Market Catalysts

July 30, 2011

The S&P500 tumbled almost 4% last week.  This was the biggest drop in a year.  Volume surged, adding validity to the downward price movement.  And volatility soared, also suggesting that the price drop was not some meaningless quirk.

The economic data points weren’t just bad; they were scary.  New home sales slipped, when it was expected to grow.  Durable goods orders dropped, instead of rising as predicted.  While initial jobless claims were reported at just under 400K, they will almost certainly be revised higher.  Chicago PMI fell, instead of holding steady.  Consumer sentiment also fell, this time to its lowest level since March 2009.  And last week’s stunner was the GDP report.  Not only did the Q2 results come in much lower than expected (1.3% vs. 1.9%), but the Q1 results were slashed down to a negligible 0.4%, down from 1.9%.  What’s worse, the GDP was also revised down for the last three years, so that the US economic activity today is still LOWER than it was back at the prior peak in late 2007!  And the government claims that we’ve been recovering for two years now?

Technically, the daily charts are broken, once again.  Not only was the 50 day moving average decisively crossed, but the S&P is now threatening the 200 day.  If the 50 day continues to dip and cross under the 200 (it’s getting very close!), then look for an additional 5% – 10% drop to quickly follow.  But in the very short-term (one to two weeks), the S&P has fallen so hard that it’s actually somewhat oversold.  And a bounce next week would not be out of the question. On the weekly charts, the topping formation that began in March earlier this year is still expressing itself.  What’s also very clear on the weeklies is that there’s a lot of empty “air” beneath today’s prices.  In other words, should another meaningful drop occur over the next month or two, there’s very little obvious support to dampen the fall.

So what sparked last week’s big sell-off?  The near-term catalyst was the US debt ceiling impasse.  It suddenly became clear to the markets that they can’t take for granted that Congress will raise the government debt limit as it has routinely done in the past.

Is this—by itself—a serious problem?  Not even close.  In effect, it’s a political charade where the two parties are playing a game of chicken. And if the ceiling isn’t lifted by August 2, then another 4%-5% drop in the S&P will almost surely end the political games and the ceiling will be lifted.

Does this mean that the markets can relax and resume rallying because some serious problem has been solved.  Yes and no.  Yes, the markets will most likely rally for a bit.  But no, the root problem (massive over-indebtedness in all sectors—corporate, household and government) will not be solved.  The can will merely get kicked down the road….for a short while.

What are the other catalysts that can rock the equity, and other risk, markets?

Sadly, the list is growing.

Near the top of the list is Europe.  And no, it’s not Greece again.  It’s not even Ireland or Portugal (although all three are still ticking time bombs).  Now it’s suddenly Spain and Italy, whose government bond yields have exploded over the last several weeks.  The problem is that Italy and Spain—each—have more debt that the other three PIIGS combined.  Italy and Spain, arguably, could be too big to save for the EU, the ECB and the IMF.  So if Italy and Spain keep falling, then look for an ugly reaction in risk assets globally.

Also on the list is China’s slowing economy.  Recent purchasing managers’ index reports are showing a huge slowdown in orders and general economic activity.  The Chinese stock market is near its lows for the year.  If the US economy keeps tanking, then China’s economy will tank with it.

Linked to China are Canada, Australia and Brazil (for their raw material exports).  All three are showing signs of weakening.  Canada, for example, just reported a drop in GDP, its largest decline in two years. Australia is suffering from a real estate bubble breakdown, one that is just getting started.  Brazil is suffering from an explosion in inflation.  If these three feeder economies start slipping, then there will be negative blow back to the rest of the world.

Finally, Japan is still struggling to recover from its earthquake, tsunami and nuclear disasters from earlier this year.  If the rest of the world continues to slow down, then Japan’s exports will get slammed, most likely shoving Japan’s fragile economy back into recession…..at a time when its government debt load is exploding and its current government (Kan) is teetering.

And there’s more.  Again, these are just the most prominent economic risks that are known.  There are many geo-political risks that are simmering and of course, there’s always the unknown unknown that can strike out of nowhere.

What makes all this all the more serious is the fact that economic stability in the world is very shaky today. So it wouldn’t take much “stress” to stunt economic activity and trigger a meltdown in global markets.

Let’s hope it doesn’t happen, but it’s best to be prepared in case it does.

