Let's go to the charts. Here's the Nasdaq 100 Index, comprised of the top 100 capitalized stocks on the Nasdaq stock exchange:
The ECB's (European Central Bank) two LTRO's (Long Term Refinancing Operations) seemed to have backfired as Spanish banks borrowed 28% of the 1.1 Trillion Euros offered in order to bolster their reserves but also to buy Spanish sovereign debt. This initially helped Spain when it went to market to rollover its debt in the first three months of the year with the attendant result of lowering yields. But now, with foreign money unwilling to buy rollover debt coming to market and the Spanish banks running out of the LTRO money they borrowed, panic is starting to take hold in global financial circles. The "double whammy" here is that not only are the Spanish banks running out of the money to finance their own country but the existing bonds they bought earlier in the year are losing value as fewer and fewer foreign investment entities are willing to take the chance and buy this paper. This is having a negative impact on Spanish bank reserve requirements. Remember, as yields rise, the underlying bond drops in value; as yields drop, the underlying instrument increases in price.
Commodity prices have been steadily declining with the street attributing the price action to the Chinese slowdown. To this I will not disagree but China is not only slowing down because of it's own internal problems (property bubble, growing banking problems) but in large part because its biggest trading partner, Europe, is slipping into deep recession. This is exacerbating global economic weakness. Here's a weekly ratio chart going back to May 2007 of the Morgan Stanley Commodity Related Index divided by the S&P 500 Equal Weighted Index :
The Commodity Related Index has been under performing the S&P since August 2011 and shows no signs of recovering. The pink downtrend line is steep and normally such steepness cannot be sustained either down or up without an occasional "reversion to the mean" (a theory suggesting that prices and returns eventually move back towards the mean or average). And this week we did see the slightest "blip" in the Commodity Related Index but until we see some pressure on that downtrend line commodities will continue their downward slide.
It will truly depend on the German government's commitment to a unified Europe. Coincident with that will be the German electorate's willingness to bankroll periphery nation debt. I've written in the past about the German mentality and aversion to inflation along with the psychological scars that the Germans still carry with them over the hyper inflation during the Weimar Republic ninety years ago.
Scott Minerd, Chief Investment Officer of Guggenheim Partners stated in so many words this week on CNBC that if the political will in the Euro Zone is truly committed to a unified Europe the Euro will have to go to parity with the Dollar. Here's the Euro as of Friday's close:
The Euro closed at 1.3077 to the Dollar. It's a long way to parity and anyone in the trading community who has been anticipating this 'short' coming to fruition in the past few years has been burnt by the resilience of the Euro. I have to agree with Scott's thesis that 'if' the Northern faction of the Zone commits to a unified Europe in its present form then the Euro has to substantially depreciate. It's the 'if' I'm concerned about.
Central banks have been printing money since the Great Financial Crisis and I've posted a number of charts over the past few months that depict that their efforts are having less and less of an impact. Here's an updated 10 year chart of the velocity of M2 Money Supply from the St. Louis Federal Reserve:
1. With all the liquidity the FED and the US government pumped into the system at the end of 2008 into early 2009 and then QE2 which commenced in the last quarter of 2010 that ratio has increased only .05 points from 1.65 to barely 1.70 (see the bottom in the grey shaded area on the right.
2. The most positive thing we can say from the chart above is that the steepness of the decline has moderated in the past six months.
This highlights the issue I've addressed in past commentaries and blog posts. Global deflationary forces are incredibly powerful and the central bank stimulus of the past three + years has done nothing more than barely stabilize the teetering system. Equities and commodities have been buoyed by the massive infusion of liquidity which have only masked the problem. And now, the price action of the past nine months suggests the 'fix' on commodities has worn off.
The central bank effort is an attempt to buy time until the deleveraging can take place and normal credit creation can be sustained on its own. Will central banks succeed? The verdict is still out and what I'm seeing almost universally in the charts since last fall is that, at the least, deflation is winning this round in the championship fight for the salvation of the global economy.
This coming week:
1. Look for the Chinese government to possibly ease bank reserve requirements. An outright interest rate cut does not seem to be in the cards. If any of the two occur it will provide a "pop" to global risk assets.
2. And of course, any rhetoric out of the European Central Bank or the FED that intimates more liquidity infusion will have a greater effect, both in terms of the "pop" and its longevity. But the question is, for how long?
3. Spain has two bond auctions this week which threaten to ignite a global sell off in risk assets if they are not well received (which seems to be the consensus). But watch for any rhetoric out of the ECB which, in the environment we're in, will serve to roil markets further.
4. Earnings season continues this week and Wall Street's expectations are so low that any earnings surprises are seen as possible catalysts to spark a new bull leg. However, I'm of the opinion that the concerns articulated in this commentary will predominate equities price action. And remember, seasonality is upon us. "Sell in May and go away ..." I don't hold out much hope for a summer rally if events in Europe heat up as I believe they will.
Unfortunately, it looks like we are entering another phase of volatility in the market analogous to the last half of 2011. If I'm right, this market will not be for the faint of heart!
Have a great week!
NOTHING IN THIS COMMENTARY SHOULD BE CONSTRUED AS AN OFFER OR ADVICE TO BUY OR SELL ANY SECURITIES, OPTIONS, FUTURES OR COMMODITIES. THE OPINIONS ARTICULATED ARE ONLY THIS AUTHOR'S WHO IS NOT A LICENSED INVESTMENT COUNSELOR OR BROKER.