Red Flags Green Flags Part 2

Red Flags or Green Flags? Part 2: Wall Street Sector Selector

Hi, Friends,

Is it red flags or green flags? Danger or all clear?

Hard to say with this week’s big sell off, the Fed cutting interest rates again but hinting this was it for awhile and the employment report on Friday. Cross currents and confusion seem to dominate with greed and fear tugging for control of the markets.

For us, it was a busy week with the portfolio rebalance, closing one trade and putting on two new positions for November. We closed out IEZ, U.S. Oil Services, which had been on since September for +4.09% gain in two months, but for new money added in October, IEZ gave up -2.86%. Earlier we were stopped out of Hong Kong Index, EWH, with a +8.6% gain for September trades and a -4.8% loss for trades put on in October.

These results reflect the choppy nature of the market we’re in and the weakness in October, but overall for October, even with the two losses, the system returned us gains of +5.93% compared to +0.15% for the S@P.

And for the first two days of November, we stand at -0.64% compared to -2.6% for the S@P.

The View from 35,000 Feet

The two big market movers this week were, of course, the Fed meeting and rate cut and the employment report on Friday. The Fed continues to catch up to the sub prime mess that we’ve been discussing for weeks, and almost daily, there’s another multi-billion dollar write off from a big financial. This week, Merrill Lynch was the big newsmaker with their CEO’s head rolling over their mounting sub prime losses and Citigroup’s CEO looks close behind with severely declining earnings for the quarter.

Of course, what’s making everyone really nervous is that no one knows for sure how big this is or what the losses on all of these derivatives are going to be, or when it’s going to be over.

I don’t have all the answers, either, but here are some things we do know:

--$800 Billion worth of sub prime loans will reset to higher rates between October, 2007, and December, 2008, and most of these homes were bought at market top.

--A Congressional Committee forecasts 2 million sub prime foreclosures in the next 18 months.

--Foreclosures compared to last year are up +201% in Arizona, +130% in Florida, +920% in Connecticut and +212% in Nevada with many other states in double or triple digit columns.

Beyond that, while the official Department of Labor jobs report showed a gain of 166,000 jobs, their informal telephone poll of households showed a net loss of 211,000 jobs and year over year job growth of just 0.7%.

What It All Means

What I wrote a couple of weeks ago appears to be unfolding:

“The economy is clearly slowing. The sub prime melt down is spreading past financials and since financials are widely represented on the S&P, that broad indicator will experience downward pressure. Oil and the high price of gasoline will act like a tax on the consumer and our petroleum based economy, and it’s hard to make a case for robust growth in the next few months.”

There are plenty of red flags and plenty of danger ahead with the credit crisis, oil heading for $100.bbl. and the consumer getting pinched as the value of his house continues its precipitous decline.

But there are plenty of green flags, as well, for each of these problems presents an opposite opportunity, and that’s what sector rotation is all about. Finding the opportunities that always exist, regardless of what’s happening around us.

The bottom line on all of this is that the probability of recession grows daily, stock prices look weaker in the short term and the Fed will continue lowering interest rates in the months ahead.

For November, I think we can expect a challenging month.


The Week Ahead

This week brings the Benny and the Feds show to Capitol Hill where Chairman Bernanke is scheduled to report to Congress; following Gentle Ben are the monthly retail sales report and the University of Michigan Consumer Confidence report.

Also, all eyes will be focused on Citicorp’s unfolding struggles and 50 more company earnings reports next week.

Sector Spotlight

Energy, international and precious metals remain the leaders. U.S. telecommunications, semi conductors and, of course, financials are the dogs, with real estate close at hand.

As I mentioned above, the short term looks decidedly weak with 75% of the sector ETFs I follow now flashing short term downward prices.

Wednesday was Halloween, and for the first time in many, many years, I didn’t go trick or treating with my kids. My big boy is in college down in Santa Barbara and my young son, now a freshman in high school, was buried in homework and too cool to go out. For all those years that have so swiftly passed, I’d dress like my kids for trick or treating. One year we were pirates, another we were Baby Darth Moll and Big Darth Moll, and my favorite was the old and young Phantom of the Opera, complete with musical score blasting from under my cape.

But my last Halloween is behind me now, and I have to say, it’s depressing. And it occurred to me on Wednesday night as the goblins came to my door, that we really should do everything in life as if it were for the first time or the last time. Because one day, it will be the last time and there’s no instant replay or another chance to go trick or treating next year.

Wishing you the best for a great autumn weekend and week ahead,

John
John Nyaradi
Publisher
Wall Street Sector Selector
http://www.wall-street-sector-selector.com