05-01 14.45

Easing
1983-05-01 8.63

Tightening
1984-05-01 10.32

Easing
1985-05-01 7.97
1986-05-01 6.85
1987-05-01 6.85

Tightening
1988-05-01 7.09
1989-05-01 9.81
1990-05-01 8.18

Easing
1991-05-01 5.78
1992-05-01 3.82
1993-05-01 3.00

Tightening
1994-05-01 4.01
1995-05-01 6.01

Easing
1996-05-01 5.24
1997-05-01 5.50
1998-05-01 5.49
1999-05-01 4.74

Tightening
2000-05-01 6.27

Easing
2001-05-01 4.21
2002-05-01 1.75
2003-05-01 1.26
2004-05-01 1.00

Tightening
2005-05-01 3.00

Also, I may add, during the 1950s, the Fed Funds Rate was generally between 1% and 3%, over most of the 1960s, it was between 2% and 6%, in the late 1960s, it rose between 6% and 9%, and in the 1970s, it was often between 6% and 12%. The Fed Funds Rate peaked at over 19% in 1981.