Macro Analysis 6/15/2012

Another volatile week has past in the stock market.  We started Monday with a sell off on the heels of the EU Spanish bank rescue plan only to regain confidence based on the promise of central bankers and rumors of a positive outcome to the Greek vote on Sunday.

I'm going on the record (early Saturday morning) as predicting a pro austerity outcome to the Greek vote as the 11 million population in that country steps back from the brink of economic disaster.  And our markets will rally on this news and because of other news events that rally may endure for the entirety of next week.  However, I'm attaching some caveats to that short term prediction which I'll elucidate on later on in this commentary.

Stocks ended the week higher with the S&P 500 registering a gain of 1.3% while the Dow Industrials rose 1.7%.  The Small Cap Russell 2000 registered a much smaller gain of 0.28% and this is a source of concern moving forward.

Here's a daily chart of the S&P 500:

(click on chart for larger image)

The S&P closed Friday just penetrating significant resistance at the 1340 level.  Of course, just poking it's beak above the level is not enough and we'll need follow thru next week but we also saw a surge in CCI (black circle) which signals significant momentum behind this move.  From a longer term perspective there's the concern that the broader market is showing relative weakness to the S&P.  The bottom panel demonstrates this as the larger cap stocks are outperforming the smaller cap stocks.  We would want to see just the opposite to confirm the health of the "bull".

Here's the Russell 2000 Small Cap Index which demonstrates the relative weakness in Small Caps alluded to above:

The Russell finished the week barely in positive territory and still must take out short term resistance (black dashed line) in order to confirm any lasting up leg in these markets.

If we get a positive outcome to the Greek vote we will punch thru the resistance levels identified above and the next target on the S&P will be 1363 based on short term Fibonacci levels.  On the Russell we will have multiple resistance levels with 800 - 803 being the most vigorous.

For all the excitement in equities due to the expectations of a pro austerity Greek vote and promises of central bank intervention, the Treasury market is not buying it!

This is the Dow Jones CBOT Treasury Index which is composed of 30-Year T-Bond, 10-Year T-Note and 5-Year T-Note futures contracts and replicates the performance of the U.S. Treasury bond market.  As can be seen, the index has backed off it's all time highs set on June 1st but this retrenchment cannot even be considered a correction.  Take note of the MACD momentum indicator in the bottom panel.  The histogram is signaling a narrowing of the signal line and MACD line meaning treasuries are regaining momentum to the upside.

Based on some other indicators we could see a bit more weakness in treasuries in the short term but the bull market in bonds is still very healthy and unless we get out from under the Euro zone debt rock (not likely) interest rates will approach levels never before seen! (seriously).

I wrote earlier in the week (Wednesday, June 13th, The "chop" before the storm) that the Dollar trade was being skewed by a record high speculative short position in the Euro which has been contributing to Dollar weakness.  Remember, the Dollar and the Euro move inversely to one another.  The Euro is roughly 57% of the Dollar Index.  These short positions are being unwound as Euro shorts are being squeezed by some of the positive rumors coming out of the Euro zone regarding Greece and central bank intervention.  Recent weak economic reports out of the US are also feeding the short term fuel to the fire:

Here's a daily chart of the Euro and I've pointed to where we closed on Friday (purple arrow).  Interestingly, if you look at Friday's candle closely you'll see the Euro rallied right up to the 61.8% Fibonacci retracement level (126.64) and then backed off to close at 126.42.  It's almost eery how those Fibonacci levels work!  Nevertheless, the 5 day moving average has crossed over the 20 day moving average which denotes further upside momentum and the other indicators on the chart are also signaling positive momentum.
With the probability that we will get positive news out of Greece this weekend and all the "hopium" surrounding more central bank liquidity, it would be reasonable to expect that the Euro will blow thru this Fibonacci level  but I would not expect the Euro to climb above the 127.85- 128.00 area.  There's anecdotal evidence to suggest that many "shorts" will not be squeezed out of their positions this time around but will pony up the additional margin requirements to stay in the trade due to the horrible situation developing in the Euro zone.

