The Bounce and the Waiting Game

May 27, 2012

As predicted, the “very much overdue” bounce arrived last week. But because volume fell, the rise in prices seems to be only that….a bounce within a new downtrend that began several weeks ago. While volatility eased back, it never really reached the crescendo levels almost always associated with climax selling and longer lasting upturns. This also suggests that the downturn and the selling are not over.

On the macro front, existing home sales missed. The Richmond Fed manufacturing survey also missed. New home sales beat expectations, but these are near record low levels, so any modest upturn still leaves mew home sales far from pre-crash levels. The big number of the week was durable goods orders, which missed badly, coming in well below expectations. And ex-transportation, durable goods were a disaster: instead of rising 0.7%, they fell 0.6%. Finally, initial jobless claims were still near 2012 highs at 370,000.

The technicals are still suggesting that the S&P is slightly oversold on the daily charts. In other words, there’s more room for a bounce before the expected selling resumes. From a weekly perspective, the picture is still very bearish. There is far more room for the S&P to drop. And the next test will be the 200 day moving average, which is now near 1,282 on the S&P. Should this not hold then a move down all the way to under 1,200 would be measured level, based on the earlier 2012 peaks near 1,420. So as mentioned last week, the 200 day will be the critically important test.

And in Europe, the waiting game is beginning. Retail deposits are starting to pour out of not only Greece, but now Spain, Ireland, Italy and Portugal. While not yet a full bank run, it’s being described as a bank “jog”. For now, the ECB and national central banks are replacing fleeing money with interstate borrowing. In effect, Germany and its central bank is filling the hole left by fleeing depositors in these periphery states.

The question is how much longer will Germany continue to let this happen. Because if, or now more likely when, a periphery state defaults and/or suffers a chaotic banking crisis, then Germany will be stuck with hundreds of billions in potential losses.

The banking system in the periphery states is insolvent… are the governments of these states. And while the policy makers have been treating the problem as a liquidity crisis, sooner or later the true solvency problem will rear its ugly head.

The policy makers will soon run out of road to further kick the can. This moment appears to be fast approaching.

And the one true solution—where Germany agrees to formally backstop all periphery debt with Eurobonds—looks politically unrealistic, especially in the time needed before the periphery blows up.

So we’re reduced to waiting…..waiting for another liquidity BandAid that buys a little more time until we go KaBoom, or waiting for the actual KaBoom.

In the meantime, many European equity markets are already pricing in the implosion. Spanish and Italian equity markets are at or below their crisis lows of 2009… So investors are able to buy many Spanish and Italian assets at 50% to 70% below peak prices.

If Euroland collapses, then prices will likely fall further, but some of the best bargains in the world are available NOW in Europe.

Much of Europe is on sale today.

When Will The Fed Cry Uncle?

May 19, 2012

Last week was brutal for risk assets, especially equities. The S&P500 dropped 4.3% which was the worst weekly loss of 2012. Volume rose, BUT not dramatically. Volatility rose, BUT not to super high levels. This means that the selling has NOT climaxed. In almost all selling climaxes, when markets reverse and jump back up, both volume and fear typically rise to much higher levels.

In macro news, consumer prices behaved as expected….rising not at all on headline CPI, and rising 0.2% on core CPI. Retail sales, excluding autos, disappointed. While housing starts were better than expected, housing permits missed. Initial jobless claims were worse than predicted. Leading indicators also missed. And the big surprise of the week was the Philly Fed Survey which, instead of rising, fell into negative territory, representing one of the biggest misses in a year.

Technically, the S&P is oversold on the daily charts. It was already slightly oversold last week, but now it’s very oversold. A bounce, even if only temporary, is very much overdue. On the weekly charts, the picture is ugly. The S&P is about to hit the 200 day moving average, which was around 1,278 as of Friday’s close. Should this critical support level not hold, then the US stock markets could be at risk of another severe leg down, very likely down to, or below, 1200 where the markets rallied starting in December 2011. Next week’s trading will be critical.

So now that the S&P500 is down about 8% since the end of March, the question on everyone’s mind is: how much more damage will the Fed allow before stepping in with more monetary “easing”, or financial repression by either creating credit money (via quantitative easing), or by shoving long-term rates down even further from their current 50 year lows (via Operation Twist)?

The answer to this question is critical to trading and investment decision-making. If you think that the Fed will not allow much more damage, then now is the time to “buy the dip’, by loading up on beat up stocks and high yield credit.

If you think that a total drop more in line with the spring 2010 and spring 2011 drops is needed (18%-20%), then now is not the time to buy, but to exit from winning positions and even to enter into short positions. Since there’s another 10%+ drop ahead of you, it’s much too early to buy now.

But there’s another problem. Over the last three years, the “effect” of the Fed’s monetary programs has been dwindling. QE1 in late 2008 and 2009 had the most effect, in terms of boosting asset prices. QE2 in 2010 had less effect, and Operation Twist in 2011 has had even less effect. Just as bad is the trend in the “duration” of the effect. QE1 worked its magic for about over a year. But QE2 boosted prices for under a year, and Operation Twist has had, arguably, the shortest effect.

So the question is, even when the Fed initiates its next stimulus program (whether it’s soon, or after another 10%+ drop in equity prices), is it possible that the effect will be very minor, and fleeting?

