Sunday, June 10, 2012

Macro Analysis 6/8/2012

Stocks had their best week of the year with the S&P 500 finishing the week up 3.73% thanks to "hopium", the new term on the street that captures the market's yearning for more QE.

 As I've stated more than a few times, all risk assets are being held captive to "headline risk".  As I write this Spain has made formal request for assistance to bail out her banks and the EU has stated they are prepared to apply up to 100 billion euros to the problem.   This quick fix should affect international markets in a positive way on Monday.  But in the current environment we're in it's impossible to predict with any degree of certainty on upcoming market activity, even in the near term.  In the case of the announcement today (Saturday), the fact that the announcement was made two days before trading commences versus if it was made on a Sunday evening before trading can make all the difference in the world.  Why? Traders have more time to think thru the implications of the announcement.  And, in this case, Spanish acceptance of a bail out is a tacit admission that they were unable to access capital markets to finance this shortfall themselves.  And that does not bode well for them or the Euro zone going forward.  Italy next? (Yes)

We're going to look at weekly charts in order to keep a longer term perspective on where we're at and where we might be going.  Here's the benchmark S&P 500 going back to July 2007 as of Friday's close:

(click on chart for larger image)

We've been in an uptrend since the March 2009 bottom and the purple dashed line is support.  As you can see we are nowhere near violating this line.  Notice the volume in the lower panel.  And I've drawn vertical brown dashed lines to correlate the volume with the price action on the chart in order to show my readers that every severe downdraft in the S&P was accompanied with what I'll describe as panic (or capitulation) selling.  We saw this in the fall of 2008 after Lehman failed, in May 2010 and again in August 2011.  Where's the panic selling today? (black circle).

As we look at the S&P up to this time from a weekly perspective we have to conclude one of two things:  Either we have just experienced your normal "garden variety" type of correction or we just haven't seen the worst yet.  I did not put any Fibonacci levels on this chart but we did bounce off a Fibonacci retracement level at 1268 and there's a cluster at around the 1216/1218 level that would provide significant support for the S&P.  On the upside we have resistance at the 1340 level.

Treasuries pulled back this week.  Here's TLT (iShares Barclays 20+ Year Treasury ETF) going back to June 2008, the proxy for the long end of the Treasury yield curve:

We've been in a steep uptrend since March of this year as delineated by the purple dashed line (brown arrow).  Momentum indicators in the upper panels are turning down.  This is a steep uptrend like the US Dollar was experiencing two weeks ago and cannot be sustained.  The challenge one has in trying to understand where Treasuries are going from here is that the "fear" or "safe haven" trade continues to prop up the Treasury market and until global fears subside we can't say that last week's pullback was anything more than a pause before a resumption of the uptrend. 

Many are wondering how low yields can go.  The answer to that question lies in repercussions to events in Europe.  The longer European politicians dangle the world economy at the precipice of disaster the lower yields will go as institutions and investors worldwide seek shelter from a potential Armageddon scenario.

Here's another "safe haven" trade; the US Dollar:

It too has taken a breather after a spectacular run up that started at the end of April.  The Dollar appears snagged at the 38.2% Fibonacci retracement level but again until global fears subside this can only be considered as a pause after an almost vertical five week run up.

Gold gave us a clear signal this week on how investors perceive it.  It's not a "fear trade" asset but an inflation hedge.  During Bernanke's testimony on Capitol Hill on Thursday Gold dropped like a rock during the testimony as the chairman made clear in so many words that the FED, while ready to step in if things in the financial global community got dicey, was on hold.  Here's a weekly chart of Gold going back to June 2008:

We've violated a long term uptrend line (grey dashed line) and the yellow metal is trading below it's 10 week and 40 week exponential moving average.  My long term outlook for Gold is bullish based on the probability that the world's central banks will be forced to print money in order to extract themselves from the Keynesian quandary the world finds itself in.

And commodities reflected the bounce we had in risk assets this week but not to the extent we saw in stocks.  Here's a weekly chart of the CRB (Commodity Research Bureau) Index going back to June 2008:

In spite of the bounce this week, the CRB is trading below its 10 week and 40 week exponential moving average and we need to see a more sustained move to the upside before we can say this is anything more than a pause before the downtrend resumes.

Europe continues to hold global markets captive as its debt saga continues.  As stated above, Spain has formally requested assistance to help its banks.  And it appears that European finance ministers have offered Spain up to 100 billion euros, or $125 billion, with the amount to be finalized when the results of the independent banking audits underway in Spain are available.  This is a significant amount more that the 40 billion euro "band aid" that was bandied about earlier in the week by some European sources.  This should be enough to provide the catalyst for some sort of relief rally in stocks on Monday morning but to what extent they will rally is questionable.  China's data dump today (Saturday) was pretty negative, showing an economy slowing much more than economists previously thought but not as much as some people were betting after the PBOC (People's Bank of China) cut interest rates on Thursday. 

The market will become more nervous as next week grinds on due to the following events:

- Greek elections on June 17th. 
- a June 18th meeting in Rome with Italy's Monti, Germany's Merkel, France's Hollande and Spain's Rajoy. 
- The FED Open Market Committee (FOMC) meets on June 19th & 20th
- the EU Summit in Brussels on 6/28 - 6/29

The outcomes of each of the three meetings above will be contingent on the result of the Greek vote.  Of all four events the EU Summit will be the yawner followed by the meeting in Rome because of EU legal constraints that make any progress toward crisis resolution a slow crawl. 

A negative outcome to the Greek election (an anti-austerity/pro SYRIZA party win) will roil global financial markets and may motivate the FED to step into the markets with additional liquidity; quite possibly in conjunction with the ECB.  But don't think an anti-austerity Greek vote automatically means that Greece is sure to leave the European Union.  Such an outcome opens up a whole realm of possibilities that I believe many in the market have not considered.

And lest you think I'm not concerned with a fallout from the Greek vote consider this quote from the Wall Street Journal Marketbeat of June 5th:

"George Soros got a lot of attention with a speech over the weekend in which he said the euro zone has three months to avert a breakup . And Soros ultimately thinks it will. "The likelihood is that the euro will survive because a breakup would be devastating," he said. For anybody who's banking on that, we recommend you pick up a copy of Barbara Tuchman's seminal work, "The Guns of August." The prevailing thought in Europe in 1914, Tuchman explains, was that a European war would be so devastating that nobody would start one.  Sounds familiar, no?" 

I'll end my comments on the Euro zone with this: the decision this weekend by the EU to throw 100 billion euros at the Spanish bank problem is a signal that EU leaders are finally starting to "get it".  The size of the aid package at least finally shows an urgency on the part of officials in attempting to address an immediate critical concern.

 No one knows how the future of the European Union will play out but I believe it will survive in some form or other.  The EU legal agreement does not lend itself to the kind of quick action we Americans are used to in our system so this saga will continue on for a number of years.  But the EU will muddle thru with the help of the ECB which will grudgingly fund the Euro zone so that the unification experiment survives.  Remember, don't listen to what Mario Draghi says; watch what he does ...  The ultimate winner if I'm right?  Gold!

There are many more hurdles that the global economy faces in the coming months of 2012, not the least are our fiscal problems in this country and the expiration of the Bush tax cuts at the end of the year.  Many on the street are saying that if we could get Europe out of the way our markets would soar.  While I don't deny that we would have a whale of a rally if that miracle came about (which it won't) there are still a host of issues that must be grappled with in this slow growth economy that I believe would make such a rally ephemeral.  I have much more to say about this but not enough time this week to say it.  Stay tuned for future commentaries ...

Have a great week!