Weekly Bull/Bear Recap: Mar. 25-29, 2013

This objective report concisely summarizes important macro events over the past week.  It is not geared to push an agenda.  Impartiality is necessary to avoid costly psychological traps, which all investors are prone to, such as confirmation, conservatism, and endowment biases. 

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Bull

+ Cyprus is committed to the Eurozone.  Its sacrifice is a signal of resilient and solid political will.  The Bears continue to dwell on crisis after crisis, but they fail to recognize that these are clear buying opportunities.  Europe is too invested in the project to turn back now; they will create solution after solution, leading to further integration.  Smart investors sniff this trend of “no turning back” (a trend confirmed by 2-yr swap spreads)… 

+ …Risk markets continue to appreciate despite Eurozone worries — the S&P 500 and Dow Industrials have hit record highs.  Stale global growth will begin to rebound due to continued resolution in Europe as well as positive spillover effects from a clearly strengthening U.S. economy:

• The Chicago Fed National Activity Index, a comprehensive indicator of US economic growth, indicates improved economic activity in February. The index’s 3-month moving average marked its fourth straight reading over zero, a level that implies an above-trend pace of growth.
• Moreover, the ECRI’s Leading Indicator is in solid growth territory, evidence of continuing growth over the short to medium-term.  Lakshaman Achuthan is hiding under a rock at this point.   
• Meanwhile, the consumer continues to chug along, defying bearish forecasts of weakness resulting from an increase in payroll taxes, gnawing sequestration, and historically high gas prices. Personal consumption and expenditures increased in February by the most in five months, while January’s reading of 0.2% was revised higher to 0.4%. Even better, because income growth was strong as well, the national savings rate actually increased from 2.6% from 2.2%.  Job creation, along with increasing home values (at the fastest rate since mid-2006 as per the Case-Shiller Index), are offsetting the bearish aforementioned effects. “The economy is in a very good place right now ahead of fiscal restraint. This recovery is sustainable. Consumers are in the drivers seat,” said Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ Ltd.  This is especially true when looking at forecasts for March auto sales.   
• An important leading indicator of the housing market, lumber prices, points to residential investment taking a central role in economic growth over the coming years.  

• The Fed’s got the economy’s back.  Dudley,  Rosengren, Evans, and Kocherlakota all announce their support for further easing until economic growth is soundly ensured.  Bernanke says that continued easing will not “beggar thy neighbor,” but instead “enrich-thy-neighbor.”  Stronger domestic economic growth will spill over to increased aggregate demand, increasing trade flows.     
• In manufacturing, the Dallas Fed reported that manufacturing activity in the region increased, while Durable Goods Orders rebounded in February. Overall, the figures suggest that industrial activity continues to expand at a moderate pace.

+ Corporate profits remain at record levels, but this is little reason to believe that they will mean revert.  Through a domestic lens, profits are indeed high vs. the historial average, but from a global perspective, profits are only a little above average and have room to grow.  Because globalization has resulted in many US corporations obtaining revenue streams from abroad, earnings will grow on an improving global economy.  “Conventional thinking sees unsustainably high corporate profits and expects a reversion to the mean. Global thinking sees no a priori reason to worry at all.” 

Bear

- Conditions in Europe are approaching a boiling point.    

The Cyprus bailout is a Pyrrhic Victory, setting two ominous precedents:  

• First, Capital controls have now created two euros, a Cyprus euro, now worth less than a true euro due to its decreased fungibility.  Furthermore, controls are likely to precipitate a liquidity and economic crisis in the country, leading to a “larger than expected” economic contraction and an eventual need for an additional bailout.  Massive job losses are coming as the country’s banking sector, a pivotal source of economic growth is decimated.  Its “solid political will” to stay in the EMU will be tested shortly with the advent of a depression.  
• Second, depositors’ skin is now in the game, which may lead to capital flight from other periphery countries.  —— Where can I find uninsured deposits as a percent of total deposits in the Spainish and Italian banking systems?

Moreover, Dutch Eurogroup head Jeroen Dijsselbloem does his best to further rock the boat by announcing that the Cyprus deal would be a template; a statement quickly refuted by the EU   (when it becomes serious you have to lie right?).  Furthermore, how can Bulls say that political will remains solid when you have comparisons of Merkel to Hitler on “El Pais” (Spain’s largest newspaper) and Luxembourg’s PM saying “Germany and Merkel are striving for hegemony…”?  It’s not only European countries who are ticked off at the Cypriot bailout package.  So….who’s next in line for the Eurozone’s 6th bailout package and a guaranteed depression?  Heeeere’s Slovenia!   

Deterioration seen this week wasn’t limited to Cyprus.  Italian yields rose on lack of a solution to the lingering political deadlock in the country.  Levels to watch on Italian 10-yr yield = 4.87 to 4.89.  A strong break over these levels will signal further trouble for equity markets worldwide.  Economic wise, the data still look bearish for the country: Industrial Orders in January fell another 1.4%, while Retail sales fell 0.5% in February.

