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Sunday, July 26, 2009

MEDIA ALERT: Regular Investors Can Use Professional Traders' Techniques to Know When Recovery Starts -- and What to Do About It

Investors can use traders' techniques to know when a recovery is underway. In particular, they can watch three indicators that traders rely on -- indicators that show that, in spite of the current market rally, a recovery is not here yet.

"Traders, especially currency traders, watch key economic indicators, since economic trends drive currency trading strategies," says Wayne McDonell , a registered Commodities Trading Advisor, Chief Currency Coach of FX Bootcamp ( ), a live forex training organization, and author of "The FX Bootcamp Guide to Strategic and Tactical Forex Trading" (Wiley Trading, September 2008).
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"Investors can use the same indicators for early signs that the economy is beginning to recover," Mr. McDonell says. "Right now, they show that the current rally will fade and the recovery hasn't started -- although we may be near the bottom."

Mr. McDonell is available for interviews and can discuss what the indicators are, what they show, and what investors should watch for:

The Volatility Index (VIX) measures optimism versus fear in the market. VIX is based on data collected by the Chicago Board Options Exchange (CBOE). It gives traders a better understanding of investor sentiment and serves as an early warning sign of possible reversals in the market. What it shows now: "The VIX normally goes up to 40 when times are bad, but during the worst of the current downturn, it went to 90," Mr. McDonell says. "We are currently back around 50 -- but for the picture to look good, it needs to go lower -- to around 25 or 30." "In other words, according to the VIX, the current market rally doesn't mean we've hit bottom," he says. What investors should watch for: Volatility hurts mutual funds in particular, "there will be no long term reversal until mutual fund money is back in the game," he says.

The TED Spread shows the difference between the interest rates on interbank loans and short-term U.S. government debt (T-bills). The interbank loan rate used is the London Interbank Offered Rate or LIBOR. "The TED spread is an indicator of perceived credit risk in the general economy," Mr. McDonell explains. "When the TED spread increases -- when the interbank rate is higher than the T-bill rate -- that's a sign that lenders believe the risk of default on interbank loans is increasing; a decrease in bank defaults lowers the LIBOR and results in the decrease of TED spread." The long-term average TED spread is 30 basis points (3/10 of 1 percent), with a normal high of 50 basis points. What it shows now: In October 2008, as the credit crisis spread, banks were afraid of each other, and the TED spread hit an all-time high of 465 basis points, reflecting high interest rates and an almost total shutdown in interbank lending. Since then, the U.S. Federal Reserve has helped bring the TED spread down by direct support for banks and by encouraging interbank lending. But interest rates on T-bills remain low and have been driven lower by the Fed's $300 billion purchase of 10-year notes, reducing the TED spread below 100 for the first time since the crisis began. There is still room for improvement. What investors should watch for: The TED spread needs to get lower. This will happen as credit markets continue to thaw, and as Treasury yields rise when investors begin to sell their Treasury positions to move money back into the stock market.

The Yield Curve shows the interest that investors can expect from Treasuries over time. A normal curve goes up sharply for short-term T-bills, then levels off more gradually since the yield for medium- and long-term T-notes should stay relatively level, rising only very slowly from the 5-year to the 30-year note. A healthy yield curve starts low with 3-month returns and slopes upward as time to maturity increases all the way up to a 30-year bond. What it shows now: The current Yield Curve is misshapen with a dip in the middle because the Fed's massive purchase of 10-year T-bills drove yields down (interest rates on bonds go down as prices rise). Overall yields are low because of the demand for Treasuries as investors seek shelter from the risks of the stock market. The Fed's actions have flattened the yield curve. What investors should watch for: A return to a normal Yield Curve as money begins to flow back into the stock market and out of Treasuries. Heavy selling of Treasuries will bring interest rates back to normal levels.

Other Signs to Watch

Mr. McDonell advises investors to watch for these additional signs of recovery:

The USD and the JPY falling. The stock market rallying and Treasuries crashing. Gold rising, along with the AUD. (Australia is rich in commodities and will benefit from a mini-commodities boom.)

"Those will be signs that the U.S. economy has hit bottom and investors are moving overseas," Mr. McDonell says. "At that point, smart U.S. equity investors should look to get back into the game."

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