I also spoke about Gold in the same blog post on Wednesday:

I know this chart is busy.  I just can't help myself!  :-)

Gold has been in the midst of a mini stealth rally and I have a thesis regarding it I'll be addressing below.  For now, I've circled the price action for the past six trading days and it appears from Friday's candlestick that Gold is temporarily snagged on a short term Fibonacci level but our momentum indicators are strengthening, albeit not too impressively.  Notice the bottom panel which is the CCI (Commodity Channel Index).  When Gold popped in the first week of June, the CCI hit a new high and then fell back when the metal retrenched.  Since that time the metal has methodically marched higher reaching the level of the first pop but CCI has not reached the same level.  This could be a divergence or it could be that the first pop was preceded by a huge immediate surge of momentum a few days before its high and that the second upswing was a steady rise.  In any case, the chart is short term constructive although admittedly Gold has much more technical healing to go after the pummeling it has taken since last September.

Commodities had a better week although many believe it had nothing to do with global economic fundamentals but due to the "hopium" anticipated by the market as central bankers promise to do anything and everything they can do to save the financial system from disintegration (aka money printing).

Here's "Dr. Copper" and it finally broke thru a steep downtrend line this week.  Does that mean global economic activity is picking up or is the market pricing in more money printing?  This is the trillion dollar question.  Conventional wisdom says the latter but if we start to see a sustained move higher in Copper it could mean that the global economy is once again garnering strength. 

One of the disciplines I attempt to keep to as I look at these markets is to maintain objectivity.  It's so easy to become entrenched in a subjective belief on where these markets may be heading. On the face of things, it's easy to get depressed like everyone else when hearing all the negative news, whether out of Europe, China or the US.  That's why charts are so helpful in checking all the media hype.

Here's a multi year daily line chart of the iShares MSCI EAFE Index which consists of publicly traded securities in the European, Australasian and Far Eastern markets:

As you can see, a massive potential "head and shoulders" pattern has developed since the March 2009 bottom.  It appeared at the end of May that we were going to penetrate the neckline which would have been a very bearish indicator of the direction of global economic growth.  However, the index bounced right at the neckline and MACD has turned positive (upper panel).  The fact that this index includes European securities is a big positive in my mind as we move forward. 

If there's any take away from the chart above it's that we must always filter the media noise we hear and always realize that invariably the media reports on past events and cannot extrapolate into the future.  Let the charts tell us what's really happening.  Until this index penetrates the neckline the verdict is out on the almost universal opinion that the world economy is heading for recession.


ANALYSIS

Despite another volatile week in global risk markets we ended a second week higher.  It's been a much needed elixir for those who trade on a daily basis to see the markets higher in the current macro economic environment we find ourselves.  But has anything really changed?  Short answer: No!

If anything, the European situation is worsening by the day (some argue by the hour).  The EMU (European Monetary Union) is caught between "a rock and a hard place".  The "rock" is EU legal and treaty strictures that make even the simplest of policy changes a multi month affair and the "hard place" is the autonomous insistence of member nations to determine their own fiscal destiny while still demanding the benefits of a single currency.  On top of this, sprinkle in a fair amount of just plain incompetence at the highest levels in some of these governments and you have the recipe for financial disaster. 

I've written so much about the different aspects of this saga that I'm frankly tired of writing about it anymore.  The problem is, as long as the Euro as a currency survives, I'll be forced to write about these issues because they will be with us for years.  The only caveat to this proclamation can come if one thing occurs:

If Germany agrees to underwrite the entire Euro experiment.  But they won't under its present political configuration so we're back to square one. 

Everyone wants the ECB to step in and prop up periphery bond markets but this is just another form of the "hopium" our markets yearn for from the FED.  Besides, if there is one sharp player over there (besides Merkel) it's Mario Draghi, ECB President.  He's not going to just print money unless the union takes substantive and timely steps toward fiscal union. 

