A friend of mine asked me about my thoughts on the market and I wanted to capture my thoughts and also put some charts up for review (I did this under two other posts.... CHART-SLAW and SON OF SLAW). Now we have made it through the Fed meeting and the ECB meeting we are coming to a point where we see that central banks may be boxed in and have little ability to do much other than talk about what they could do..... until they are forced to do something entirely out of the box (yes, this is still coming).
Let's break the perspective into two broad categories. First, we'll talk about all the reasons the market looks bad and how the gathering clouds could reduce the gains that the market has posted so far this year. Second, we'll review all of the reasons that the market could actually go higher.
CLOUDS ON THE HORIZON
ECB - LOT'S OF BARK, NO BITE
Draghi and pals really did have great success a month or so ago when they claimed they would do anything and everything without limit to save the Euro. Well, it sounded good and the market was happy..... till everyone realized that practically no other country would approve the measures and possibly the most important one, Germany, can't constitutionally do what needs to be done to save Europe. I'm hearing more whispers that perhaps Germany is beginning to see the light and might even consider their own exit from the Euro. Mark September 7th on your calendar as this is the day the German High Court will decide if the extraordinary measures proposed by the ECB are allowable in the context of their constitution. If the German court pulls a Chief Justice Roberts and twists their laws to promote a greater government, then the Euro could very well emerge stronger (with a little addition by subtraction as Greece has to go). If though, the law really is the law, we can expect a very messy situation until the people demand to be saved by the ones that are destroying them.
FED - ON HOLD TILL NEXT MONTH
The Fed last week told us that conditions in the US were slowing, but hadn't gone so far that they would intervene. Of course they didn't miss the opportunity to let us know that more QE could still come later. The reality here is that more "twisting" probably won't help too much as rates are in the cellar anyway. I had an interesting thought the other day that ultimately we would see the Fed buying index futures to bolster stock prices at some point, but so far I don't think this has happened (except during the flash crash --- we'll never know). When we do see this type of extraordinary action, you can be sure that it will be implemented when the complete collapse is unavoidable.
What do I expect in September? Well, I think the easy thing to expect is that we will have them tell us that they will not only keep interest rates low through 2014, but we'll also see them promise rate stability through 2015. This could make some opportunities very interesting and will highlight those ideas later.
The script is already being played out in front of us as we've had a host of Fed Governor's give us their views on what needs to be done. We've had calls for more stimulus and of course we've had the token hawk, Dallas Fed President Fisher explain that nothing more needs to be done except for fiscal actions by Congress. As we've discussed at length, Fisher and any other hawks are just useful tools to make it look like there is a reasonable discussion going on. Dudley, Yellen, and Bernanke are the only votes that count and we all know that ultimately more QE is coming.
Despite the powerful interventions of QE, QE II, QEIII, and all sorts of other efforts, we really are slowing down in the US and globally the economic turn seems to have happened in Europe and in Asian countries. I think we have determined that the US has not decoupled from the world and likewise, the world has not decoupled from the US. As world economies slow, we could see the unorthodox intervention I mentioned above to save the US system. Transports like the rails and UPS are all showing weakness and the sudden and abnormal spike in gasoline prices in July won't help them much either. Today's MCD same store sales data suggests that Europe is a total disaster so watch those multi-nationals.
NO TRUST - GOOD KNIGHT CONFIDENCE, GOOD KNIGHT
I have posted quite a few notes lately suggesting that the retail investor is simply not on the same playing field as the high frequency trading bots and institutions. The entire system seems to be structured in a way to rip money away from Mom and Pop and remove them from the markets. Banks through their trading of derivatives and manipulation of LIBOR continue to show that the culture is rotten in that industry. We also see the regulators asleep at the wheel and the PFGBest scandal is a damning indictment of their inability to see any of these acts until the collapse of the ponzi is complete. Finally, the Knight Trading incident added to the fat-finger May 6th flash crash may be the final straw that breaks the back of small investors that are actually paying attention to their accounts. While I am pretty confident that the average investor has no idea what happened last week to Knight and their bots-gone wild match-making test software fiasco they may hear and learn about it as more dominos appear to fall and of course liquidity will suffer in the long run. It appears that Knight was able to somehow salvage itself and obtain critical financing to stay in business, but this event shows just how significant "fat-finger" errors can be in terms of lost capital and potential job losses. Knight employed more than 1,500 people and it boggles the mind to think that all of them could have been out of a job as a result of a software program that ran for 45 minutes. Makes you want to buy some stocks doesn't it?
Here is a great article today highlighting the impact our markets feel under the weight of HFT attacks. This post looks at 1 second in time in the trading of gold prices.
FISCAL CLIFF AND POLITICS
Let's not kid ourselves at all. While Obama has a few left leaning views, Romney is no super-conservative savior either. In fact, other than a few guys that say they are Tea-Party guys (and then don't actually act like it or don't have any power to actually do anything) both sides are equally terrible. The bottom line is that the arguments between these two disaster parties are stupid and not based on any real substance. In order to actually make a real dent in things we need to halt deficit spending and actually force government to quit growing! These cuts will hurt, and our economy would absolutely grind to a halt.. Unfortunately addictions are really tough to quit and so the process will be painful. The adults in the room need to ask themselves if they want a few years of pain or a complete collapse. Since there are no adults in the room (Executive branch or in the Senate or Congress), we will continue down the path of destruction till Japan implodes and it will be too late to do anything but watch the event happen here.
The theatrics of budget cutting and the fiscal cliff are a sham and will certainly be a distraction and may get markets rolling over soon. Let's not kid ourselves, we'll be rolling over the debt we'll just be subjected to political posturing from both sides with little real substantive cuts or fixes.
