Let's look at some weekly charts. This is the New York Stock Exchange (NYSE) Composite:
Let's look at some market internals. This is the NYSE McClellan Summation Index. It is a breadth indicator derived the McClellan Oscillator, which is a breadth indicator based on Net Advances (advancing issues less declining issues). The Summation Index is simply a running total of the McClellan Oscillator values:
Commodities are giving us a mixed message. This week Copper staged a significant rally, punching thru two Fibonacci resistance levels (black circle) on info that Chinese demand for the metal is growing :
But another industrial metal, Steel, is still in the doldrums:
And basic materials (wood, concrete, iron, etc.) are also going nowhere. This is a weekly chart of the Dow Jones World Basic Materials Index:
The US Dollar has been supportive of strength in "risk on" assets for the past few weeks. Here's an update of a chart I have been posting for the past few weeks. It is a comparison of the US Dollar with all the other major foreign currencies on a three day moving average basis. Although there was a little "jog" this week it looks ready to resume its downtrend against the major foreign currencies:
In an effort to keep my readers apprised of inflationary trends in the economy I promised that I would post updates on the velocity of money that I receive courtesy of the St. Louis Federal Reserve.
The first chart is the measure of M2 Money Supply in the economy:
Here's a close up of the same chart above showing the last five years:
What a week! The markets were held captive to clueless politicians and their running mouths and nothing else seemed to matter but every peep that came out of Washington.
I'm not going to get into minute detail about the negotiations but will only provide a synopsis. If you've been following the news you know as well as I do what's going on. But I am going to address market perceptions on the negotiations as well as market direction.
But first, a word on Europe. Greece finally received approval for another tranche of aid (44 billion euros) and the German Bundestag voted to support the aid recommendation from the Troika. This served to buoy the Euro throughout the week.
On Friday after the market closed, Moody's downgraded both the Euro zone's bailout funds following a recent similar move on France (November 18th), the second-largest contributor to the rescue funds.
The European Stability Mechanism (ESM), a permanent 500 billion Euro strong fund established on October 9th, was downgraded to Aa1 and its predecessor, the European Financial Stability Facility (EFSF) due to be phased out next year - was downgraded to a "provisional" Aa1. The Euro initially took a dive on this news but quickly recovered.
As I pointed out last week there's a Dr. Jekyll/Mr. Hyde scenario developing over there. As the Euro zone sinks deeper into recession it seems at the same time the crisis that we've been dealing with over the past two years is dissipating. I outlined some of the factors that are contributing to this in last week's commentary and I invite my readers to review those points should they need to.
Now, the cliff! As I cut thru the noise out of Washington here's how I seeing this issue playing out. Democrats are insistent that the tax rates for the wealthiest of all Americans go up. The Republicans have already stated that they agree with more tax revenues in cutting tax loopholes as a precursor to revamping the tax code in 2013. But they will not agree to an increase on the tax rate. As Senator Mitch McConnell has stated in so many words, money is money regardless from where it comes.
Obama and the Democrats believe that, because of the election results, they have a mandate to demand these taxes. They do not. As an aside, Obama had more of a mandate when he thrashed McCain in 2008. This last election saw Obama carry 50.1% of the popular vote to Romney's 48.4%. In 2008 Obama carried 52.9% of the popular vote to McCain's 45.7% . But we need to remember that among the many definitions of the word politician is "one who convinces others of what is not true". And it only works when you have a largely uneducated "couch potato" electorate. But I digress.
With all this wrangling, spending has hardly been addressed other than some vague comments by Dems on means testing for Medicare.
The market is convinced that a deal will be reached but only at the last minute. I tend to agree if for no other reason that both sides don't want the legislative branch of the government to be seen as dysfunctional (even though they are).
Anything can come out of these negotiations but it is becoming more apparent to me that the Republicans may need to acquiesce to Obama's demands on the wealthiest 2% of Americans. Everyone in the Beltway understands that if there is agreement on this issue a comprehensive agreement will come very quickly.
But how will the market react to an agreement? In the longer term, it all depends on the details of the agreement. After some turbulence earlier in the week the market seemed to calm down and is acting like a deal is inevitable. Depending on when (if) the deal is announced and how much the market has appreciated since the negotiations began, the deal may be already priced into the market and/or we may get a relief rally. But I believe that if the agreement is just a band aid to avoid the cliff, the market will inevitably not be pleased with the result.
The concern I have is that the negotiations have largely been centered on extending tax increases on a fractional portion of the population while largely ignoring the 900 lb. gorilla in the room, expenditures. Yes, taxes have to be raised and comprehensive tax reform would be the best way to accomplish this. But it is also clearly apparent to all but the extremely naive that entitlements must be significantly cut as well.
Any agreement that does not address entitlements or even "kicks the can" on these issues into 2013 will weigh on our markets. How and in what way? That's the challenge. I had much success this year in predicting market direction in relation to ongoing turmoil in Europe but these negotiations and their aftermath are virtually impossible to predict. And global financial markets are being held captive to it all. This is it, folks! Nothing else matters, not economic reports, not Euro zone developments, not Israel attacking Hamas, nothing! Until we get an agreement expect more volatility but with an upside bias.
Lastly, I want to speak of the divergences identified earlier in the commentary. As previously stated divergences can continue for months and even years but I also believe that the longer they continue the more negative the implications. Right now, the ten major financial institutions on Wall Street are predicting significant gains for the S&P in 2013. With central bank liquidity, both here and in Europe, bolstering financial markets it is hard to argue with them. But the chart of the NYSE Bullish Percentage Index posted above spooks me as does these two charts which are updated charts on the effects of the Fed's quantitative easing on stocks and commodities:
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 REGISTERED INVESTMENT ADVISOR OR BROKER ... yet!