I started my first issue of 2006 focusing on the relationship between short-term interest rates and stock prices. This has been my most reliable indicator.

History is quite clear on this: rising short-term interest rates have been followed by sharp market corrections. Latest example: short-term interest rates bottomed in 1999 and rose until 2001. The market peaked in 2000. You know what happened next. The same pattern repeated itself over and over again in the past.

2006 was definitely different. Short-term interest rates started rising in 2004 and by 2006 they reached 4%, up from 1%. The market ignored the tightening cycle and had only a short-lived correction in May-June. Quite frankly I was surprised – and I still am.

In the first half I was cautious about the market and I was correct in calling the bottom in June-July. I underestimated the strength of the economy in the first half of 2006. The outcome was that I was wrong on the bond market. I am still baffled why the economy was so strong. Some suggested the reason was the huge amount of money printed to repair the damage of the hurricanes. Possibly.

Since my objective is to minimize risk and volatility, the reduction in commodity sensitive stocks was correct as the economy started to slow down.

But the market was at a transition (and I still believe it is), and it was difficult to find sectors that dominated the market. In retrospect I should have reduced more aggressively the cash position when I called the bottom in June. The lack of a precise leadership made me more concerned about risk than opportunities. I was too cautious.

Because of this mindset I ignored emerging markets. Their lack of liquidity just scares me. See what happened to the market in Thailand – down 20% in one day because they announced restrictions on capital flows.

2007 is opening with my forecast of a top in short-term interest rates, commodities and stocks as the economy keeps slowing down. There is no question the market leadership is at a transition. Read on for details.

(This Observations appeared in the 1-07-2007 issue of The Peter Dag Portfolio ).

George Dagnino, PhD Editor,
The Peter Dag Portfolio.
Since 1977
2009 Market Timer of the Year by Timer Digest
Portfolio manager

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1 comment:

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