Euro Crisis Solved? Hardly.

June 30, 2012

The S&P 500 climbed 2.0% last week, but on declining volume, which is hardly a ringing endorsement of the price jump. And volatility, while it did inch lower, did not drop nearly as much as one would expect from such a sizable price rise. On a daily basis, the S&P is now slightly overbought. Breadth indicators are also very stretched; the McClellan oscillator closed the week at a level so extreme, it’s been reached only three other times in the last three years. In every prior case, the stock market pulled back markedly, over the following two weeks, after reaching this level.

Macro news continues to be weak. About the only bright spot is housing, and not because it’s roaring back, but only because it’s not falling any more, at least for now. New home sales inched higher. The Case-Shiller home price index finally turned positive, but it usually does every spring. And pending home sales beat expectations. That said, most other areas in the US economy disappointed. Durable goods orders ex-transportation were far lower than predicted. Initial jobless claims climbed even higher, even as most of the millions of people who enjoyed 99 weeks of benefits over the last two years have fallen out of the program. Personal income missed expectations. Chicago PMI disappointed, and so did consumer sentiment.

But none of these grim facts mattered to stocks. Why? Because Europe held its umpteenth summit and announced another “solution” to the banking and sovereign crisis, which is currently centered over Spain.

Supposedly, Spain’s banks will be able to get billions of euros in support, but without the conditions that were attached to bailouts for Greece, Portugal and Ireland. And the bailout funds may not necessarily subordinate existing bondholders.

But many details were left out….as usual. But such details were exactly what caused every prior summit “solution” to fail over the last two years.

And this solution will be no different. Sure it will cause a spike in stock prices in the very short term, and this has already started.

But because the fundamental problems (excess debt and a trade imbalance between the core and the periphery) in Europe have NOT been solved, this summit announcement is no true solution.

Once the markets have a chance to digest the details, they’ll figure out that nothing has been solved. And the exact same thing—that happened after EVERY prior solution was digested—will happen: the risk markets will sell off.  This could take a few weeks to occur, but it will happen.

In the meantime, long investors should enjoy the ride, but be prepared to reverse themselves not if, but when, the euphoria wears off.

Watch Out for Lower US Corporate Earnings

June 23, 2012

In the end, the Fed disappointed. While Operation Twist was extended, no QE3 was announced. And that’s what the markets had expected. So sure enough, risk assets sold off. Surprisingly, stocks did not sell off all that much, at least not yet. The S&P ended the week down almost 0.6%. Volume rose. But volatility did not; the VIX fell slightly, suggesting that growing complacency among investors and traders.

The conventional wisdom is that the markets simply hadn’t fallen far enough for the Fed to have enough political cover to launch another round of quantitative easing. Therefore, therefore there’s no need to panic, because as soon as things get worse, then—surely—the Fed will come to the rescue. Surely.

The macro data in the US continues to deteriorate. It’s getting so bad that it wouldn’t be surprising if the NBER, 6 to 12 months from now, declared that a recession had started in the second quarter of 2012. Specifically, housing starts fell; they were supposed to rise. Initial jobless claims rose….again….this time to just under 390,000. Existing home sales disappointed. And the Philly Fed survey missed badly.

Meanwhile, overseas, Europe is still stuck in recession, with Germany being the last of the strong leaders to succumb. India is sinking. China is struggling, and new revelations are suggesting that actual economic activity is far lower than what’s been officially reported. Brazil is slowing rapidly. As the price of oil collapses, so does Russia’s economy. And anyone else supplying China—think Australia and Canada—with raw materials is also showing signs of weakness.

But US stock prices have been holding up, remarkably. While the rest of the world is down 15%-30% from most recent peaks, the US stock market is off only about 5% from its April highs.

So the question is can this relative out-performance continue?

Well not if US corporate earnings start to break down. And that’s exactly what’s been happening. According to Goldman Sachs, a wave of negative earnings pre-announcements has been sweeping across the market. While the reasons for the lowered guidance varies, the spectrum of firms slashing forecasts is broad. The firms include: Proctor & Gamble, Texas Instruments, FedEx, Bed Bath & Beyond, Nucor, Ryder Systems, Adobe and Starbucks.

The bottom line is this—unless P/E multiples suddenly start expanding (and they’ve been contracting roughly for about 10 years now), then stock prices and the overall market is looking like it’s headed for a more meaningful correction.

