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April 2nd, 2010 @ 8:07 pm by Matt "NewstraderFX" Carniol

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Good Friday’s Non-Farm Payrolls report showed that more jobs (162,000) were created in March than for any month in the past three years. Private payrolls (excluding 39,000 governments jobs) increased by 123,000, the third consecutive increase. All told, the January and February job counts were increased by a combined 62,000, putting the March gain at 224,000 when added together, including  temporary workers hired for the 2010 census.

Employment of private temporary workers, considered to be a leading indicator of permanent hiring, climbed in March for a sixth consecutive month but their share in the payroll count is diminishing, showing companies are becoming more optimistic.

The report will have important implications for a variety of asset classes, so let’s look at what could happen.

S&P

Stocks are likely to remain on the upswing that began in March 2009 as the S&P 500 moves inevitably to the pre-Lehman collapse level of around 1250. In the beginning of the year, I said that the S&P would hit this level by the end of the first quarter and while that didn’t happen, this important benchmark is bound to be reached soon. Simply put, stocks have followed the improving trend in jobs for months and there’s no reason to believe that will change now.

The Dollar

In my opinion, because the recovery appears to be gaining strength, the Fed will drop the “extended period” language by the end of this quarter, possibly at the June meeting, and make its first move before the year ends. The reason is that the Central Bank moved to a 0%-0.25% interest rate policy under “emergency” conditions which no longer exist, and a symbolic move away from this extraordinary stance will serve as a signal to the market that officials are gaining confidence in the recovery.

As the market moves to this perception, the dollar will gain against the pound, aussie and yen. The big move figures to come against the euro because, due to the fiscal problems affecting Greece, Ireland, Spain, Portugal and Italy, the ECB will be among the last Central Banks to make a move on rates. The yen seems destined to head towards 100 to the dollar as Japanese investors seek better returns abroad and because Japan’s currency should assume its role as the major funding vehicle for carry trades.

Treasuries

Rates on government debt will continue to move up as the recovery gains momentum. We’ve already see the 10 year note surpass 3.9%, and a move above 4% by the summer will no doubt be seen. That’s going to affect mortgage rates, which could finish the year around 5.5% for 30 year loans.

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August 11th, 2009 @ 10:32 pm by Matt "NewstraderFX" Carniol

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Fed heads like me will be parsing the FOMC statement on Wednesday for clues regarding the future of monetary policy, which naturally will affect the valuations of all asset classes including currencies, stocks, and commodities. The first thing that any Fed watcher does is to look for changes from the previous statement, so let’s break it down to the three main areas of interest.

Interest Rates

No one expects interest rates to change on Wednesday, but it will be important to see if the language regarding the need for “exceptionally low levels of the federal funds rate for an extended period” is retained. The odds are that it will be however, expect to see the dollar gain as traders in Fed Funds Futures price in a rate hike perhaps as soon as December if it isn’t. One of the world’s great Fed watchers, Bill Gross of PIMCO, is of the belief that the Fed won’t be making a move on rates until well into 2010, if then.

Inflation

Because of the output gap, the difference between potential and actual GDP, the Fed is of the belief that “substantial resource slack is likely to dampen cost pressures,” and that “inflation will remain subdued for some time.”  (By “resource slack,” the FOMC is referring to the amount of workers who are unemployed).

Be aware that when the Fed talks about inflation what they really are most concerned about is the potential for a wage-price spiral as seen during the 1970’s. The reality is that there’s very little chance of seeing that occur anytime over the next several years. For one thing, there are much fewer unionized workers. Second, and even more important, there obviously is an oversupply of workers relative to the amount of jobs available which means there’s little pricing power among employees. Third, companies don’t need to hire more workers because contrary to what usually happens when companies eliminate jobs, productivity (worker output per hour) is rising (6.4% in Q2 on an annualized basis according to Tuesday’s report). Aside from that, the report also indicated that labor costs fell the most in eight years over the period.

