Another Hope-Based Bounce

July 29, 2012

Seemingly out of nowhere, the world’s stock markets jumped on Thursday and Friday last week. After grinding lower over the three prior days, stocks soared and more than erased the earlier losses. The S&P ended the week 1.7% higher. The week’s volume rose, but only modestly. But volatility did not pay along. It rose, albeit only slightly.

What happened?

Nothing of substance, but mere words. On Thursday morning, the ECB president, Mario Draghi, promised to do “enough” to “preserve” the euro.

Nothing really new. No details. And no actions. Just promises to act.

And the promises weren’t about boosting growth, wealth, productivity, or other broad and noble economic goals. Instead, they were about preservation, or preventing the death of the euro. It’s that bad? One of the most powerful leaders in the eurozone is openly admitting that without strong action, the viability of the euro is on the line.

But that didn’t seem to matter to stock markets, because they roared out of the gate on Thursday and continued to go higher on Friday.

All based on hope, hope that the ECB will back up its words with massive actions, and very soon.

Never mind that this has never happened before; the ECB has always, it seems, been a day late and a dollar short when coping with the euro crisis.

But it worked—again—this time. And if the ECB does not come through, very shortly (as in next week), with these actions, then we could see a huge reversal in the mini boom.

And never mind that the German financial minister has announced, as was fully expected, that Germany would not agree to the ECB’s buying of Spanish and Italian bonds (which would be one of the massive actions that could actually help keep risk markets elevated for a longer time).


This is what trillions of dollars of risk asset markets have been reduced to—mere bystanders watching the ultimate deciders of what an asset is worth….the central banks of the world.

But in case it still matters to others, the fundamentals in the US continue to erode. Both the macro economy and individual corporations keep on disappointing. The Richmond Fed index utterly collapsed. Both new home sales and pending home sales disappointed…badly. Durable goods orders (ex- autos) also missed badly. And while the GDP estimate for Q2 slightly beat expectations, the consumer spending component (and in the US this represents about 70% of GDP) grew at the slowest pace in a year. Finally, consumer sentiment came in a the lowest level in 2012.

Meanwhile, corporate earnings and forward guidance continues to fall. Wall Street darling Apple missed expectations for the first time in years. And many other firms, both in technology and in almost all other sectors, are both missing expectations (for both revenues and earnings) and guiding down forward expectations.

That means that stock prices are holding up because the P/E multiple is starting to expand lately.

And that means that prices are rising on hope, hope that the ECB and other central banks will soon, very soon, deliver another bid dose of monetary stimulus.

They have weeks, not months, to satisfy these market expectations.

Otherwise, things will get very ugly, very fast.

Will the Stock Market in 2012 be a Repeat of 2011 and 2010?

July 21, 2012

The S&P limped across the finish line gaining 0.4% last week, but almost losing this gain on a sell-off on Friday. Interestingly, the small cap index, the Russell 2000, lost almost 1.2% for the week, and the Dow transports fell even harder…..losing 2.3%. Short-term volatility sagged over 2% taking the VIX back down to the mid-teens, or about as far down as it ever goes.

Also interesting were the breadth indicators. Almost all of them deteriorated. The McClellan Oscillator fell hard. The NYSE new highs minus new lows also dropped. The NYSE advancing volume minus declining volume fell. It seems like the rise in the S&P was driven by several large cap leaders; meanwhile, most of the other “soldiers” in the stock markets struggled. This is not a good sign. And when the severe negative divergence of the Dow transports is factored in, bulls ought to begin to worry about the sustainability of the recent rebound.

Other traditional technical data are still somewhat bullish. For example, the uptrend on the daily charts is still holding. But momentum is weakening and starting to diverge bearishly.

Meanwhile, the US economic slowdown is becoming so apparent that even the mainstream media is having a hard time  ignoring it. Last week, retail sales (both headline and ex-auto) plummeted. Existing home sales badly missed expectations (and lately, housing was supposed to be the one bright spot in the economy). Initial jobless claims, sure enough, after the effects from the July 4 holiday week faded, soared back up to the near 400,000 level. The Philly Fed missed and leading indicators also fell hard. Several well-respected economic forecasting groups, such as the ECRI, are openly declaring that the US is already in recession, and that it will take 6 to 12 months for the NBER to formally declare that it began in mid-2012.

But what about the stock markets? Will they echo the big corrections of 2010 and 2011, when the S&P fell about 17% and 19% respectively?

Actually what’s more surprising is that the S&P hasn’t already fallen and by even more than the 19% we saw in 2011.


Because the US economy appears to be slowing down more dramatically today than it did in the late spring of 2010 and 2011. This will inevitably lead to lower corporate sales and earnings. And this in turn will put pressure on stock prices.

So why hasn’t the S&P plunged?

Well aside from the consensus of hope based on the Fed coming to the rescue, it seems that the timing is simply off by a few months, when comparing 2012 to the prior two years. Over the next 60 days, US corporate earnings guidance for the third quarter and the rest of the year will come under tremendous pressure.


Because corporations and analysts have been pushing out the rebound in earnings for 2012 to the fourth quarter. While earnings growth in the first, second and now third quarters have been getting crushed, there’s been a huge shift of expectations into the last, or fourth, quarter when firms will “make up” and year-to-date earnings shortfalls.

And that’s the problem. Because, essentially firms and their analysts are betting on a Hail Mary pass to make their years. And the odds are not good that this pass will be completed.

Finally, the last time that the fourth quarter was supposed to “save the day” was 2008…..when not only did the fourth quarter not save the day, but it went on to collapse…..taking stock prices down with it.