-  Red flags are waving in terms of global growth.  The level of complacency throughout the investment community is at deafening levels.  All of a sudden the Phd in economics, copper, is disregarded as a bellwether indicator of global growth.  Perhaps because its clearly not confirming the bullish narrative - (the red metal broke through its multi-year symmetrical triangle pattern to the downside).  What’s more, South Korean GDP disappointed, as did industrial production.  Was this due to Abenomics? - (keep an eye on a possible rising wedge for the Kospi).    

- Is manufacturing in the US really picking up? Most of the rebound in Durable Goods Orders was due to the volatile transportation sector. Core durable goods, a gauge of business spending, actually fell at the steepest rate since July last year (-2.7%), surpassing economists’ forecasts of a 1.2% drop. Meanwhile, the Chicago purchasing managers index came at a disappointing 52.4 versus analyst expectations of 56.1. New Orders plunged 9 pts and Backlogs are now negative.

- Is the housing recovery real?  Not when mortgage purchase applications, a measure of true sustainable demand and not investor buying, is not confirming.  Furthermore, for all the talk of large YoY gains, it’s important to see the forest for the trees; home prices are still down 30% from their peak 7 years ago.   

Starting the Week: Jul 16-20, 2012 

Upcoming Economic Releases/Events I’m Watching

July 16

• U.S. Retail Sales
• Empire Manufacturing Index
• Spanish Industrial New Orders

July 17

• ZEW Economic Sentiment
• U.S. Core CPI
• U.S. Industrial Production
• NAHB Housing Market Index
• Chairman Bernanke Testifies (2 days)

July 18

• Building Permits
• Housing Starts
• Beige Book
• Spanish Home Prices

July 19

• U.K. Retail Sales
• U.S. Initial Jobless Claims
• Existing Home Sales
• Philly Fed Manufacturing Index
• Italian Industrial Sales and New Orders
• Conference Board U.S. Leading Index 

Technical Notes

• Heavy band of resistance between 1,360-1,374 due to 100-day moving average & 2 past fails to break higher.  
• Support at 1,332-1,338 Upward trendline & 50-day MA then another band of support at 1,305-1,310, which is where a L-T trend line & 200-day MA both lie.
• Inverse Head-&-Shoulders has completed & the S&P 500 has been trading in a bullish manner ever since. 
• Keep an eye on the large triangle being formed from the highs of the bull market and the recent lows; solution may not be far off.

General Notes

• Interestingly (and somewhat expectedly), prospects of stabilization in China sent what was poor action in Europe to the back burner.  As long as Spanish or Italian bonds don’t fall out of bed, more news like this would keep the bears at bay.    
• Copper showing meddle last week.  A strong break above $3.52 could signal a possible stabilization in China.    
• Chinese coal companies have historically been almost perfect in identifying turns in economic activity.  So far, they look sluggish.
• Spanish and Italian sovereign yields remain quite elevated, especially on the heels of the Eurozone summit, which was suppose to resolve everything.  Higher yields would likely affect U.S. markets.  
• ECRI’s announcement of the U.S. being in recession seems ominous.  Like I covered in my recent Macro Outlook, the global economy is suffering from a strengthening crisis of confidence due to uncertainty and austerity in the Eurozone.

Thoughts on Tomorrow’s Fed Decision

Tomorrow’s the day.  Will the Fed throw the kitchen sink as proposed by Rosenberg, or just initiate Operation Twist?  I remain of the notion that the Fed will do less…for now.  

Obviously it’s impossible to predict what will happen.  A Eurozone collapse would more than likely trigger a QE3.  

In either case, I’ll be very focused on the Fed’s statement for signs of a potential Unemployment Rate target or a QE3 in the coming months.  

If the market rallys on such news, will it be a rally similar to 2009 and 2010?  I don’t believe so.  The law of diminishing returns also applies to monetary policy in my view.  This view is supported by the fact that the S&P500 has almost given back all of its QE2 gains.  Furthermore, how will loosened monetary policy perform without a fiscal accompaniment?

The market doesn’t care what I think though.  It’s imperative to be nimble during these uncertain times.        

Thoughts on Gold’s Sell-off

Today gold is down roughly $80, equating to a roughly 4% drop. Many are speculating whether the gold bubble is about to burst.  The fact that so many people are ready to call the top makes me skeptical that we’ve reached that point. However, that doesn’t mean that it’s improbable that we’ll see a decent sell-off in the following weeks to flush out the weaker hands.

Of interest has been the recent negative correlation between stocks and gold. When stocks have gone down, gold has gone up and vice versa. This may be the market’s way of telling us that it’s expecting quantitative easing (QE).  Here’s how.  Falling equity prices would concern Bernanke as they undermine already fragile consumer and business confidence.  Falling confidence could result in a self-fulfilling prophecy of a double-dip recession.  Therefore, he would engage in further monetary easing (QE) to boost asset prices and confidence.  However, this would effectively lead to a further debasement of the dollar.  This prospect boosts bullish gold bets as investors seek to preserve their purchasing power.       

Today, we have some interesting market action. Gold is taking a tumble while at the same time stocks are not responding in kind. Equity’s are only slightly up. Could this mean that the market is beginning to anticipate than Bernanke may not announce any quantitative easing? I have been skeptical of such a program being announced at Jackson Hole. I believe that the Fed is close to running out of bullets and Bernanke wants to save the precious few that he has left for when he has fiscal stimulus at his back.  We’ll find out Friday.