Economic Growth

Most economists, including such luminaries as Paul Krugman and Nouriel Roubini, believe the economy has bottomed although in the case of Roubini the opinion is that the economy will remain in recession through the end of the year. The Fed itself was fairly sanguine about the prospects for economic growth in June, saying that “policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will contribute to a gradual resumption of sustainable economic growth in a context of price stability.” Nothing has really happened since June 24 to change that outlook given the improvements seen in the ISM’s, housing, Q2 GDP along with the July jobs report and unemployment rate, so expect to see a similar opinion expressed in Wednesday’s statement.

Putting these three together really indicates that a sweet spot exists for stocks, because the economy is set to improve while policy looks to remain expansionary as inflation remains low. The latter point is especially important because it means that in real terms (taking inflation into account), any percentage gains will be that much higher, i.e. that the purchasing power of the dollars you receive when you cash in your investments will not have eroded to an appreciable degree.

Those factors certainly have been great for stock investors; the S&P has gained nearly 12% since the FOMC met on June 24. The problem is that for forex traders, the concurrent movement in the dollar (short) against the euro, pound and A$ hasn’t been quite as pronounced during that period although those currencies did make significant moves against the yen (they have made significant gains on the USD overall since March). Also of note is that USD/JPY, which basically mirrored S&P movements for several years, hasn’t done anything of note since the March rally although it the yen does gain rather dependably on days when stocks retreat.

The Fed may also make a decision regarding whether to extend its $300B program to purchase Treasuries. If they choose not to continuing purchasing U.S. debt it could cause interest rates to rise, which will tend to put downward pressure on the dollar. Also, Congress wants the Fed to extend its program to purchase commercial mortgage backed securities for another year, so look for the FOMC to comment on that.

Commercial real estate is likely to present the biggest obstacle to economic growth over the medium term. There’s a crisis looming there because of the inability of property owners to refinance debt which is coming due. Rents and property values have fallen dramatically, which means that there will be less income available to service the debt and that banks will require any loans they do make to have lower loan to value ratios.  Property values are forecast to remain depressed which means that many owners are underwater on their mortgages, another recipe for rising foreclosure rates.

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July 27th, 2009 @ 1:36 pm by Matt "NewstraderFX" Carniol

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To become a really great trader takes more than smarts; it also requires you to make a cold, hard assessment of your strengths and weaknesses. You have to know exactly what you can and cannot do, trade to what you can, and not let your weakness dominate. The following lesson from Warren Buffett should be instructive in this regard.

Back in September of 2008, Goldman Sachs was looking for a “stamp of approval” so the company turned to probably the most famous and respected trader in the world, Warren Buffett. Goldman agreed to pay Mr. Buffett an extraordinary rate of interest-10% a year on $5 billion worth of preferred shares.  Buffett however wasn’t satisfied with that-he insisted on obtaining warrants which gave him the right to purchase Goldman stock for $115 per share, about where the stock was trading at the time.  In fact, Buffett never would have gotten into the Goldman investment in the first place without receiving the warrants-they were a “kicker” on the deal that he absolutely insisted upon.

Buffett probably could have negotiated a better price for the warrants because remember, it was Goldman who came looking for Buffett, not the other way around. Here’s where it gets interesting.

As Mr. Buffett has often said, he’s a long term investor with no ability whatsoever to trade in the short term. But he doesn’t let his inability to trade in the short term (his weakness) get in the way of his long term trading ability (his strength). Within three months of making the $115/share deal, Goldman was trading at about $52, making the warrants virtually worthless because no one is going to exercise the right to buy something at a loss. Aside from that, the deal looked even worse because remember that Buffett never would have bought the preferreds without the warrants in the first place.

When Goldman sank to $52, Warren Buffett didn’t turn tail and run by cashing in his preferreds because they now were attached to worthless warrants. In other words, he didn’t let himself get stopped out of the trade. Why? Because Warren Buffett was trading to his strength-the long term; he wasn’t going to let a short term fluctuation (which he admittedly has no ability to trade anyway) interfere with what he knows to be his greatest abilities.

In the meantime, Goldman closed at about $162 on Friday, meaning that Mr. Buffett is up around 40% on those warrants. And he’s still getting paid 10% a year on his preferred shares.