What if the spark that shoves asset prices further down comes from Europe, say Greece leaving the Eurozone and repudiating all its sovereign debts, leading to a disorderly default, a banking crisis, and numerous spillover effects across the rest of Europe, and even the world?

Will the Fed’s magic have the same effect….as it did in 2008-09, 2010 and 2011?

Here’s a piece of advice—don’t hold your breath.

Don’t Forget Gold…..and Silver

May 12, 2012

The S&P500 dropped another 1.15% last week, after falling even harder the previous week. This time, volume rose, which adds validity to the price drop. Also, volatility inched higher, suggesting that investor complacency—while still unusually low—is gradually wearing off.  After this latest price drop, the US equity markets look like they’re moving to the bearish side of the tipping point discussed here last week. Even though a short-term bounce is possible, further selling is looking more and more likely.

The US macro data continues to disappoint, implying that the US economy is stalling, if not headed for a double dip recession. Wholesale trade grew at half the rate predicted by economists. International trade results were horrible; these will directly reduce upcoming GDP growth figures. Initial jobless claims were worse than expected. Only consumer sentiment, a number seemingly pulled out of left field, rose more than expected.

Technically, the S&P is somewhat oversold on a short-term basis; this is visible on the daily charts. Longer term, using a weekly charts covering several years, the S&P is turning down and the risk is that the downside is large—there’s a lot of “air” beneath the current price levels and while many intermediate support levels lie below, these support levels are not that strong and could break down quickly until much lower prices are reached.

And if US stocks do continue falling over the next one, two or three months, then remember that other risk assets will very likely fall too (only US Treasuries and the US dollar stand to rise in the face of a major “Risk Off” episode).

Gold, and silver, for example will most likely get whacked. The price of gold could fall to, or even below) $1,500. Silver could fall much more dramatically, in percentage terms, to $25, or even$20 if the selling in risk assets were strong enough.

And just as with equities, a brutal sell-off in precious metals should be embraced, not feared. If gold and silver were to go “on sale” it’s important to be prepared to buy more, not to freeze in panic and just watch, or even worse, to sell at low prices.

The smartest money will be thanking their lucky stars if stocks and metals (and other assets) go on “clearance sale” and will be buying with both hands.

So as difficult as it may be, financially and psychologically, prepare now for this possible opportunity to buy gold and silver.

Why buy more gold and silver?

Precisely because the key reason behind its decade old price appreciation has not ended…..and shows no signs of ending anytime in the near future:  the Fed will keep real interest rates negative.

And if risk assets sell off badly enough, the Fed (through another round of QE) could drive real rates even more deeply into negative territory.

So if you own US Treasuries yielding 1.5% while associated inflation is 2.5%, then you’ll be losing money after inflation and even more so, after taxes are factored in.

In this situation, gold and silver will ultimately preserve real value, perhaps even delivering positive real returns.

And if these metals plunge in price during a general risk sell off, there will be no better time to buy more in preparation for the inevitable rebound in prices.

Remember, be your own central bank—buy gold….and silver.

Tipping Point?

May 6, 2012

The S&P500 dropped 2.44% last week, the largest weekly loss of 2012. Volume was not huge. One the one hand, this suggests that there wasn’t a lot of conviction behind the selling; on the other hand, this may suggest that complacency is still intact and that if this sentiment changes, downside volume could pick up notably. Reinforcing the complacency argument is the VIX index. While it did jump about 17% it closed the week at a relatively mild 19. By no means, is there any real fear in the equity markets. Yet.

In macro news, the story of the week was jobs. The payrolls number missed, badly. The labor force participation rate fell, and thousands of folks left the workforce. The so-called recovery is clearly showing signs of stalling. To add insult to injury, ISM services also missed badly, as did construction spending. Personal spending was lower than expected; personal income was slightly greater (even if this number is massively propped up by US government transfer payments). The Chicago PMI also missed badly.

Technically, the S&P500 sits on the edge of much deeper losses. Both the daily and weekly charts look like they’re about to break down. The is very worrisome because both short and medium term perspectives seem to be screaming the same thing—look out below!

Aside from the bad US economic news, the world is looking to France and Greece and their national elections over the weekend. In both states, there is a great fear that incumbent politicians—politicians that have been supportive of the Euro and austerity on their respective citizenry—will be thrown out. If this happens, then the entire Euro project becomes more prone to dissolving. Why? Because if the citizenry of each member state become fed up with incurring pain to save the banks, then they would be implicitly saying no to the euro. Because leaving the euro would be—ultimately—the only truly effective way to end the top-down imposed austerity.

This doesn’t mean that a defecting state wouldn’t incur a great deal of short-term pain (of course it would) but it does mean that people are reaching the limits of suffering for the benefit of the ruling financial elites.

Like Iceland, which said NO to the banksters, a defecting state could begin traveling down the road to true recovery by refusing to pay for the losses of others. Iceland is impressing economists world-wide with its strong growth rates and declining unemployment rates. Iceland is still far from returning to GDP levels enjoyed before the global financial crisis began in 2007, but it’s on its way.

Soon, we will see if Greece, Portugal, Spain, or some other state chooses to follow Iceland’s lead. And if this weekend’s elections turn out the way that polls suggest they will, then Europe could be in for a messy and tumultuous summer.

Risk markets, especially equities, would not be happy.