Which of course, brings up our friends at the Fed. For as soon as any meaningful correction materializes, then—and only then—can we count on the Fed to act more forcefully, with QE3 or some other scheme whereby it prints new money and injects it into the risk asset markets (if history is any guide, then most of this new money will not flow to the general economy and Main Street), pumping stock prices right back up to where they were, or better yet, even higher.

Main Street will keep suffering. Wall Street will cheer.


A Rally In Advance of Central Bank Stimulus

June 16, 2012

As expected, the S&P500 climbed 1.3% last week, because the short-term uptrend that was established the prior week was still in effect. But the rise in prices wasn’t as strong as the 3.7% rise the week before, so momentum is weakening. And this is backed up by a decline in volume. Also, volatility barely changed; this also suggests that upward price movement is not well supported.

Technically, some breadth measures point to a very overbought situation. The McClellan oscillator is near levels that are usually associated with pullbacks. Other longer term breadth indicators are still bearish. The new high minus new low index has been, and still is, trending downward. Finally the weekly price charts for the S&P are still in bear mode. The downtrend that began in April is still in intact.

US macro news continues to deteriorate. Retail sales, ex-autos, fell much more than expected. Initial jobless claims are knocking on the door of 400,000….a level associated with official recessions. The Empire State manufacturing survey collapsed. Industrial production disappointed. And the stunning number of the week was consumer sentiment. Over the last two months, as corporate production data slipped lower, consumer data was staying resilient. Until now. Consumer sentiment on Friday fell far more than expected, to a level last seen in 2011.

So how are US equity markets holding up so well….in the face of a clear global economic slowdown and a still unresolved European crisis?

Simple. Equity markets have been trained, like Pavlovian dogs, over the last three years to have the Fed come to the rescue and pump up stocks, but only AFTER they have fallen over 20%.

This year, in the face of even more dire economic news, US markets have fallen less than 10%, and have already started to recover?

Why? Because markets are now pricing in a Fed rescue….well before….any rescue has even been announced.

If you’re trained to believe that the Fed will bail out sagging stock markets, then why not just keep buying stocks, or at least why not keep holding on, when you know, just know, that the Fed will pump prices back up anyway?

What can go wrong?

Interestingly, that’s very much what many stock market experts claimed would happen in 2007 and 2008.

According to them, there’s no near to fear any stock market declines because the declines would be mild and even then only short-lived.

But then something went horribly wrong. Somehow, US stock markets fell over 55% at the lows in March 2009.

What’s most interesting is this—only three years later, many market participants have forgotten this little fact….this failure of the Fed to keep stock markets from imploding.

According to these market experts, this time is different; this time the Fed won’t let it happen.



Now it’s Spain’s Turn

June 9, 2012

Just as expected, it didn’t take much for the S&P500 to bounce after being fairly oversold on a daily basis. The S&P managed to jump 3.7% on nothing very meaningful however. In fact, Ben Bernanke from the Federal Reserve disappointed markets, which were looking for strong hints of more QE, when he did NOT hint that any new monetary program was around the corner. Volume was solid and the VIX slumped over 20%.

That said, the S&P500 is still in a downtrend when looking at the weekly charts. It will take a much larger rally to negate this downtrend. On the daily charts, the oversold condition is no longer in effect. Technically, the market is still looking up and could easily rise another 25 to 35 points before becoming overbought.

Other breadth indicators are mixed. The daily new highs minus new lows index has been weakening for three straight months. This has not reversed. The McClellan Oscillator is actually slightly overbought; based on this, a short-term pull back would not be surprising. The Summation Index, however, has just started to turn up; it’s possible we could rally another week or two, before becoming overbought on this index.

US macro news certainly did not spark the rally. Factory orders disappointed, badly. ISM services essentially met expectations. The same thing happened with initial jobless claims. Consumer credit plunged, far more than predicted. And international trade was worse than expected; this will lower Q2 GDP results.

After the week’s trading ended, Spain announced that it would most likely seek bailout funds over the upcoming weekend.

Why is this important?

Well, to start, Spain denied that it would need a bailout only two weeks ago. This was denial was delivered by the prime minister of Spain. The point is that why should any leader in euroland be believed if their words are, well, worthless. Trust and credibility will be decline, even further, in euroland.