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Greece Defaults

July 23, 2011

The S&P500 managed to jump 2.2% after the world breathed a sigh of relief upon learning that the Euro elites had succeeded in kicking the can down the road for another few months.  Volume, unfortunately, did not jump up to match the buying enthusiasm most likely expressed by headline-reading algo’s and fast hedge funds; the average retail investor continues to deem the stock market too risky and continues to pull money OUT of the stock market.  Volatility, as would be expected in an up week, backed off, but not nearly back down the recent lows from April and May.

The economic news flow was light last week.  Although housing starts were better than expected, the much larger existing home sales figure badly disappointed; instead of rising as expected, sales fell almost 1% in June vs May, and they fell almost 9% year-over-year.  Housing inventory also jumped. Initial jobless claims rose more than expected, as has been par for the course over the last three months.  The Philly Fed survey missed expectations, again.  And leading economic indicators met expectations.

Technically,  equities are in another uptrend, driven primarily by relief that Euroland will not be imploding…..yet.  While equities are still oversold—on the daily charts—and showing lots of negative divergences, the relief rally could continue for another few weeks…..assuming no large disruptive events interfere with this bounce.  After the sugar high wears off and more important and immediate fundamental reality (such as the global economic slowdown and the absence of monetary and fiscal stimulus to offset it) sets in, equities will promptly resume their fall and this time without the benefit of cheap tricks to prevent painful financial damage.  This should be the “big one” that many bears have been waiting for, a drop that lops off at least 20% from the S&P.

Meanwhile, it finally happened last week: Greece defaulted.  Even though most media headlines decided not to highlight this fact, a few did speak the truth:

http://www.reuters.com/article/2011/07/22/us-eurozone-idUSTRE76I5X620110722

What’s also satisfying is that this call was made here—definitively—in a blog entry titled “Greece Will Default” back in the first half of 2010.

Why did Fitch declare that Greece is in default?  Simply put, Greek government bondholders will not get the return that was originally promised by the government.  The net present value will be lowered. In short, Greek bondholders will not earn the returns that were originally promised.

More importantly, will the latest Greek bailout be THE solution that finally ends the debt crisis of the PIIGS and ends the threat to the euro itself?  In a word, no.  Not even close.’

Nothing has been fixed.  The root problem of excess debt driven by excess spending (in a currency union that prevents devaluation) has not been solved.

The ONLY thing that’s been gained is more time, a longer fuse, before the ultimate ending—the full default of ALL the PIIGS and the end of the euro as we know it today.

So let’s mark this new and much more broad prediction.  The original (Greece will default) prediction came true, over a year after it was made.  The second prediction is no less likely to come to fruition.

The Rubicon has been crossed.  There is NOTHING that can be done to prevent this final devastating outcome, unless of course, all the nations in the euro zone bind themselves together politically the same way all 50 states in the US have done, which is virtually impossible to occur in time to avoid catastrophe.

To repeat, all the PIIGS will default.  The euro as we know it will end.

We’ll be sure to revisit this entry, even if it takes a year or two, to be able to say, once again:  Told You So.


Value vs. (Fed Inspired) Price

July 17, 2011

The S&P500 tumbled 2.1% last week on a notable jump in volume, which serves only to add validity to the price drop.  The VIX (or volatility index) jumped over 22%, also confirming the drop in price.  The schizophrenic action of the stock market continues to play out—after being very overbought two weeks ago, the market has rapidly moved away from that condition.  While it’s not oversold, it’s no longer stretched to the upside as badly as it was only 7 trading days ago.

The macro data took another turn for the worse last week.  The international trade balance came in much worse than expected, suggesting that Q2 GDP will be revised lower.  Core producer and consumer prices were higher than expected. This means that the Fed has much less room to resume QE anytime soon; with core inflation jumping, more QE would only shove inflation even higher.  Initial jobless claims met expectations, but they were still in the solid 400,000 range.  The Empire State manufacturing survey fell again—after it was projected to rebound strongly.  Industrial production was much lower than expected.  And the shocker for the wee was consumer sentiment, which collapsed to 63.8 the lowest level since March 2009 when the latest market lows were being put in.

Technically, the uptrend that began two weeks ago is on the verge of breaking down, but to be fair, it hasn’t done so yet.  Many other momentum, oscillator and breadth indicators are showing continued signs of weakness.  And to be sure, there are little to no signs of technical strength.

