Everything seems to be developing more positively for the global economy. As stated in my commentary last week and reinforced by news this week, both China and Europe are on the mend.
Europe has really settled down with both Spanish and Italian bonds getting a great reception at their auctions this week. It's apparent that foreign money is now flowing back into Europe. And the extreme risk of Euro zone implosion is off the table as reflected in this one year daily chart of the Dow Jones Europe Financials Index comprised of major financial institutions on the continent. We've superseded the high set in March, 2012 after which Spanish banks threatened to crash the Euro zone banking system:
Here in the US we have a recovering housing market thanks to low interest rates, courtesy of the Fed. Unemployment, though still at unacceptable levels, is improving. Consumer sentiment, though recently rattled by the "cliff" negotiations", is still rising and inflation is contained (for now; more on this next week).
We still have act two of the "fiscal follies" coming to a theatre near you in February and Wall Street is largely acting like an ostrich with its head in the sand on this issue. In last week's commentary I discussed a few different scenarios that may emerge from the confrontation in Washington. There will be some significant volatility over the next six to eight weeks because of these political wranglings.
My personal opinion is that the Republicans will not give ground this time around. I think they will choose to force us over the "sequester cliff" on March 1st. Hopefully they'll allow Obama to raise the debt ceiling. Whether both parties in the aftermath of such a scenario come to terms on more sensible cuts is open to conjecture. But if they decide to kick this can anymore there will be reverberations in our treasury market. Today, with the rest of the world still healing from the gaping financial wounds of 2008, our debt is still the safest place to park money with few other options available to investors. But if we don't show a "good faith" attempt to address our debt issues, our debt will get downgraded again and I believe this time, given a steadier growth rate, interest rates will start rising.
If there is anything on the horizon that will have a negative impact on the global economy it would be the Federal Reserve's inability to unwind the trillions of dollars in Treasuries and MBS that's on their books. The widespread belief is that this process will be messy. I personally am not sure but when everyone seems to be leaning on one side of the boat on an issue, I like to get on the other side so I don't get wet!
As far as stocks go, Small Caps as reflected by the Russell 2000 are at historic all time highs. Mid Caps as reflected by the S&P Mid Cap Index are also at historic all time highs. The fact that small and mid caps are leading this market higher is extremely bullish. As stated last week this is predictive of higher stock prices going forward.
We had record inflows into stock mutual funds this week and the Fed's liquidity pedal is to the metal! Even with the "fiscal follies" on the horizon it would be financial suicide to believe that the path of least resistance for stocks is down.
I know I said last week that if the sequester kicks in stocks would be in for a rough time for the rest of the year. I've reconsidered my thesis for two reasons: any economic drag from the sequester will be in proportion to the amount of time it stays in force and second, it's difficult to measure the negative impact from these spending cuts. All we can say is that there will be a drag on growth; we can't be definitive as to the magnitude. I'll probably be addressing this subject more in next week's commentary.
The S&P500 is bumping up against some formidable resistance in the 1470 - 1475 level. It must clear the early September intra day high of 1474.51 for the next leg higher to occur. If we can clear this barrier, the next possible theoretical resistance levels would be 1528.72 and then 1609.44 based on Fibonacci price extensions .
We're inching closer technically to a level which will tell us whether the grand Keynesian remedy that put the huge tourniquet on a mortally wounded world economy is going to work. Below is a monthly chart of the S&P500 going back to 1983:
Now, although a head & shoulder formation is potentially bearish there are a number of points to remember:
1. The right shoulder is only half formed. The S&P could continue to move higher from here.
2. Momentum indicators are useful but no indicator is 100% reliable and price action is the most reliable predictor of future direction.
If the right shoulder on the chart came to fruition from present highs and broke the neckline, the projection down as per classic technical analysis would suggest an S&P of 100! Or are we finally coming to the end of this secular bear market that started with the dot.com bubble and bust of 1999/2000?
Theoretically, the bias in the market is always to the upside. Option pricing models are predicated on this premise. Considering the longevity of the bear market we've been in, the avoidance of financial meltdown, the ability of major global corporations to thrive in a slow growth economic environment and the ongoing success of the private sector to deleverage, the only thing that can hold us back is the Keynesian failure to diffuse the massive debt on public sector balance sheets. The concern always has been that central banks were running a race against time which is the only way to unwind this debt. Given recent events in Europe and a strengthening economy here in the states and China, it's becoming more apparent that they are succeeding in winning this race.
This time next year stocks will have surpassed their previous all time highs.
I'll be back next week with a more comprehensive commentary.
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!