What would have made this trade even more difficult for mere mortals is that his positions were played out all over the financial press. And although I don’t have the exact quotes, I distinctly remember an article on CNBC which postulated that the “old boy had lost his touch” when Goldman’s price was declining. Meanwhile, Buffett had warned during an interview that it always was possible (one could argue probable) that he might get things very wrong in he short term.

So, what are the trading lessons here? First, you always want to trade to your strengths. If you have a system that works for you, stick with it. If you don’t, get one that does. Second, if Warren Buffett is one of the world’s great traders, and he sometimes has to hold a trade at a loss in order to eventually become profitable, chances are that you and I are going to have to be able to do the same thing. Most importantly, don’t get into a trade if you aren’t willing to hold a loss and don’t get into a trade if having a loss is going to make you believe that your original opinion was wrong to the point where it forces you to close your position. Those are pretty high standards-it probably means that you’re going to have less trades but it also probably means that the ones you have will be that much more successful.

On a different subject, here’s why stabilization in U.S. housing along with rising equity markets are so vital to a global economic recovery.

U.S. homes prices lead the way because they’re the ultimate collateral for the $11 trillion of US home mortgage debt, a significant share of which is held in the form of asset-backed securities by foreigners. Some economists are now saying that prices appear to be stabilizing (even though they could drift a bit lower into 2010) due to the decline of inventory overhang being brought about by the sharp drop in the number of new homes coming onto the market.

Rising stock markets are a major contributor to global business activity in two major ways. First, rising share prices will lead to increased household wealth and spending. We’re seeing this happen in China, where a 50% increase in stock markets has led the way to a 30% rise in consumption on the part of consumers. Second, as the market value of existing corporate assets (proxied by stock prices) relative to their replacement costs grow, it will make economic sense for business to make new capital investment, a significant driver of GDP.

One factor that is likely to remain as a huge driver of improving equity prices is the continued policy of monetary expansion. During a Town Hall interview with PBS on Sunday night, Fed Chairman Bernanke retained the dovish outlook displayed in his Congressional testimony last week by implying that the emergency liquidity programs will be unwound only when there is certainty of economic recovery while reiterating his expectation of low inflationary pressure over the next couple of years. He also forecasted unemployment above 10% and suggested that the first half 2010 may not mark the peak jobless rate, meaning that at this time the Fed is not expecting to raise borrowing costs until well into 2010 and possibly later.

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July 15th, 2009 @ 2:13 pm by Matt "NewstraderFX" Carniol

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There are  times when deciding not to trade is the best trade you can make and right now appears to be one of those times. I know, I know, there are a certain number of you guys out there who claim to be very nimble when the market is moving sideways (as it has been over the past 6 weeks or so) but for the vast majority of traders (me included), sideways movement is just too hard to deal with. The problem is that staying on the sidelines is difficult for many to do because they develop a syndrome I call ‘trader’s finger,’ which means your finger gets itchy to push the buy or sell button.

It’s very important to resist the urge to trade just for trading’s sake or because you feel you have to “do something” like earn a certain amount of pips each week.  I haven’t taken a trade since I saw the markets moving sideways weeks ago and I’m feeling better about my decision every day.

I can’t feel comfortable in a trade if I don’t have a clear idea of where the market will be in a few weeks or months and what’s even more important is that I’ve avoided putting myself through the mental anguish of making bad trading decisions and losing money, which I hate to do and which I know is inevitable when markets get choppy.

Basically, I have the same goal in trading that I have when I get in my car, which is to not get into an accident. The way I look at it, as long as I avoid crashing, the odds are a lot higher that I’ll eventually get to my destination.

What’s interesting is that over the past few weeks I’ve seen so many “professional” opinions on Bloomberg or wherever turn out to be totally wrong. Even good ‘ole Marc Faber, one of my favorite people, appears to have gotten things incorrect when he said 2 weeks again that the dollar was set to gain over the next two months or so. Since then, he might be ahead a little bit but what’s more likely is that all the back and forth movement has caused him a lot of aggravation.