Also, there’s the problem of Spain’s size and where the money will come from. Keeping in mind that until now Spain was one a rescuer, not a victim in need of a rescue, Spain will now change sides…..shifting a huge burden on the remaining rescuers in Europe.

Spain could potentially require hundreds of billions of euros in bailout funds. Given that several hundred billion euros have already been committed to bailouts for Greece, Ireland and Portugal, just where exactly is this massive pile of new money supposed to come from? Nobody knows for sure, at this time.

Finally, Spain’s deal could spill over to other troubled PIIGS. First, if Spain gets a bailout without draconian conditions (think austerity), then why will Ireland, Greece and Portugal just sit there and not ask for their harsh packages to be renegotiated to match the one given to Spain? Also, there’s a good chance that if Spain needs a bailout, then markets will turn to the next “domino” that could fall, namely Italy. And that’s where this game would end. Because even if euroland elites are able (and that’s by no means certain) to con the public into believing that they will come up with hundreds of billions of euros, euros that don’t exits, to bail out Spain, there’s no way they could do the same with Italy.


Well, the first reason would be the size of the bailout. Italy could require over half a TRILLION in euros, to prevent a financial and sovereign collapse.

Now just WHERE would such money come from?

Exactly, nobody knows.

Tis But a Scratch

June 2, 2012

Well so much for that bounce….from two weeks ago….because it lasted only 5 days. Last week the S&P500 slid over 3% and ended the week at its low point. Volatility surged over 22%, suggesting that there was conviction in the selling. Volume jumped on the big down days, even though total weekly volume was not huge, due to the loss of a trading day because of Memorial Day.

As expected last week (“the downturn and the selling are not over”), the US equity markets resumed their downturn. What’s worse, most of the year-to-date gains have now been almost erased. The Dow, in fact, is now in negative territory for the year.

US macro news has gone from bad to worse. Home prices fell more than expected, as reported by the highly respected Case-Shiller index. Consumer confidence sank. Pending home sales plummeted. Initial jobless claims jumped way above expectations, and are now creeping closer to the traditional recessionary boundary of 400,000. Chicago PMI badly missed, hitting the lowest level since September 2009. ISM manufacturing also missed, as did personal incomes. The big number of the week—and the biggest shock of the week—was the payrolls number which badly missed expectations, by coming in at only 69,000. Headline unemployment reversed course and rose up a little, as did the more broad (and accurate) U-6 figure. Average hourly earnings rose by half the expected rate. And when the 204,000 imaginary Birth/Death jobs are factored out, it’s clear that jobs may have actually gone negative in May. It looks like the US is joining the rest of the world…..back in recession. The question now is: how severe will the slowdown be?

Technically, the S&P500 is still oversold on the daily charts. It wouldn’t take much good news—even if fleeting—to generate an oversold bounce. But the weekly charts (as mentioned last week) are still overwhelmingly bearish. There is STILL more much more room for the S&P to drop. Also discussed last week was the sanctity of the 200 day moving average, which was in fact violated on Friday at close. This suggests that support is eroding, and that even if we see a bounce in the short-term, more selling could take the S&P down well below 1,250 and closer to 1,200.

And from a bigger picture perspective, let’s remember that the S&P500 is down ONLY about 10% from its April and May highs. This is truly only a “scratch”—nothing to sneeze at, but also nothing to  fear. So far.

The real test would come at levels closer to 20% below peak. This is roughly where the biggest drops in 2010 and 2011 ended, and formed the foundation for larger multi-month rallies.

And while 2012 so far seems to be following almost the same script, it’s far to early to know if we’ll fall as far before policy makers (most importantly, the Fed) panic and rev up the printing presses.

And it’s far too early to conclude that if (or when) the Fed steps in that it will have the same effect on   equity prices. The results over the last three years are pointing to a disturbing trend—while Fed programs do boost stock prices, each successive program boost prices by a smaller percentage and for a shorter period of time.

There’s a chance that even if the Fed jumps back in with another Operation Twist or QE3, the markets will not move very much, or for very long.

After all, the US 10 year Treasury rate plunged to 1.45% on Friday, which is near the lowest level ever reached in the history of the nation.

How much of a benefit—to the economy or to the stock market—will a further push down to say 1.2% have?

Arguably, not much. Especially since nothing seems to have worked for the US economy (in terms of reaching escape velocity) with all the prior stimulus programs.

Another dose, of the same failed medicine, might not do much good.