So with all that said, where do we go from here?  I'm very certain we will see a significant rally in the beginning of the week.  Greece will step back from the brink and vote for the pro austerity parties.  But this is merely the prelude to addressing the ever growing realization that Greece is an economic basket case on life support and there is very little hope (probably an overstatement) that the country can avoid leaving the EU. 

Secondly, there's an awful lot of "hopium" going around Wall Street that the FED, at their meeting this week, will move to inject more liquidity into the system.  Most are predicting an extension of "Operation Twist", scheduled to end on June 30th.  I'm ambivalent on this prediction.  But I don't believe that the FED will come in with anymore easing than this if they even acquiesce to the street's desire.  Depending on the outcome of the FED meeting, the rally I expect on Monday may dissolve on Wednesday after the FOMC makes its policy announcement.

I've been watching Gold's price action and we will get a clear signal this week after the FED's announcement on whether Gold will continue higher.  On the theory that risk assets can assist us in determining the future, any upward movement in Gold at this point in time is predictive of further dilution of fiat currencies, and is forewarning of inflationary pressures ahead. 

The G-20 meeting this weekend will be a non event.  Much bombast amounting to nothing will come out of the meeting. 

There is a wild card out there that can give a significant boost to stocks in the short term and possibly have long term implications for our economy and stocks.  The Supreme Court is expecting to rule on the constitutionality of Obamacare possibly as early as this coming Monday (but most likely during the week of June 25th).  An overturning of the individual mandate (Intrade gives an 80% probability to this) would most likely unravel the entire law.  The market will sky rocket on an overturning of the law and a major impediment to hiring will be lifted.  This could be a major economic game changer and a serious blow to President Obama's reelection hopes.

I'll end this commentary with a very long term monthly chart of the S&P 100 Large Cap Index.  It is an index comprised of the 100 largest companies (by capitalization) on the S&P 500.  This chart goes back to 1983.  I've highlighted all the major stock market events with an emphasis on events since 2008.  Notice the historic bull market of the 80's and 90's culminating at the dot.com top of 2000.  The panel below the chart is the percentage of S&P 100 stocks trading above their 200 day moving averages.  The 200 day moving average is used by many institutional investors as a buy/sell signal.  Generally speaking, when an index or stock drops below its 200 day moving average many investors will jettison the position and a close above the 200 day will signal a "buy" (all other things equal):

As we try to understand the longer term picture for risk assets there are a few take aways from this chart:

1.  The divergence in the lower panel of stocks exceeding their 200 day moving average as the market made successive post crash new highs is telling.

2. The waning effects of each successive QE are also apparent.

3. The downward sloping trend line from the peak of the dot.com bubble is a big negative for our markets long term.  And the fact that this latest push higher didn't even reach that resistance is also a big concern.  Until the index can penetrate the red dashed line on the chart I cannot be positive on stocks on a long term basis.

It's a trader's market and with all the violent swings we've been having there is money to be made in these markets on momentum swing trades.  Otherwise, if you're a "buy and hold" investor as most of you on this distribution list are, you better have at least an 8 to 10 year horizon in order to start seeing capital appreciation.  High yielding dividend plays will be your best bet.  At least you can get paid while you wait.  It must be remembered that, generally speaking, someone who was invested in stocks in 1929 did not break even on his investments until 1954!

I say all this with the reminder that my crystal ball is no better or no worse than anyone else on the street.  But it is undeniable that mammoth deflationary forces are weighing on risk assets and deflation can never be good for stocks.

Well, next week will be an interesting, to say the least.  Strap yourselves in for the roller coaster ride.  Sometimes I feel like I'm back on the Wild Mouse at the Rye Beach Amusement Park!

Happy Father's Day and have a great week!

PS.  As I send this the first Greek exit polls are coming in with the pro austerity party barely ahead of the anti -austerity Syriza Party. 

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