Now, Marc Faber is probably one of the world’s great traders but even he looked to be suffering from trader’s finger during his last Bloomberg interview. Back in March when markets were really crashing, he seemed to go out of his way to say that stocks were set to rally-and that turned out to be one of the year’s great calls. He didn’t have quite the same confidence 2 weeks ago however-in fact, it looked more like he was saying something in order to justify being interviewed. After all, it’s hard to get in front of the cameras and advise people to stay on the sidelines!

But when you think about it, why should that be so? I know that I put just as much effort into making a judgment not to trade as I did when I called a 1000 pip short trade on the pound last summer (my “Four Figure Trade” article), or when I went long on GBP/JPY and AUD/JPY in May (see twitter) and made about 900 pips over 4 days, or when I made about 400% on some A$ options (twitter again) between April and May.

Now, what am I looking for that could start a trend? Simple really if you use some logic. Let me ask you a question.

Is it not true that all of the fiscal and monetary policies have been put in place because the economy is in an emergency situation? Of course it is. So then doesn’t it follow that if and when the signs are given that these extraordinary policies can begin to be withdrawn it indicates that conditions are improving and will continue to do so? I would think so. In fact, I was hoping against hope that the G8 might signal just that last week but unfortunately, they did just the opposite when they said that now is not the time to begin withdrawing liquidity. Apparently, they weren’t in a “green shoots’ mood in Italy (although we did learn that Obama has a preference for satin-clad booty…lol).

Likewise, when economists like Paul Krugman are talking about the need for a second stimulus, that doesn’t exactly instill much confidence in me that the economy is set to improve in a meaningful way any time soon. And when I hear Nouriel Roubini talking about unemployment going to 11%, an anemic recovery and the chance of a double dip recession along with housing prices falling another 20%, somehow it just doesn’t put me in the mood to buy and hold for the long term.

In fact, I think that professor Roubini helped put the kibosh on the spring rally, so what we need to see is some data proving his opinions on the economy are wrong (a tall order, I know). So, it would be great to see new unemployment claims fall below 500K per week and for the number of continuing claims to stop making fresh records with each report. Stabilization of housing prices as measured by the S&P/Case-Schiller Home Price Index would be helpful. The ISM’s above 50 would be very significant.

Obviously it’s going to take some time to see these data points materialize but what I’m also going to be looking for are any surprises like Bernanke announcing the Fed was “electronically” printing dollars. Listening to what’s being said at Jackson Hole next month could prove to be valuable.

Also, check the Fed’s H.4.1 report each week, specifically the line regarding the amount of deposits commercial banks are holding at the Fed banks under liabilities. In normal times there’s about $14B or so on deposit being kept there because of reserve requirements but at the height of the crisis banks were hoarding nearly $1T .

All that money sitting at the Fed means  the banks aren’t lending (or doing very little lending). We need to see that trend towards normalization because as the amount on deposit decreases, the velocity of money increases as banks make more and more loans.  The amount kept on deposit decreased to about $625B just before stocks took in March but increased to about $900B during the stress tests, so I would like to see it get at least to that level (and decrease further) again.

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July 13th, 2009 @ 11:44 am by Matt "NewstraderFX" Carniol

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There were two very good articles (actually, one is a thread in the forum section) posted on FF recently that I thought had a lot of relevance for traders. What I’d like to do here is expand on both and tie them together because I think there are some very valuable forex trading lessons to be had. The first was an article posted by Piptrain called “How The USD/JPY Can Predict The End Of The Recession” and the thread that caught my attention was called “Giving Up” by Jimmy Jones.

Piptrain made the very astute observation that USD/JPY had gone from being a co-incident to a leading indicator for the S&P. This is incredibly important because if you know the market is setting up to be in either a “risk on” or risk off” trend, you can enter some trades with potentially huge returns.

To review, “risk on” means investors are buying riskier assets like stocks and commodities as they sell the safe ones-the USD and Treasury’s. Risk off is of course the opposite. The market went into severe risk off mode after Lehman Bros. collapsed last September and we’ve now come to the end of the risk on rally that Bernanke ignited in March.

What also happens when the market is in risk on mode is that the yen falls as traders sell it against the (formally) higher-yielding currencies. At least, that was the case until USD/JPY apparently became a leading indicator of the market’s appetite for risk.