SMALL BUSINESS OWNERS = NO JOBS
Policy, policy, policy. The bottom line is that no smart employer is going to add to headcount in this environment. Why would you attempt to grow your business with the threat of more regulation and more tax obligations unless you knew there was a significant upside? While the passage of the Healthcare Act and it's affirmation by the Supreme Court clears the uncertainty it also ensures that employers will think harder about providing benefits and adding people to the roles. The tax roll-back issue is also one that prevents smart employers from taking significant risks at this time.
Commodity prices are really at a critical juncture. Europe is slowing. Australia says that China has stopped slowing. Droughts have caused massive spikes in corn and soybean prices. Gas dropped significantly since May 1st (when we said to get out...thank you) and now have roared back in a very unusual July move. Gold and silver seem to have gained some traction, yet also are poised to rally or fall significantly shortly. So what is the point? I believe that the main item we need to watch is oil and gas prices. If oil and gas move higher, Europe and China suffer and we will too. If oil stays below $90, we could see a domestic improvement here in the US despite some of the headwinds I've noted above.
MIDDLE EAST - ARE YOU PAYING ATTENTION?
Last, them me wrap up this section about the threats to the economy with a thought on the Middle East. The Arab Spring, or better stated the Islamic Revolution, that seized Africa and the Middle East last year still continues to have a destabilizing impact on the region and the world. In very short order, the very nature of the Middle East was changed. The situation is clearly not settled in Egypt and the region's stability is very much in question until this is resolved. The Syrian situation too seems to just be getting started and the nation's importance is not to be underestimated. Iran needs Assad and Assad needs Iran and Russia needs a strong Iran in this theater of the world as a thorny irritant of the USA. If Assad is close to being overthrown we could easily see the use of chemical weapons on the Syrians and or Israel in an attempt to muddy the waters and draw by-standers into the fray (NATO or the US as Russia and Iran already have assets there). Once Assad reaches this point of desperation, there won't be a check on him as he attempts anything to delay an end to his power.
An attack like this or an entry into this conflict will move oil prices significantly higher and a sustained period of time with high prices will absolutely slow our economy and our consumption.
We are seeing a few signs that all isn't well and that the US consumer is still able to recall what it was like in the financial pit of 2008. Revolving credit is beginning to fall again as consumers pay down debt and also the high-end retailer Coach missed big last week when they reported their earnings. Finally, Priceline also fared poorly this week as they cited that European travelers are way down. Remember, 70% of the US economy is based the American consumer being a total clown and spending their way to poverty. Without Joe-6-pack blowing his wad of cash on payday, much of the Fed's improvement scheme will have been for nothing.
ALRIGHT, THAT'S ALL NEGATIVE, WHY WILL THE MARKET LAUNCH HIGHER?
We've said it before and we'll say it again, the Fed has this market's back. When the street is actually hoping for negative news, you know that we live in a crazy world! As I mentioned above, we will see action within the next several months from the Fed and this must be counted as a positive for equities. I've heard thoughts that the next move will be to drive mortgage rates so low that absolutely everyone will refinance in hopes that it causes every market participant to rush out there and buy a rent house with their uninvested cash. Perhaps that strategy is starting to work already as I speak with someone every day about low interest rates and the potential for buying rent houses......watch out bubble here we come!
Housing construction and existing sales seem to be improving and certainly homebuilder stock prices continue to do well. XHB is at 3 year highs too. Housing related plays like Mohawk Industries all have similar charts that are right at the edge of multi-year break outs higher.
Employment continues to look better here in the US. We have seen great momentum in agriculture, trade, and transportation areas along with retail. Negative areas continue to be in public education, public administration, and food service and hotels. Broadly speaking, jobs are out there and this is shown by the continued growth in online job listings available. The Monster.com online job index shows that the number of available listings and postings continues to grow, although at a slower pace. MONSTER INDEX
USD TOO STRONG
A quick glance at the USD Index chart indicates that the USD has gone just a bit too far, too fast as it was recently at the top of the 2 standard deviation bollinger band. Since mid July, that has corrected a bit and thus we've had a nice equity rally. I think I still might continue to believe that markets will continue to try to believe in Draghi and the ECB's successful management of their crisis. I do believe that Draghi is crazy smart and was so smart in his recent tact to dismiss concerns about Spanish long term bonds while crowing about the relatively low funding cost levels in the 2 year bonds. This powerful David Copperfield-like distraction has worked well and I assume it will till it doesn't. If it does for a bit more time, we'll see the USD Index fall to near $80.
TRADING OUTLOOK - ALL SYSTEMS GO FOR 1 MORE MONTH
In closing, I've laid out both sides of the near term arguments for a higher and lower market. The US economy seems to be sliding along, but mostly due to a lack of clarity on policy and fiscal issues. Elections do matter as well, but nothing matters as much as the September 7th German High Court ruling on the fate of the ECB's coordination to save the Euro.
Until September 7th, I do believe we'll see the market defy gravity and wander up simply because this market is one where absolutely 100% of the participants believe it is too high and due for a correction.
The bond market is usually the best indicator of big macro moves, but we know that each credit market is so distorted that real decisions cannot be made based on manipulated treasury rates, Lie-bor rates, and any spread that is derived from them. Interestingly, I have noticed some odd activity in the corporate bond market in the last several days where new bond positions have appeared for sale at unusually high yields. While I personally haven't been able to purchase them despite my best efforts, the fact that they are there for just a few minutes indicates to me that really smart money may be liquidating positions since yields are so low (smart money exiting). While this has only happened 4 times so far this week, this is odd that the offer price was so low and I will continue to monitor these events.