Sunday, February 22, 2015

Money moves into Europe!

Since my last commentary the market has been pushed to and fro with concerns over a Greek exit from the Euro Zone and with Friday's "agreement" in Brussels it appears that the Greek saga has been pushed back another four months when another day of reckoning will rear it's ugly head.

Monday will tell us much regarding the Tsipras' government's resolve to stay in the zone when they submit their list of alternative reform measures to the EU.  If there's any fudging on the Greek government's part to dodge the general thrust of the austerity measures originally imposed upon them, it will be back to the drawing board once again and more market volatility will result.  Still, the market has been very resilient throughout the negotiation saga of the past few weeks and I believe any market moves will be muted.

In my opinion, the two biggest concerns market players have at this point is the uncertain ramifications of a Greek exit from the EU and the risk of contagion as other separatist movements on the European continent might be emboldened to instigate a break away from the EU.  While I don't see the latter as a significant risk, the uncertainty of the former is creating market volatility.  However,Greece is the only sovereign "basket case" in the Euro zone and a "Grexit" (Greece leaving the EU) is still a very small probability.  The Tsipras government is playing a game of chicken ...

Cartoon courtesy of SoberLook
@soberlook


 ... which they cannot win and if the ECB withdraws their support from Greek banks it would immediately result in abject destitution for the Greek nation and spawn a humanitarian crisis of huge proportions.

In the meantime, there continues to be glimmers of reflation in the Euro zone.  Here's just one example.  Italy and Spain, two nations which have struggled since 2008, are turning up:

Chart courtesy of SoberLook
@SoberLook

Other economic indicators (credit growth and expanding money supply) are giving significant support to international equity and commodity valuations.

For instance, oil looks like it has found a floor and even after a disappointing report on Friday where the reduction of US rig counts was lower than expected, "black gold" was remarkably resilient.  Many traders (and I) expected a much more severe sell off and it seems like West Texas Crude has some support at $50/barrel:


(click on chart for larger image)

This weekly chart clearly shows the strong bounce in the area I earlier marked as "potential drop zone" and we are now at the top of another resistance area.  My thesis on oil's recent bounce in the face of gross oversupply and static demand is market expectations that Europe is now stirring we are going to start to see some measurable global economic growth which will increase demand for oil.

Whether oil's bounce and recent positive economic reports out of the EU (as unbalanced as they are)  are more than "head fakes" only time will tell but there's no question that cheap oil and a weak Euro are starting to produce some growth in Europe and is gaining the attention of market participants.   We may be starting to see a rotation out of US equities and into European shares as the chart below shows:

(click on chart for larger image)

This is a weekly chart of the Dow Jones Europe 600 Index, a broad based index of European stocks and I want my readers to notice the price relative chart in the bottom panel.  After a long downtrend, European stocks have jumped and are, at least for now, outperforming their US counterparts.  I believe this explains, in part, the relatively sluggish nature of the advance of US equities as money flows are starting to move out of the US into continental stocks.

The beginning of a rotation into European equities may explain why US stocks seem lethargic at these levels and I was thinking there might be a global rotation going on but not so in Emerging Markets:

(click on chart for larger image)

 This is a weekly chart of the iShares MSCI Emerging Markets ETF (EEM) and the price relative chart to the S&P500 in the bottom panel is showing continued under performance.  We do see some glimmers in momentum in the top panel (red arrow) where MACD is undergoing a possible crossover while the ETF itself is snagged on Fibonacci resistance.

I consider the price action in EEM logical given present conditions in the global economy.  I have said more than a few times in past commentaries that, at a macro level, the consuming economies in the West will have to lead us out of this global economic malaise we find ourselves in before we can start to see a significant pick up in economic activity in the developing nations of Asia and the Mid East.  Simply, until Emerging Markets and China transition into true consuming economies, it is dependent on the West (US & Europe) to pull us out of this low growth, disinflationary to deflationary mire we find ourselves in.  There's much more to say on this topic as I believe that, at a foundational level, global economic challenges are structural in nature mainly based on demographics.  However, I neither have the time or the inclination to comprehensively address this issue at this time.

Here in the US, stocks continue higher with unimpressive momentum as can be seen in a daily chart of the Wilshire 5000 Index below.  All the major averages saw all time highs again on Friday but we're starting to see that rounding top action which usually presages either a "garden variety" correction or a consolidation:

(click on chart for larger image)

This is a daily chart of the Wilshire 5000 which is the entire US stock market.  US stocks managed to break out of a trading range (green highlight) that started right around the first of the year on what I consider unimpressive momentum.  We'll see if the market can sustain the breakout and Friday's candlestick was a positive but my intuition tells me we may not maintain these levels in the short term. I suspect we'll retrace Friday's price action back below the break out (brown line) on Monday.

When all is told, the markets are generally moving true to their inter market relationships.  Part of oil's bounce and the possible ascent of US stocks can be traced to what is at least a consolidation in the US Dollar.  Below is a chart of the Powershares DB US Dollar Bullish Index Fund (UUP) which is a popular trading vehicle if you don't want to trade the currency directly:

(click on chart for larger image)

The dollar is forming a less than perfect bullish ascending triangle which usually means a break out to new highs.  However, the Relative Strength Indicator (RSI) in the top panel has weakened considerably which makes me think the dollar could fall out of the triangle to the downside.  This would be a catalyst for equities and commodities in the short term and would serve to mitigate disinflationary and deflationary pressures in the global economy.

In my last commentary I made much of the price action of Treasuries in determining general market direction.  Well, if rates are any indication, this market is moving higher:

(click on chart for larger image)

Here's an update of a chart I've posted many times before of the Ten Year Treasury yield.  Since February 2nd, the yield has backed up almost 45 basis points(green highlight)!  Treasuries are telling us that while rates are still incredibly low, economic growth is gaining momentum.  Now, we've seen this movie before so I wouldn't be surprised if this is a "head fake" and a trend line I drew on the chart above shows we haven't broken trend yet but the spike in yield in a few weeks is impressive.

Much of the action in the Treasury market is the result of participants trying to discern when the Fed will commence raising short term interest rates.  While some are targeting June others are targeting September and still others are targeting 2016.  My view is that it will happen later rather than sooner.  Everyone expecting a June lift off points to the seemingly excellent employment reports we have been seeing.  And I know this is anecdotal, but I don't know anyone who lost a job in 2008 who, if they found a job, is making more money than in the job they previously lost and I don't know anyone who's pulling down annual raises that are meeting even the lowest inflation levels we are experiencing.  If the employment reports were threatening an overheating economy we would be seeing inflationary expectations rising.  And we're not:

(click on chart for larger image)

This is the TIP:IEF ratio which is a measure of the market's expectation of where inflation is going.  I have posted a more detailed explanation of how the ratio works in past commentaries but for now, if the ratio is rising inflationary expectations are gaining steam and if the ratio is dropping, disinflationary to deflationary expectations are taking over.  I highlighted where we are now in (green) and we've just bounced in the last few weeks after a sustained descent that started in July 2014.  The bounce can be explained by the recent comeback in the price of oil as anything else.



Summing up, I'm constructive on equities going into mid year with a possible slowdown in the next month.  The Treasury market is telling us that Greece is a non event and that global economic growth is turning positive.  If we get some continued traction in the Euro zone we could be setting up for another banner year in equities.  But as I've harped on in previous commentaries, Europe is the key to the global economy truly turning the corner. Certainly, there appears to be movement into European stocks as evidence that the reflation trade is starting to take hold over there.  I'll be watching for signs of life in Emerging Markets next.

Have a great week!

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