Market Temperature and Spain’s Pain

The S&P500 inched up 0.8% on light volume. For the second week in a row, the 30 day VIX rose slightly, suggesting that more professionals are starting to buy insurance against a general market sell-off over the next month or so.

Other technicals are also hinting at caution. The percent of investors who are bullish has reached heights associated with former short-term tops. The same applies to the percent of firms in the S&P that are above their 150 day moving average; while very high, this indicator is turning down. Insider selling is soaring. The NYSE summation index has been falling for several weeks now. And Treasury prices jumped back up (yields fell). Ironically, many of the same warning signs appeared in the spring of 2010 and 2011. Both times the stock markets sold of about 20%.

In macro news, the string of misses continued to grow. Pending home sales, the Chicago Fed survey, the Dallas Fed survey, consumer confidence, the Richmond Fed manufacturing index, durable goods orders, initial jobless claims, Chicago PMI, and personal income ALL missed expectations. Only consumer sentiment and consumer spending beat estimates. As described last week, the US economy appears to be slowing down.

Spain is back in the news. Last week, its government bond yields soared back up to higher and more troubling levels. The economy is sinking back into recession, and at the end of the week, the new government announced a massive $36 billion deficit reduction plan. Coming a day after almost a million workers held a general strike (shutting down most of the nation’s economy), this plan will shove the economy even further into recession. Meanwhile, Spain’s unemployment rate is pushing 24%, public debt (national and regional) is soaring, and real estate values are plunging. And the Spanish banks that have loaded up on public bonds are staring at implosions not only from collapsing real estate collateral values, but also the possible collapse of their public bond holdings.

Spain is very quickly moving toward disaster.

Meanwhile in the US, markets are positively exuberant. Despite weakening economic indicators, and despite the slowdown of corporate profits from record high levels (relative to sales and GDP), and despite the outflow of Main Street retail investors, the stock markets have continued to rally.

Almost every measure of equity market sentiment, bond market spreads, and overall market psychology are implying that, today, the stock markets are over-bought and over-valued. This means that the risk to being fully invested is excessively high and that the prospective returns are correspondingly low.

Better to wait for lower overall prices before meaningfully increasing equity exposure.

That said, there are individual equities and high yield bonds that have been oversold and could offer the lower risk entry prices and higher prospective returns.

In equities, HP is amazingly oversold and cheap by any common measure of value. In high yield, the coal sector has been thrown out. While many of the leading players are hitting new lows in stock prices, their bonds have also sold off and are now offering huge spreads even for medium term notes. Nibbling on these notes (especially those of the strongest of the coal miners) can provide a relatively safe, and potentially highly rewarding opportunity to capitalize on the sell-off.

At a time when almost everything in US capital markets is highly priced, there are still some securities and sub-sectors that are on sale…..and offering good value.

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