The Big Picture

By Colin Twiggs
January 16, 2007 5:00 a.m. ET (9:00 p.m. AEDT)

These extracts from my daily trading diary are for educational purposes and should not be interpreted as investment advice. Full terms and conditions can be found at Terms of Use.

The Big Picture

One of the biggest failures of the discounted cash flow model, used by many investment institutions to value future cash flows, is the use of long-term risk-free (treasury) yields instead of a stable bench-mark rate. When yields are low, valuations are higher, and when yields rise, values decline. Rising long-term yields can have a profound impact on equity markets.

Ten-year treasury yields remain in an up-trend, having respected the 3-year trendline. Expect another test of resistance at 5.25%.

The yield differential (10-year minus 13-week treasury yields) remains negative, warning of long-term pressure on banking margins and a possible down-turn.

Equity Markets

There is no indication as yet that the current bearish divergence on Twiggs Money Flow warns of anything more than a secondary correction for the Dow Industrial Average, but we need to remain vigilant.

Gold

Spot gold is in a large triangular consolidation which started with the high of May 2006. The metal has so far respected support at the mid-point of $600. A fall below this level would signal a test of primary support at $560. Breakout above $650, on the other hand, would signal resumption of the primary up-trend.

Crude oil prices below $55 are likely to reduce demand for gold, while a weaker dollar would increase demand; two opposing forces that may offset each other.

Source: Netdania

Crude Oil

Crude broke through support at $55/barrel, signaling a long-term down-trend. The next major support level is $40. Recovery to above $55 appears less likely, but would indicate a weak down-trend and possible bear trap.

Currencies

The euro penetrated support at $1.30, indicating a slower trend. If the retracement respects the (green) upward trendline, the up-trend will be considered healthy. A fall below $1.25, though less likely, would signal reversal.

Source: Netdania

The dollar is in a long-term bearish descending triangle against the yen, with support at 100. A breakout above the December 2005 high of 121, however, would be a strong bull signal for the dollar. Failure to breakout would most likely form a bullish ascending triangle between the (green) upward trendline and resistance at 121. A fall below 115 is less likely at this stage, but would signal a test of long-term support at 100.

Source: Netdania

Wright Model

Probability of recession in the next four quarters remains at 45 per cent according to the Wright Model.

There is some evidence that the Wright model may understate the probability of recession in a low interest rate environment (as at present). The model emphasizes the nominal level of short-term interest rates and ignores whether these rates are rising or falling. It also does not adequately explain the behavior of the market during the 1966 and 2001 recessions, when interest rates were low.

He who knows others is wise;
He who know himself is enlightened.

~ Lao Tzu