Wednesday, October 12, 2005

Chart of the Day -

Chart of the Day -

Today's Chart of the Day is a good one. It shows the strong relationship between the Fed Funds rate of change and the S&P earnings rate of change.

In the mid 1980's and again in the mid 1990's the earnings growth peaked but the stock market rallied because the Fed Funds stopped going up. Does this situation have a familiar feel to it?

S&P earnings growth has been unusually strong for the past couple of years. The growth rate is unsustainable. However, the leveling off of earnings is likely to be accompanied by a leveling off in Fed Funds.

Remember, the market does not need interest rates to go down. Should the Fed signal that it will likely stop raising rates anytime in the near future, this market is primed for a super jump.

Again, the current earnings rate on stocks is better than 7%. The rate on 10 year bonds is less than 4.5%. Stocks can climb in value by 35% or more and still be at attractive evaluations relative to bonds!

Many active traders are now sitting in a net short position! They are actually betting on the market going down. Betting on a down market has historically been a very tough bet to win. I can't remember the exact odds but the one year odds are about 70/30. Even the daily odds are something like 53/47 against.

The good news for investors is that those who are betting against the market today will buy massive amounts of stock when the market takes off. At first they must buy back the stock they have sold short, then to recover their losses they will feel the urge to buy extra stock on margin on the way up.

The reason the moves off of bottoms is often so volatile is because short sellers are at great risk when the market starts to rise. They must eventually buy back the shorted shares, no matter high high they go or how many times the shares are split.

It is time to prepare to be aggressive buyers. The market needs only a small catalyst to start the stampede. A move large enough to spooke the short sellers is all we need to be off and running.