Stock Markets Depending on Hope

July 14, 2012

The S&P500 eked out a tiny gain of 0.16% last week on essentially nothing but hope. Volume was very light, and volatility barely changed from its already very complacent levels.

Breadth, as measured by the McClellan oscillator, was bearish. But when looking at the new highs less new lows, breadth did improve. The bullish percent index fell slightly, and put/call ratio was virtually unchanged.

Although there were few reports, the economic news continued to mostly disappoint. The small business optimism index missed already lowered expectations. US international trade was still solidly negative, not a good sign for upcoming GDP reports. While initial jobless claims beat expectations, the fact that the July 4th holiday split the week had a lot to do with the better than expected news. This is likely a one-time event. Despite the large drop in oil prices over the last month, producer prices fell much less  than the consensus estimates; this means corporate profit margins will get squeezed more. And the biggest surprise of the week was probably the consumer sentiment result—it fell hard, instead of rising slightly as expected. This was the biggest miss since December 2009.

In technical terms, the S&P’s upward channel, on the daily charts. is still holding. Last week’s line in the sand—1,320—held. But on a weekly basis, the downtrend that began in April is still in effect. The recent highs are still much lower than the early 2012 highs, and until (or unless) these earlier highs are broken, the weekly downtrend must be respected.

So if the S&P500 seems to be holding up—not making new highs, but not collapsing either—then how do other correlated markets compare to US stock markets?

Let’s start with the euro in US dollars, which is usually positively correlated with US stocks. Last week the euro fell to its lowest level since mid-2010. Ever since early 2011, the euro has been in a long-term downtrend…..yet the US stock markets have been holding up.

How about the 10 year Treasury, which in terms of price is also positively correlated with US stocks. Last week the 10 year yield fell to a near record low, which was set only weeks earlier. How far back does the record go? Try 200+ years, since the United States was founded. Yet the US stock markets are ignoring this signal.

What about commodities? Well over the last two months, both oil and copper have dramatically pulled back in price. Yet the US stock markets are down only in the mid-single digits from their 2012 highs.

How can this be? While almost all other correlated asset classes are suggesting that US stock prices ought to be far lower, they’ve been holding up.

And as discussed before, the number one reason behind this resiliency is hope, specifically hope that the Federal Reserve will simply not let stocks fall very much.

Amazingly, after the US stock markets fell over 50% in 2002 and 2009, investors have brushed aside all evidence that the Federal Reserve is perfectly capable of losing control over the US stock markets, and are now hoping that this time is different.

We shall see.

Are the Big Risks Fully Priced into the Markets?

July 8, 2012

The S&P500 gave back almost 0.6% last week which was shortened by the July 4th holiday. So understandably, volume was very light, and volatility was almost unchanged. While we’re in the quieter summer season, most traders will be back next week manning their desks until the Labor day holiday.

During the week, several short-term breadth indicators reached extremely overbought conditions. The McClellan oscillator  closed above 100, a level not seen in many years. And at that level, pullbacks—even if temporary—usually follow.

Other technicals point to a continuation of the uptrend that began in early June, but the movement is losing steam, or momentum. So it wouldn’t take much for the five-week uptrend to be broken. A close in the S&P below 1,320 ought to do it.

On a weekly basis, the late spring downturn is still in effect, mainly because last week’s peak in the S&P has not even come close to breaking above the late March and late April highs. Until that happens, the S&P is, at best, consolidating.

Meanwhile macro news continues to disappoint. ISM manufacturing crashed below 50, to its lowest reading since July 2009. ISM services also missed meaningfully (by one full point). Initial jobless claims, while still very weak, came in slightly better than expected. But the big number of the week—the June payroll report—was a loser. New jobs created missed expectations, and if the magical birth/death numbers are subtracted, then true job creation was negative. Not good. The broadest measure of unemployment (U-6) inched higher as well. It’s becoming more clear, especially after the ISM reports, that the US economy is slowing and at risk of falling into another recession. While the rest of the world has already slowed down materially, it now appears that the US will not be able to “de-couple” and avoid its own slowdown.

Economics aside, one huge risk looming in the markets is way that stock prices, especially US stock prices, have seemed to defied the increasingly negative macro news.

So the question is, are most of the big risks lying ahead fully priced into risk asset markets?

Bruce Kasting, a veteran Wall Street trader and regular Zero Hedge contributor, says no. In his most recent entry, he argues than several huge risks are barely priced into today’s markets.

He starts with China and its impending hard landing. More and more current data is suggesting that China’s true (not officially reported) slowdown is massive. Instead of growing at 10% and instead of slowing to 7%, there’s a real risk that China is slowing to only 3% growth. If so, the downside to risk markets would be huge. None of this is priced in, argues Kasting.

Next, in FX markets, the Swiss peg is in real danger of being broken. And if this happens, then Switzerland will have no choice but to impose capital controls. This will “scare the crap out of capital” markets, says Kasting.

Also, the euro (in USD) acted in a very strange way over the last two weeks. For the first time in years, it seemed like it was not supported. In other words, it just kept melting down, with no strong bid to boost it. If this continues, argues Kasting, then the euro could fall all the way to parity…..and this would be very bearish for S&P earnings and prices.

And there’s more. But the bottom line is that Kasting points to specific examples that support the argument that stock prices in the US, and in other parts of the world, are holding up based on hope and faith, not the hard facts which are becoming uglier and uglier.

Kasting is convinced that the downside to risk asset markets is much greater than commonly believed, and he’s betting accordingly.