Submitted by Mark Hanna
Courtesy of MarketMontage. View original post here.
Despite the “everyone is at the Hampton’s, let’s melt this market up” Friday, the action the prior day remains very worrisome. Healthy markets should not be this volatile, and that applies just the same to UP moves as it does to DOWN moves. The helter skelter 1.5% up, 2% down, 1% up, 1% down is not a sign of health, and these comments remind me of the environment of April which was similar to what we are seeing the past few days.
While we are waking up to a gap down open, what is happening in any one particular day is not the point – it is the environment. After a few weeks of oversold bounce on hopes of central banker interventions/government rescues that selloff Thursday was a massive day of distribution and does not install confidence in the broader stock picture. A week ago Friday was the first day we began to see individual leaders breakout on their charts and actually hold those breakouts. Unfortunately that only held true through FOMC announcement day on Wednesday when “the action” was constructive despite the volatility – therefore a grand total of 4 days. But Thursday seems to be the real reaction to the Fed’s announcements. So it appears this will be the second failure of an IBD “Follow Through Day” in as many tries. There is no shame in that – it is one tool of many, and has a 30% false positive ratio. When it confirms in an accurate way there should be a multi month rally that follows, which is why there is no rush to go “all in” once a FTD signals.
A quick look at the S&P 500 – I’d like to point out a gap below that was formed in early June. It is now visible on the S&P 500 chart so I will use the SPY ETF; it is down there at 1295. Normally these market gaps fill within weeks/few months unlike gaps on individual charts. So if weakness continues this is an obvious level to target. S&P 1340 and NASDAQ 2900 continue to be key multi year levels that the market only briefly popped it’s head over, only to quickly fail.
Larger picture, even if we removed the structural issues of Europe and this was 2005 rather than 2012, the backdrop would not be very positive. The U.S. is dealing with a debt bubble (slowly), Europe has some countries in full blown depression, while Germany has slowed to stall. And China is slowing dramatically no matter what the official data says – you can see this in the commodity markets where China is the end all, be all. [May 13, 2009: Commodities – It’s China’s World; the Rest of Us Just Live in It] In most major commodities China sucks up 30-50% of all global demand. And commodities have for the most part been in freefall for months; the most obvious being oil. But steel and coal and the like have been weak far in advance of oil. What is often forgotten is it was not the U.S. (or Europe) which led the world out of the depths of recession in 2009 – it was China. They did a stimulus program equivalent to over 20% of GDP (!) [Feb 16 2009: Is China Pulling an Alan Greenspan?] – of course that led to long term misallocations (empty cities anyone?) [Jun 2 2011: China Beginning to Feel Hangover from Lending Boom] [Mar 29, 2011: [Video] An in depth Look at China’s Empty Cities] [Jan 14, 2011: [Video] Behold China’s Nearly Empty Mega Mall] [Nov 13, 2009: Ordos – China’s Empty City] that were entirely predictable [May 27, 2009: How is China Spending their Stimulus… and How Many Loans Will go Bad?] but in the short run it drove global demand. The country cut interest rates for the first time in 4 years recently, but it was when they directed their banks to make a massive amount of loans that things really went into overdrive back in 2009. No such major directive yet.
Of course it is not 2005 but 2012 (or is it 2010… or 2011 – they are all repeating very similarly!) In these ‘dire’ moments in 2010 and 2011 central authorities came to the rescue and summer dips were seen as buying opportunities in retrospect. I believe this is why this year’s selloff – while sharp in May – is ‘contained’ relative to the prior 2 years. People have recency bias and see the pattern and believe we will repeat. Maybe so – maybe not. But this is the first year corporate profits could be significantly impacted – not the case in 2010, 2011. Full year estimates for 2012 are very back loaded to Q3 and Q4, based on bottom ups projections. But the top down (macro) point of view is not matching up even if policy intervention comes in hot and heavy globally later this year. At this point cost cutting is done (not many left to fire without impacting business), and government stimulated revenue is slowing sharply. Meanwhile profit margins are finally contracting after a few years of strong expansion. In the end – even if it’s hard to remember in this new era of central banks now targeting stock prices – valuations of companies are supposed to reflect profit potential.
Speaking of the topic of rescues/interventions/save the world meme, the Europeans meet at the end of the week and we can be sure to have another fun filled week full of rumors of this or that. One or the other will drive the market up (or down) intraday this week as we continue this UNHEALTHY volatility based on nothing but rumors and headlines. It seems some form of banking union is the most probable ‘first step’ of agreement – but how to fund it is will be an interesting question. Unlike the U.S. (or U.K. or Japan) there is no central government which can just print dollars (or technically create them in a computer) to fund bailouts of Citi, Bank of America, Fannie, et al. Hence in Europe someone actually has to put money “into” the rescue fund from existing stockpiles. So banking union, deposit insurance, et al – good, but money from where? Devil in the details.
In the U.S. we will see economic data centers on housing, confidence, and some regional Fed surveys. Chicago PMI (expected 53.1) on Friday is one to keep an eye on – automotive has been one of the bright spots the past 18 months, and this region is heavily exposed. If it comes in below expectations things might be degrading domestically even quicker than anticipated.
Overall, we face the same quandary as the past 2 years – an economic slowdown for one reason or another (think Japan earthquake, or Greek crisis 1.0, Greek crisis 2.0) boxed in by fiscal/monetary stimulus – real or imagined. Looking out a bit, both the ECB and Bank of England are meeting next week and expectations are both will stimulate (QE by the latter, rate cut by the former). U.S. monthly employment will also be reported that week and this might be one report the market is rooting for awful news since it will surely bring in the Fed. While these actions seem to have little effect on the real economy while it is deleveraging, they continue to act as heroin for the market. Until at some point they won’t.
Disclosure Notice
Any securities mentioned on this page are not held by the author in his personal portfolio. Securities mentioned may or may not be held by the author in the mutual fund he manages, the Paladin Long Short Fund (PALFX). For a list of the aforementioned fund’s holdings at the end of the prior quarter, visit the Paladin Funds website at http://www.paladinfunds.com/holdings/blog
