Saturday, December 8, 2012

Macro Analysis 12/7/2012

Most of the major averages eked out small gains this week and seemed oblivious to the political gridlock in Washington about the fiscal cliff.  A favorable employment report on Friday solidified the weekly gains.  The Nasdaq 100 and Composite were notable exceptions as both indexes registered losses for the week in excess of 1%.  And this was the main reason why:

(click on chart for larger image)
Apple has lost, by some estimates, 150 billion in market capitalization since its high in September and after a brief rebound toward the end of November resumed its decline this week.  I circled the last three days price action.  The stock was pummeled on Wednesday and after a dead cat bounce on Thursday, slid into the weekend with another ugly day on Friday.  Many reasons have been offered for the decline but I think it all has to do with compressing profit margins due to growing competition, especially in Asia, and the realization that the tech giant is only as good as its last product line. 
The entire technology sector has been lagging the general market for awhile as can be seen in the Technology Select Sector SPDR ETF below:
(click on chart for larger image)
The bottom panel is the price of the ETF relative to the S&P 500 (white arrow).
Aside from technology I believe this market wants to go higher.  The market is extremely resilient in the face of a looming fiscal crisis.  Here's the CBOE Volatility Index or VIX, better known as the fear gauge:
(click on chart for larger image)
With readings hovering in the 15 - 16 range, the market is telling us there's no reason to fear the "cliff".  Mr. market is implicitly stating that there will be a resolution to a potentially devastating blow to the US economy.  I'll have more on this in my analysis.
Technically, stocks are on the verge of breaking out to the upside as seen on the following chart of the S&P500 SPDRs ETF which mimics the actual S&P500:
(click on chart for larger image)
SPY is in the process of filling in a gap (parallel red dashed lines) that was created when the ETF sold off in early November.  I expect that, barring a curve ball out of Washington next week, SPY will break out above the upper red dashed line.  The next target will be the blue dashed line that seems to be coming from off the chart but is actually a resistance line established from the early October high.
Treasuries advanced toward Fibonacci resistance but were unable to broach that line and caved on Friday on the heels of a monthly employment report that gave a positive slant to not only the employment problems we've had since 2008 but to the economy as a whole.  Here's the iShares Barclays 20+ Year Treasury Bond ETF:
(click on chart for larger image)
We're right on the cusp of an uptrend line established from the late October lows and if we penetrate that line and the Fibonacci support right below it we could stall at the 50 day moving average but most likely will drop to the 38.2% Fibonacci support line.
As I see the global economic scene unfolding at the end of 2012 I can't think of many reasons to park my money in Treasuries and I suspect the big money is also feeling the same way.  I'll elaborate on this thesis in my analysis.
Gold had a hectic five days after the bloodbath it sustained the week before.  However, by the end of this trading week end it had stabilized and was showing some signs of strength:
(click on chart for larger image)
I circled the week's price action where we saw some follow thru early on from last week's sell off. However, the price action reflected in the last three candlesticks suggests accumulation is taking place in the yellow metal.
As I look at stocks, Treasuries and Gold I sense everything is coming together to paint a bullish scenario going into year end and probably beyond.  But it all depends on developments within the beltway.
Commodities were mostly flat to down this week as they have been for some months.  The big story is oil which continues to deteriorate in price:
(click on chart for larger image)
I rarely discuss oil in the commodity section because its price is driven by so many other factors that often have nothing to do with economic activity.  But this is a big developing story.  Many of you are already aware that fracking technology has led to the ability to access literally trillions of barrels of oil and trillions of cubic feet of natural gas in this country.  Recent projections for south Texas alone estimate that there's enough NATGAS to keep frackers busy for the next forty years.  The same is true for oil in North Dakota.
West Texas dropped like a rock this week (see chart above) and although Brent Crude did not suffer the drop West Texas did this week I submit to my readers that this price action is the harbinger of things to come.  Please don't misunderstand, I'm not talking about $.99/gallon gas next year but I am talking $2.50/gallon gas next year.  And that's only the beginning!  There are vast economic and financial implications to the discoveries we've made in this country due to fracking technology and these implications for our economy and our currency will play out to the advantage of the US well into the last half of this century (no exaggeration!).  I'll end with this: for those who thought the US would eventually lose its status as the world's reserve currency, these discoveries make certain, barring another agreement similar to Bretton Woods, that our country will retain that status well into the next century (meaning 22nd century).
In the short term, rather than a lower oil price signalling a weaker global economy,it is liable to be, all other things equal, a catalyst for strengthening economic growth in the world economy.
The Dollar staged a rally toward week's end that had to do as much about a weakening Euro as anything else.  The European Central Bank (ECB) held interest rates steady after their monthly meeting but it was apparent to all that with Germany joining the European recession and continuing poor economic data from all over the continent, the ECB will be cutting rates next month.  The Euro, being 57% of the Dollar index, took a dive right at the resistance I pointed to in last week's commentary (see chart below), breathing some life into the US Dollar:
(click on chart for larger image)