USD/JPY (as well as the other yen crosses) had basically been falling right along with the S&P ever since the market peaked in October 2007 and the move into the yen accelerated when global stock markets collapsed through last Fall after the Lehman bust.  But starting at the beginning of 2009, things changed.

USD/JPY started appreciating in January even as the S&P headed lower, making a bullish divergence just as the MACD sometimes does. The way things look now, what USD/JPY was telling us was that the market was setting up to be in risk on mode; the only thing it needed was the right fundamental catalyst which it got on March 15 when Fed Chairman Bernanke went on 60 Minutes and announced the Central Bank was “electronically” printing dollars. Active depreciation of the dollar is a pretty sure way to ignite a stock rally because if the dollar looks set to depreciate, anything you buy with it (like stocks and commodities) has to gain in nominal if not real terms.

Even more interesting is that during most of the recent rally, USD/JPY was going down-in other words, it was making a bearish divergence, signaling that the rally could only go so far because investors were not truly buying risk. All it needed to completely kill it off was perhaps something like the poor NFP report we got 2 weeks ago.

An even stronger indication that the market is moving into full risk off mode is that USD/JPY is continuing to depreciate even as stocks head lower-in other words, it isn’t making a bullish divergence now which is entirely justified especially after all the recent talk about deflation being a bigger concern than inflation along with the G8 saying that now is not the time to begin withdrawing the extraordinary monetary and fiscal policies that have been implemented during the crisis.

So what can be gained from this?

  1. It does indeed look like stocks and commodities are headed lower, which means the dollar will gain against the higher-yielding euro, pound and A$.
  2. If stocks do go down and USD/JPY starts showing a bullish divergence, we’ll know the market is at least prepared to gain given the right set of economic fundamentals.
  3. If stocks eventually gain and USD/JPY shows a bearish divergence, stay ready for an eventual decline
  4. If USD/JPY gains along with stocks, the rally probably has legs.

Giving Up

Jimmy Jones is talking about giving up trading because after finding success during the rally, he’s found things to be very difficult more recently. The exact reason why Jimmy Jones has found it so difficult to trade lately is because the market entered a consolidation period where price moved back and forth but did not trend. Trading is relatively easy when markets are trending because you can “set and forget” or even take profits along the way and buy on dips (in an up-trending, risk on market) or sell on strength in a down trend. But when markets are moving sideways, as they have been over the past few weeks, it’s very easy to see your account get shredded.

Trend following systems like moving average cross-overs all share the same characteristics-they look good in a trending market but fail utterly when markets are moving sideways. They cannot tell you when a trend will end and they certainly can’t tell you when markets will go sideways, which as we know are the most difficult markets to trade. In fact, sideways markets are the main reason why so many forex traders fail.

There are some traders who claim to be good in these types of markets but for the vast majority of us (myself included), they’re just too hard. I basically avoid them like the plague and if that means I don’t have trades for a few days, weeks, or even months-fine. I’ll keep my powder dry for the time when I believe markets can trend. In other words, the decision not to trade is a trade itself.

The only way to avoid this type of price movement is to be an astute observer of what’s happening with the markets in terms of the willingness to buy (or sell) risk and what makes that especially hard is that is that different circumstances create a different set of conditions. For example, what killed the March rally in my opinion was all the talk about deflation from people like Bill Gross of PIMCO, economist Nouriel Roubini and FOMC member Janet Yellen. Why? Because if deflation is truly the risk, the dollar is not likely to depreciate which means the risky assets bought with it (stocks and commodities) are not likely to gain.

I’m not saying this is easy. You have to do your homework. But being aware of what’s going on will help you spot when the trends might start and more importantly, end.

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July 10th, 2009 @ 3:29 am by Matt "NewstraderFX" Carniol

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Fed Chairman Bernanke’s little stock rally, which was initiated when he announced on 60 Minutes that the Fed was “electronically’ printing dollars, has apparently come to an end (at least for now). As a currency trader and market observer, you’ll want to know why and the reason has to do with the most famous currency pair you’ve never heard of. Ready? It’s called…

S&P/USD

That the dollar moves inversely to riskier assets like stocks (and commodities as well) isn’t a matter of some kind of mystical correlation that can somehow “break.” The key to knowing this is to understand what really is happening when stocks (or commodities) appreciate, which is easy to see once you accept the existence of S&P/USD.