So what’s been keeping the stock markets resilient?  They are, after all, only a few small percentage points below their recent cycle highs.

Well, it’s hard not to come back to our friends at the Federal Reserve for the answer.  As mentioned in prior discussions, the correlation between the S&P500 and the Fed’s QE programs has been almost 90%.  And since one is a single decision (QE essentially dictated by Ben Bernanke) and the other is a result of billions of relatively small and rapid transactions, most independent of each other, it’s fair to conclude that the Fed’s action CAUSED the market melt up.

So then, the next question arises—why fight this force?  If the Fed has pushed up prices, then why not just accept them and join the party at Club Stock Market?

But this one is more subtle.  Jeffrey Snider (via ZeroHedge) does a good job separating these two important and very distinct concepts.  He states “successful investment is predicated on buying something valuable before the wider world recognizes that value, with the greatest hope that the rest of the world will see that value.”  Eventually, and almost always, the world does recognize the true value, and price catches up.  In fact, this is the core concept behind Graham and Dodd and their value investing doctrine.  Value is not price.  Determine value, and price will follow.

The Fed, however, is trying to turn this reality upside down.  Per Snider, the Fed has been “ensuring that marketplace actors have enough money to prop up prices”  to “create the illusion of value through price action.  By maintaining high valuations due almost solely to their own purchases, they hope to “attract” additional investors into the process.”

This will fail.  Because per Snider, this trick depends on the public’s continued belief in the infallibility of the central bank.  The instant this belief gets shattered, a deadly game of musical chairs will ensue.  And most participants will not get a chair; they’ll see their stock prices collapse because they were not fast enough to find a chair before the music stopped.

In the end, all taxpayers end up paying for the collapse, because they will be called upon (actually, forced) to recapitalize the Fed when its pump and dump scheme falls apart.

And fall apart it will.  They always do.

While “Central banks are betting the financial health of their constituents on the theory that they can buy prosperity”, history has shown that money printing has never brought true wealth or prosperity.

History shows that the Fed will fail.  The question is simply when.


Jobs: the Ugly Truth about the US Economy

July 9, 2011

For the week, the S&P500 managed to eke out a tiny 0.3% gain, even after suffering from a serious tumble on Friday.  Volume for the week was very light, adding little conviction to the slight price gain. Volatility was unchanged, but still near multi-year lows, suggesting that complacency is reigning.  There’s a lot more “what me, worry?” attitude, than any genuine fear.  From these levels, history suggests that fear and volatility can rise much more than it can fall.

The economic data were much worse than expected, starting with factory orders which rose less than economists had forecast.  The ISM services index fell more than predicted.  Initial jobless claims, at 418,000, were again at levels usually associated with economic slowdowns, not solid growth.  And consumer credit rose, but when Federal government supplied student loans are stripped out, consumer credit actually fell.

Technically, the market’s small rise this week was not unexpected, coming after the previous week’s strong move upward.  But by most technical measures, the S&P500—on the daily charts—is overbought, almost as severely as it was oversold…..only a few short weeks ago.  On the weekly charts, the weak downtrend that began with the Japanese earthquake is still in effect, although this would break if the S&P hits new highs 2011 highs over the next few weeks.

The big news of the week, the shocker, was the June jobs report.  Economist across the world were predicting that over 110,000 new jobs were created.  In fact, there were whispers and rumors that the figure could come in much higher, perhaps even 200,000.

The actual result?

A measly 18,000.

And as bad as this headline number was, the details beneath the surface were just as ugly.  These included:

  • Without the magical Birth/Death jobs (+131K), over 100,000 jobs were actually LOST in June
  • The household survey showed that 445,000 jobs were LOST in June
  • The unemployment rate went UP to 9.2%
  • The broader unemployment measure (U-6) went UP to 16.2%
  • Average hourly earnings stagnated; they were supposed to rise 0.2%
  • The average workweek FELL; it was forecast to remain steady
  • The labor force participation rate FELL to a new 25 year low
  • The employment-population ration also fell to a multi-decade low
  • The average duration of unemployment rose to 39.9 week, an all-time record high

So while the stock markets have been pricing in a “recovery” over the last year or two, this jobs report turns any talk of recovery into a joke.

