Sunday, November 25, 2012

Macro Analysis 11/23/2012

Pivotal events since my last commentary on 11/9 have changed market sentiment and the direction of stocks.  Never mind what the pessimists are saying, a conciliatory tone coming out of Washington on the fiscal cliff, a sincere effort to keep Greece in the the European Union and growing evidence that China's economy is turning around is fueling upside momentum in stocks.  I believe we will get our Santa Claus rally and I will elaborate on these comments in my analysis.

Let's go to the charts:

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Here's the S&P 500 and we've had two remarkable buying surges in the past five trading days.  We're now above the 200 day moving average and bumping up against resistance at the 50% Fibonacci retracement level (white arrow).  Based on Friday's price action I expect the S&P to take out this resistance level easily next week. 

On Friday, 11/23, a shortened trading day (markets closed at 1PM EST), stocks staged an incredible buying frenzy in the last hour of trading.  Every time I've seen this kind of market activity there has been a strong follow thru on the next trading day.  Pundits will point to the light trading volume on Friday as about half of Wall Street was out of the office still celebrating Thanksgiving but I contend light volume doesn't matter.  A buying surge of that magnitude, even on a holiday shortened trading day, tells me there was institutional buying, regardless of light volume.  It was akin to the market's reaction when Mario Draghi made his famous "whatever it takes" statement on Thursday, 7/26/2012.  On that day, the news hadn't even hit the wires yet and I watched the market surge into the last hour of trading.  On that Friday the market took off like a rocket to the moon!  We'll see if I'm right on Monday.

(click on charts for larger images)

We do have a resistance area on the S&P which I've delineated above on a 60 minute chart of the S&P500 SPDRs ETF (SPY) which tracks the performance of the S&P 500.  We will need to fill in the gap I've outlined with the two horizontal dashed red lines.  I'm confident that this will happen next week (probably on Monday or Tuesday).

Treasuries have been weakening as per our inter market relationships and I see this continuing in the short to intermediate term:

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This is the Dow Jones CBOT (Chicago Board of Trade) Treasury index which is a compilation of the price of the front-month future contracts for 5-year and 10-year notes, and T-Bonds trading on the CBOT.

To try to understand the price action of Treasuries in terms of our inter market relationships the Fed's enormous influence on this market must be kept in mind.  Additionally, in times when new supply is coming to market (like next week when the Fed auctions off about 80 billion in short to intermediate term bills and notes), this indicator will give us a skewed signal on the direction of stocks and commodities.  In the short term, I'm using US Dollar price action as the primary counter signal to the direction of stocks and treasuries as a secondary indication as to their direction.

Gold has been reacting well to the "risk on" environment we now find ourselves in and the chart below highlights the two big "up" days we had in stocks and how Gold closely tracked stocks price action (two black arrows):

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Momentum indicators are favorable for further upside price action and I'm guardedly optimistic on the yellow metal resuming its bull run after a considerable consolidation period. 

Gold's future is and will be predicated on the ability of central banks to break deflation's back in the global economy.  For that reason, Gold will give us our first signals that the deflationary cycle is over.  When might that occur?  Obviously, no one knows but I feel confident it will be later rather than sooner.

Commodities are still going nowhere and it is pretty obvious they will not be giving us any prior signals to a strengthening global economy.  Here's a weekly chart "Dr. Copper" who it is said has a PhD in economics:

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We've just barely broken thru a downtrend line that was
 established in August 2011.  Commodities will be coincident evidence of either a strengthening global economy or growing inflationary pressures.

Our beloved Dollar has taken a turn lower in the past few weeks.  Here's an update of a chart I've posted before that compares the Dollar against all the major foreign currencies on a five day moving average basis:

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With the exception of the Yen that has much to do with a probable turn in Japanese monetary policy, the Dollar is weakening against all the major foreign currencies.  And the Euro is exploding!

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As I've stated before, with the Euro comprising 57% of the Dollar Index we need to watch this currency very closely because as the Euro tracks so does equities.  On a weekly basis we're at a short term crossroads:

(click on charts for larger images)

This is an update on a chart I've posted before.  I circled this week's price action in white and if you look closely the Euro is butting up against a steep uptrend line (purple dashed) it had briefly pierced.  Close by is an older down trend line (yellow dashed) that is being threatened by the European currency.  It's not impossible, for reasons I'll elaborate on in my analysis, for the Euro to break through both of these lines in the next few weeks.  If it does, stocks will be off to the races!

And here's a look at China:

(click on charts for larger images)

I circled the week's price action.  On Wednesday, the Shanghai Composite had an "outside reversal" day, meaning prices opened lower than the previous days close and closed above the previous day's high.  This is a potentially very bullish pattern.  With the relatively good economic news coming out of the world's second largest economy we should start seeing this index move higher next week.


In order to assist my readers and others who may not always follow my commentaries I'm going to post a matrix which helps to understand some of my comments in these weekly posts. 

I'm a strong adherent of inter market relationships and I use these relationships in all my trades.  They serve to give very accurate predictions on where risk assets are going on a short to intermediate term basis but I've even found them to be fairly effective in predicting moves on a daily basis (although their predictive value does become more nuanced). 

These inter market relationships change infrequently and some of them on this list have been steady since before the bubble and bust (1999-2000):

                 Inflation              Deflation

If Stocks                               rally                       correct
Then Treasuries               will correct            will rally
Then Gold                           will rally              will correct
Then Commodities            will rally               will correct
Then US Dollar                  will correct          will rally

As stated in my introductory comments there has been a sea change in sentiment in the market from the dark days immediately after the presidential election.  The biggest catalyst for the change has been the conciliatory tone from US political leaders after the initial meeting on the fiscal cliff on Friday, November 16th.  The press conference after that meeting served to reassure markets that there was an even chance that there will be some kind of agreement to avoid the "cliff".  Notice I said "some kind of agreement".  In my opinion, the market doesn't care in the short term whether the Obama Administration and the Congress kicks the can down the road.  The market just wants some finality.  Any agreement that keeps a lid on the problem will be met with a ferocious rally (at least initially).

