Are the Big Risks Fully Priced into the Markets?

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.

 

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