Ordinarily, I would take this as a signal that we were going to start a period of Dollar strength which is "risk off" for stocks, gold and commodities.  However, with the FOMC (Federal Open Market Committee) meeting this week and the probability that they are going to extend "Operation Twist" but with unsterilized money I anticipate the Dollar will weaken considerably against the other major foreign currencies.  As an FYI, the Fed may expand their balance sheet from an additional $45 billion/month to $85 billion/month.
A weaker Dollar is just more fuel to the bullish fire that I sense is igniting as I write this.
A number of events this week that, on the face of things, might be taken as extremely bearish with negative implications for the US economy, may actually be extremely bullish.  We just have to dig in under the headlines a little bit to understand what is really going on.
First of all, Europe is quiet and is liable to be so for some time.  Spanish and Italian bond yields are stable to dropping and although the entire Euro zone is mired in recession, you would never know it when you looked at the charts of the European bourses.  Here's the German DAX Composite:
(click on chart for larger image)
And here's the the Europe 350 iShares ETF comprised of the top 350 capitalized European compnies traded in Europe:
(click on chart for larger image)
Now, admittedly one can make a cogent case that both indexes are bumping up against resistance and IEV is sporting a possible triple top.  But my reason for posting these charts is to show that considerable liquidity has been pumped into these stocks since June and these charts are hardly telling us that Europe is on the precipice of economic and financial implosion.
Secondly, Chinese stocks are finally reacting to the recent bullish economic data that's given hope to investors:
(click on chart for larger image)
The Shanghai Composite had a big week (see black circle) and although we have a long way to go and the 50 day moving average is still under the 200 day moving average the Shanghai managed to close just above it this week.  I know it's early but I'm predicting China is finally coming back, at least for the first half of 2013.
Now, let's talk about the "cliff".  I spoke above about events that took place this week that would seem, on the surface, to be extremely ominous and bearish.  The two developments that initially spooked me were:
1.  Treasury Secretary Tim Geithner telling CNBC's Steve Leisman this week that the Obama administration was prepared to go over the cliff if the Republicans did not acquiesce to Obama's demand that the tax rate go up for Americans making over $250,000.00/yr
2.  Obama added to his first fiscal cliff offer that he have unilateral power to raise the debt ceiling in the future; that is, without Congressional approval.
We need to keep a few things in mind regarding point one.  First of all, the results of all the national polls clearly show that the Republicans will be blamed if the nation goes over the cliff.  Second, if we do go over the cliff the Obama administration will get exactly what they want; the end to the Bush era tax cuts.  So what do the Democrats have to lose by not compromising with the Republicans?
The above synopsis is simplistic as the Democrats would also lose in going over the cliff because of all the entitlement cuts that will also take place.  But if we were to go over the cliff the negotiations would still go on and probably lead to a roll back on the entitlement cuts and further tax reform.  Indeed, Obama has already hinted that he was open to tax reform that would inevitably lower the tax rate of upper income Americans by broadening the tax base.
So, as I see it, Boehner and the Republicans are between "a rock and a hard place" regarding point one.  Political expediency dictates the Republicans caving on point one.
Point two is more problematic and I just don't know where the Republicans will come down on this issue.  I personally think it's dangerous for any one branch of the government to hold this power unilaterally, especially given the fiscal mess we find ourselves in.  And this could be the point that pushes us over the cliff.  This is a way more tougher pill for the Republicans to swallow than the tax increase issue. 
There's many more moving parts to the "fiscal cliff" that can be explained but my purpose in composing these commentaries is to distill the avalanche of information I take in on a weekly basis in order to whittle down to the salient issues that may move financial markets. And the points I identified above are the two main obstacles to an agreement on this crucial issue.
I believe we'll get much more clarity on where we're going on the cliff this coming week.  Everyone in Washington wants to go home for the holidays.  The President and his family are scheduled to depart on December 17th from Washington for their annual Christmas celebration in Hawaii.  So far, he's on schedule to depart.  Most of the Congress went home for an extended weekend this past week but a core group stayed behind to continue whatever negotiations are going on. 
Anything can happen but I'm guardedly optimistic there will be a resolution for no other reason than the market, as measured by the VIX and to a lesser extent Treasuries, is not worried about it. As stated earlier in the commentary, stocks are starting to price in a resolution. Personally, I'd say we're going over the cliff.
If/when it becomes apparent we're going to go over the cliff the last few weeks in December will be ugly for stocks.  A "kick the can" solution will be met with a relief rally that will quickly fade.  A comprehensive agreement would touch off an explosive multi week rally.  With improving economic fundamentals, a turn around in China, a healing Europe and now a responsible plan to reign in the gargantuan deficits in the world's largest economy, such a plan could set the stage for a very bullish 2013 for stocks, regardless of the fiscal drag from higher taxes and reduced spending.
In the short term, dollar weakness should keep risk assets levitated in the upcoming trading week.  Of course, headline risk will predominate all market price action but barring any substantive news out of Washington look for a break through in the S&P with a target of 1435.00.  
Have a great week!