Many are stating that we will experience some market volatility as the negotiations resume this coming week.  While I can't deny that comments emanating out of the beltway may stir financial markets I don't believe, contrary to many pundits, that we are going to see the acrimony between the parties we experienced back in 2011 over the debt ceiling.  This time around there is enormous pressure by the American people and many special interest groups on the President and congress to make a deal.  Additionally, the President's hand has been strengthened because of the latest election and although I disagree that the election results handed him a "mandate", the fact that the Dems won an additional two Senate seats definitely puts the Republicans at a disadvantage in the negotiations.  Also consider that some of the biggest pressure on both sides to make a deal before 1/1/2013 is coming from Wall Street.  All politicians are much more sensitive to the impact their comments have on the financial markets.

Expect many Republicans to renege on their pledge of no new taxes to Grover Norquist and his Americans for Tax Reform.  If I'm wrong on this expect us to go over the cliff in January.  Indeed, there have been some insightful theses bandied about in the press that going over the cliff would change the negotiating paradigm on the cliff and would give the Republicans the upper hand in 2013 in arbitrating a better deal with the Dems.  While I fully agree with these theses I believe the Republicans will not go down this road.  It's too risky as they are presently seen by the electorate as the more intransigent of the two parties (whether rightly or wrongly) and will not chance being voted out of office in the next congressional elections in 2014.

While Europe still appears to be a simmering mess there have been a number of events/issues that are easing economic and financial conditions over there:

- The entire Euro zone is still contracting and the economic reports that came out this week show the slowdown is having a noticeable effect on Germany.  However, the data is still mixed with German manufacturing, though still contracting, coming in better than expected while German services data came in weaker than expected.  Additionally, German future business sentiment is showing noticeable improvement.  France's stats also were mixed this week.

- Spain still has not requested assistance from the ECB and ESM and although Spanish bond yields have been edging higher they are still way below the crisis levels they were at during the summer and have actually backed off a bit recently.

- Greece and Spain are showing a positive trade balance (meaning exports are outpacing imports)!  Although the reason for this is because they are not importing anything because nobody is buying anything because no one has a job I thought I'd throw this in because it sounds impressive  :-)  But in all seriousness, recent think tank studies show that Greece is starting to make some intermittent progress in digging itself out of the hole it's in.  The future of this progress will depend much on Greece's commitment to structural changes in its economy (ie. minimizing it's entitlement programs, the civil service and generous pension programs).

- Liquidity conditions are easing in the Euro zone.  Rather than bore you with the details you can decide whether to bore yourself at  .  But don't dismiss this seemingly arcane information.  Lack of liquidity throughout the Euro zone has been a bane to the region since the start of the crisis and grew to a crescendo in August/September 2011 when it seemed that global financial Armageddon was on our door step.  Mario Draghi's policies changed all that and when economic and financial history is written about the Euro zone he will be duly recognized.

- There's been much press last week on the inability of the EU to agree on how to ease Greece's debt burden so their debt can reach the target of 120% of GDP by 2020.  The IMF (International Monetary Fund) has been pushing for creditor nations to "forgive" some of the Greek debt on their books but this is politically unpalatable, especially to the Germans, as Merkel prepares for elections in 2013.  However, it does seem clear from the news reports that there will be some agreement this coming week (probably on Monday) in which the Greeks will be lent 10 billion euros so they can buy back that amount of debt while forcing private investors to take another haircut (accept less than the bonds are worth).  If we get an announcement like I described stocks will rally.

- In recent commentaries I've made a big issue on the possibility of Catalonia's secession from Spain.  Latest polls out of the region now suggest that the secessionists may not get the majority they need to demand a referendum vote on secession.  Things are still fluid there and the elections are taking place as you read this commentary (if you are reading it on Sunday).  If the secessionists take a majority of the parliament this will be a market negative on Monday, 11/26.  Inevitably though, this movement toward secession has some significant hurdles it faces in order to come to fruition.  The issues are detailed and I cannot get into them here.  However, if the Catalonians voted in a referendum for independence from Spain, rather than seceding from Madrid, they would probably use the   popular sentiment in order to attempt to wrest more control of their budget from the general government.

- The FOREX (Foreign Exchange Market) obviously likes what's going on in Europe as the Euro has been rallying strongly and it appears we will see more follow thru on this stength next week barring any negative news out of the EU on Greece or, to a lesser extent, Catalonia.

Europe's problems will continue to haunt the global economy for years but with every passing day it is becoming more apparent that the bond buying program that the ECB has put in place has served to stabilize the European financial climate.  I sense the Armageddon theses that were once very real possibilities are now dissipating.  Stabilizing Europe has gone a long way in giving the market the finality it needs to move forward.

Finally, the Chinese HSBC Manufacturing PMI (Purchasing Managers Index) reported Thursday night came in at 50.4 after a previous reading of 49.5.  Any reading over 50 is indicative of an expanding economy while any reading below 50 signals a contracting economy.  This is the first expansionary reading in 2012 and is further evidence of a Chinese economy slowly climbing out of its slowdown.  The market is responding positively to the news, which was to be expected.  I'll be more of a believer once the Shanghai Composite Index (posted above) starts moving higher in earnest.

Have a great week!