Sunday, November 11, 2012

Macro Analysis 11/9/2012

Markets had another volatile week as US stocks voted on the reelection of President Obama with a resounding sell off .  The S&P 500 dropped over 2.5% on Wednesday and followed that decline on Thursday by dropping an additional 1.22%.  Equities finally stabilized on Friday but serious technical damage has been done.

In all fairness, the Obama reelection, though providing most of the catalyst for the dive in equities, was not the only issue the market was concerned about.  Europe continues to fester with political tensions and the probability of a Greek exit from the Euro zone growing again,Spanish bond yields creeping up for a third week in a row and terrible economic numbers coming out of Germany and France.

But the immediate main issue for the market was the prospect of another four years of an Obama administration and a Republican congress with the fear that political gridlock will continue while the country sprints over the fiscal cliff.  And the President did little to encourage Mr. Market in his news conference on Friday afternoon when he arrogantly drew a line in the sand by proclaiming he would veto any legislation that included tax cuts for those making over $250,000.00/yr.  The market as measured by the S&P dropped nine points in about five minutes after he made those remarks.

Here's where we are in the S&P:

(click on chart for larger image)
The S&P has penetrated its 200 day moving average (black arrow).  Many mutual funds and institutional investors use this moving average as a signal on whether stocks are in a bull or bear market.  If we don't get a bounce off this line this week there's a pretty good chance we will penetrate the Fibonacci support level at around 1346 and revisit the June lows at around 1270.  On Friday, the S&P closed at 1379.85.
I've outlined the main fundamental reasons why stocks are turning lower but technically it's because of what's happening on this chart:
(click on chart for larger image)
This chart compares the US Dollar with the other major foreign currencies on a five day moving average basis.  It's pretty evident that the dollar is generally strengthening across the board against the other major foreign currencies.  What's noteworthy is the Dollar's strength against the Euro which is 57% of the Dollar index. 
Inter market relationships dictate that a strengthening Dollar equates to weakening commodity and stock prices.  Why?  A stronger dollar means that it takes less dollars to buy stocks and commodities.  More importantly, a stronger Dollar is flashing that we are in a "risk off" environment.
But look at what's rallying:
(click on chart for larger image)

Gold took off last Monday and never looked back, ending the week in a consolidative tone.  As a student of candlestick charts, gold's chart explained the reasons for its powerful rally and why it may not continue next week.  Monday saw a modest rise followed by Tuesday's price action where all risk assets rallied in anticipation that the candidate that was elected to the presidency that night would do what was necessary to address and avoid the fiscal cliff.  Wednesday's price action formed a gigantic "doji" candlestick which signifies indecision as gold reacted to the Obama win with a Republican congress; the reason for former gridlock.  Thursday had a decent rally as all kinds of news reports were pointing to compromise between Democrats and Republicans on the issues which had heretofore been the impetus for gridlock.  Friday's candlestick was another "doji" signalling indecision but with a negative bias as the market found out after Obama's news conference that the President might not be as conciliatory as the news media suggested.
The message from the gold chart is clear:  until we get reliable news out of Washington that there is progress in avoiding the fiscal cliff, gold will go nowhere unless Spain asks for a bailout from the ESM/ECB.  As I stated in last week's commentary, the fiscal cliff is deflationary and gold does not like deflation.
My analysis will be brief in this commentary as the same issues the market has been dealing with in past months are still with us.  I would invite those who are not familiar with those issues to read my last three commentaries. 
Probably the biggest news items after the fiscal cliff that impacted markets this past week was news out of Europe.  European economic growth, as everybody has been expecting, is contracting and the contraction is gaining momentum as austerity's bite digs deep.  In this particular case however, that slowdown is impacting the economic powerhouse of Europe.  German industrial production was down 1.8% MoM (month over month) against expectations of a
-.5% drop.  In addition, German Services PMI (Purchasing Managers Index) deteriorated MoM.  French Services PMI also deteriorated MoM.
Greece is also making headlines after a razor thin majority in their parliament approved the austerity cuts the coalition government negotiated with the "troika" amidst violent protests in Athens.  Now it appears the EU is not ready yet to disburse the next tranche of aid to the insolvent country which means the Greeks need to sell T-bills to cover redemptions to the ECB (European Central Bank) due in about a week. 
The Greek saga is not going away and we will inevitably see a Greek exit from the European Union.  No one can tell when this will occur but the "northern periphery" (Germany, Finland, Netherlands) no longer has the political will to keep pumping Euros into the Greek "black hole".
And then there's Spain.  Spanish bond yields are creeping higher and Rajoy has finally admitted that he will not seek a bailout until he knows where the ECB is going to stabilize Spain's long term rates if/when the Spanish government finally requests intervention in the bond market.  But the ECB has repeatedly stated they will not target interest rates.  In the meantime the bond market is getting impatient with Spain's equivocation and as yields on the 10 year Spanish bond close in on 6%, pressure will mount on the Rajoy government to ask for help.  When will Spain formally request a bailout?  Watch the Spanish bond market and our stock market.  As yields rise above 6% our markets will drop in a commensurate way.  If/when we start closing in on 6.5% things will get REALLY ugly.  Now, I don't expect things to deteriorate that badly.  But remember, this is Europe; anything can and will happen! 
I want to touch on China.  Much is being made about minimal improvement in the Chinese economy but as I've stated many times, no one can definitely be sure what's going on there because, as we shall say, there's a question regarding the veracity of the economic numbers.  Certainly, the Shanghai Composite isn't predicting any strength in the Chinese economy:
 (click on chart for larger image)
Everyone lauded the Chinese CPI (Consumer Price Index) coming in below expectations at 1.7% this week,  signaling inflation is waning in the country.  Many believe, because of low inflation, this will allow the Chinese government to further stimulate the economy.  But if the recent spate of marginally better economic metrics are correct then the Chinese government will not provide additional stimulus. 
I stated this fact in past commentaries but it's worth noting again:  "China is the tail that the dog is wagging".  They do not have a consumer based economy yet and so still rely on exports to sustain their growth.  With Europe contracting, Japan economically dead in the water, and the US the nicest house in the global economic slum, how much can the Chinese economy grow?
Finally, I want to touch on the fiscal cliff.  I was extremely disappointed by the chip President Obama wore on his shoulder and the attitude he displayed at his news conference on Friday.  It was anything but conciliatory!  Yet, I was equally flabbergasted by the street's take on the news conference.  It was almost as if they were in denial and ignored his belligerent tone and intransigence.  And about an hour later Obama's White House spokesman, Jay Carney, drew a line in the sand by stating unequivocally that the President would veto any legislation that included tax cuts for the rich; those making $250,000.00 or more per year.  This issue has been a main sticking point in any negotiations between Republicans and Democrats regarding the fiscal cliff and our deficit.  But US stocks voted on the President's attitude and what he had to say about compromise at the news conference by dropping like a rock.
Unless the President's remarks are political posturing ahead of the negotiations, the odds of going over the cliff are growing.  And I believe it is a lot more than political posturing.  I personally don't believe the street understands the type of personality we have as President.  The President, with all due respect to the office he holds, is an ideologue and as such will do anything and at any cost to further his agenda.  If I am wrong we'll know next Friday after we get initial reports following the first negotiations scheduled at the White House.  And I sincerely hope I am wrong for the good of the Republic.
This will be my last commentary until the Thanksgiving Day weekend.  There's things to do and people to see ...
Have a great week!