There has been no true recovery……on Main Street.  Joe Biden, Timothy Geithner, and even President Obama have been touting the “recovery” story for almost two years.

It’s a lie, pure and simple.

It’s a myth designed to placate the public into living their lives with false hope that things will truly get better if they simply “hang in there” for a while.

And for a while this strategy worked, mainly because of the 99 weeks of unemployment checks that citizens have been receiving.  Other “sedatives” include food stamps (now called SNAP) which with about 40 million participants, is at a record high—fully one in seven Americans is on food stamps today.  Other “bones” that the government has thrown the masses is housing support.  Millions of underwater and delinquent homeowners have been living in their homes for almost two years without making a mortgage payment, allowing them to survive despite the loss of employment.

And there’s more.  But the point is that there is NO recovery.

There is instead, a continuation of the recession that began in late 2007.  Simply put, this recession has never ended.

What’s worse, it’s nowhere even close to ending.

Why?

Because NONE of the root problems that led to the original Great Recession, the credit crunch and the global financial crisis has been solved.

Arguably, these festering problems have grown larger, setting the stage for a crisis that could be even worse than the one we witnessed in late 2008 and early 2009.

The stock market has been manipulated upward (the Fed has openly admitted to doing so in the Washington Post in 2010) to fool the public into thinking that things are OK.

Things are not OK.

And one day soon, they’re going to get a hell of a lot worse.  This jobs report is just the tip of the iceberg.


The Bounce

July 2, 2011

Well it finally happened.  The widely anticipated bounce in the S&P500 has arrived, and it was a big one. The index jumped 5.6% last week. The bad news was that volume fell.  This means that the spike in prices didn’t happen because new buyers rushed in (that would be good news and a reason to expect a strong follow through).  Instead, prices rose primarily because short sellers covered there bets, and by doing so, they shoved prices much higher.  So this was a professional, computer-driven reaction that the general public had nothing to do with.

In the economy, the news was mixed.  Personal incomes were lower than expected; spending only met expectations (which were for zero growth, month-over-month).  Worse still, when inflation is factored in, real incomes decreased.  Also, all of the modest increase in nominal incomes came from government transfer payments (think unemployment insurance, for example) which is not sustainable. Consumer confidence fell, when it was expected to rise.  Initial jobless claims also disappointed—again coming in deep into the 400 thousand range.  Consumer sentiment was worse than expected, as was construction spending.  ISM manufacturing was stronger than the regional Fed surveys were hinting it would be, but the dreaded drop in the ISM was probably only postponed until next month.

Technically, the S&P has established a new uptrend on the daily charts.  Last week’s move higher however, was unusual.  As already noted, the swiftness and severity of the rise smacks of short covering, not new and enthusiastic buying.  Also, this surge—though only a week old—has already hit many overbought levels.  It would be very unusual for the pace of this rise to continue.  If anything, a pullback would not be out of the question.

That said, over the next week or so, the power of last week’s rise does suggest that there may be some follow through.  New money, money that was on the sidelines sitting out the prior two month decline, might start to jump in and nibble on stocks.

Sadly, this new buying does nothing to take away the longer range risks, risks that have not only not gone away, but have arguably grown larger.

The Fed’s QE2 money printing program officially ended last week.  This single factor explains as much as 90% of the stock market’s advance from last year.  So with the money pump shut down, the stock markets will be very vulnerable to declines.  The timing between this shut down and stock price declines is tricky.  Last year, after QE1 ended, stocks advanced for another three weeks before turning down in earnest.  This suggests that another couple of weeks of advances should not surprise anyone, and this would mesh well with the technical, momentum follow-through effects pointed out above.

Also, the prime reason for the last week’s surge—the relief that Greece will not default—is far from a true and permanent fix.  The can has merely been kicked down the road, perhaps for only a couple of months, until the early fall, when Greece will need still more money to avoid a default.  And this Greek BandAid does nothing to fix the growing, and possibly explosive, problems in Portugal, Ireland, Spain and now Italy.  Any one of these nations could explode with a financial crisis at any time, judging by their terrifyingly high government bond yields.

So while the S&P500’s 200 day moving average held, as postulated here last week, all of the forces that dragged the S&P down to this support level, in the first place, have not gone away.  At best, they’re taking a short break.  So the need to batten down the hatches has not been eliminated; it’s simply been postponed.