Look at it this way; when stocks go up, what are they going up against? The dollar of course. The same for goes for commodities because those are priced in dollars all over the world. Well, if these riskier assets have gone up, isn’t it than also true to say the dollar has depreciated. Absolutely. So when the market is buying risk, the dollar will tend to fall as a matter of due course.

What’s really interesting is that in the rare instance (like now) when the Fed is actively trying to devalue the dollar (because the economy is faced was the more serious threat of deflation), the Fed can create a stock rally just as Bernanke intended to do by admitting to the electronic printing of dollars on national television. Why? Because if you are convinced the dollar is going to depreciate, doesn’t that also mean that anything you can buy with it is going to be more expensive? Of course. And the convinced you become that the prices of liquid assets (like stocks and commodities) are going to rise, the more inclined you will be to buy them.

So what’s really happening in the current environment is that the Fed, through its actions and comments on the dollar (and on deflation/inflation which is the same thing) is pushing the market for riskier asset classes up and down. Let’s look at some recent action.

Bernanke’s rally pretty much fizzled out in the middle of May, but it got a temporary boost (about 4%) in the week following the last meeting on June 24 when members removed the deflationary concerns which had appeared in the April 29th statement. But then something interesting happened.

On June 30, San Francisco Federal Reserve Bank President Janet Yellen expressed some deep concerns about deflation. “I’ll put my cards on the table right away,” she said. “I think the predominant risk is that inflation will be too low, not too high, over the next several years.”

Now, remember what we said; if the market is convinced the Fed is depreciating (creating inflation), riskier assets are going to be bought because inflation means their prices are going to rise (at least nominally). No one wants to hold cash if the potential for inflation is on the horizon, because cash is guaranteed to lose value in an inflationary environment.

Conversely, if inflation really isn’t a threat and the possibility of deflation exists, there’s no reason whatsoever to buy riskier assets. Afterall, your cash is guaranteed to increase in value in a deflationary environment because prices are going down!

In fact, in a deflationary environment you make more money simply by being a “lender” (keeping for money in the bank or in Treasuries). A little arithmetic will show you how this works.

Your real (inflation adjusted) rate of interest is equal to the nominal rate (what the bank is paying you) minus the rate of inflation or R = N – i.

Let’s say inflation is 3% and your bank is paying you a nominal 4% on your deposit. Your real (R) interest rate is the Nominal (N) rate minus inflation or R = 4% – 3% which equals 1%. In real terms you’ve only earned 1% on the money you have in the bank

Now, let’s say there’s deflation (negative inflation) of -2% for the year and your bank is paying you a nominal rate of 3% on your deposit. What’s the real rate of interest you’ve earned?

R = N – I or R = 3 – (-2) = 5%. In real terms, you’ve earned 5% on your deposit!

Now, if I’m guaranteed to earn a risk-free return of say 5%, and I think prices are going down, why in the world would I buy a riskier asset? In the hope that someday its price might go up? Hope is a bad rational for making a trade.

So, Ms. Yellen, with her deflationary concerns, helped kill the rally. She wasn’t alone however; the Fed, with its expert manipulation of the media via the pundits seen all over Bloomberg, started so make plenty of deflationary noises around the middle of May.

As a trader, there are times when you can put this to very good use for longer term trends (which really is where the money is made). If the Fed does start talking about inflation and making noises like it might raise interest rates, do yourself a favor and sell the dollar as you buy riskier assets like stocks and commodities.  But if they continue to talk about the risks of deflation, there’s little reason to sell the dollar or to buy riskier assets. Buy the dollar at that point because it will be in demand.

BTW, Thursday’s weak market action off the surprisingly good unemployment numbers, along with the subsequent decline of S&P futures overnight, bodes very poorly for stocks and very good for the dollar. I can hardly think of a more bearish sign for stocks than the market failing to rally on good news. Afterall, it the market can’t rise when the news is good…

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