Tuesday, October 25, 2011

The Morning Call -- The EU continues to diddle itself, but fewer people care


The Market

Technical


The indices (DJIA 11913, S&P 1254) soared again yesterday. They remain within their intermediate term trading ranges (10725-12919, 1101-1372). In addition, they have fulfilled the ‘distance’ element of our time and distance discipline with respect to breaking above the 11719, 1230 resistance level. As I have noted several times, the next stop appears to be 12919, 1372.

Volume declined, as did breadth. The VIX declined out of the upper zone of its current trading range--which, if it continues, would be a positive for stocks.


Finally, a re-check of our internal indicator shows that in a Universe of 165 stocks, 77 have now broken above their comparable 11719 level, 39 have not and 49 are too close to call. That is not as decisive a reading as I would have expected based on the pin action of the Averages. Indeed, in our Universe, less than half are confirming the indices upside break. Granted another 49 are right on the cusp of breaking out. However, I am going to be much more cautious than I might otherwise be until our indicator is providing stronger confirmation of the Averages.

GLD also rallied; it continues to trade in its intermediate term up trend.

Bottom line: the indices’ break above 11719, 1230 has been fairly decisive and I think that we have to honor that. However, our internal indicator is less significant and I think we must honor that also. Accordingly, our Portfolios will put some cash to work at the Market open this morning; but not as much as I had planned originally. I will await a stronger performance from our indicator before re-investing more money,

Fundamental

Headlines


As one might judge by the Market’s pin action, almost everything was coming up roses yesterday:

(1) only one economic data point: the Chicago Fed’s business index was not nearly as bad as anticipated,

(2) meanwhile, corporate earnings continued to smoke estimates, with yesterday’s highlight being Caterpillar. As of the close last night, 70% of the S&P reporting companies are beating expectations with overall profits are up 16%,

(3) M&A activity is starting to pick up, the latest being Cigna’s purchase of Healthspring for $3.8 billion,

(4) Chinese PMI was much better than expected which had many analysts that had been bearish on China upgrading their forecasts.

(5) two Fed governors were out talking QEIII.

Of course, the operative word above was ‘almost’ because the EU leadership continues to yank itself off and, rhetoric aside, the biggest risk to our forecast remains that events are moving faster than the political class.

The good news is that for the first time in a month or two, (good) US/global economic news has trumped that of (bad) news on the EU sovereign debt problem. Certainly, this could be a one day phenomena. But I wonder if investors haven’t concluded that these guys will only do what is absolutely necessary to be sure that there is no collapse tomorrow and that will continue to be the case for years (Japan 2.0); and that in the meantime, (1) the longer this drags on the more time the global banking system has to rid itself of EU debt and (2) the rest of the world may be able to get along just fine without growth from Europe.

Bottom line: the flow of US data points to an improving economy, albeit sluggish at best; corporate profits are better than I would have ever expected; and suddenly, the outlook for Chinese economic activity is picking up. The questions are (1) will Europe implode and (2) if it does, will it take the rest of the world with it?

As far as (1) is concerned, I believe that the eurocrats have realized that they are dealing with a potentially explosive problem and that they will do something to prevent the worse case scenario. However, that ‘something’ will by and large involve taking sufficient steps to allay disaster but not fix their problem. Japan 2.0 appears to be the endgame. So (2) is important only to the extent that the rest of the world can continue to grow even as Europe diddles itself. So far the data is suggesting that it can; however, that remains an open question which in turn demands caution in our investment strategy.

The EU leaders have yet to accept reality (medium):
http://www.wilmott.com/blogs/satyajitdas/index.cfm/2011/10/24/EuroZones-Leveraged-Solution-to-Leverage

What they are doing wrong (medium):
http://www.zerohedge.com/news/guilt-growth-lies-laziness-and-liquidity

And now they are looking to the US (taxpayer) to help bail them out (medium):
http://www.zerohedge.com/news/hope-efsf-solution-vanishes-europe-comes-crawling-uncle-sam

The predictive value of Mr. Market (short):
http://www.capitalspectator.com/archives/2011/10/does_the_stock.html#more

The latest from John Hussman (long):
http://hussmanfunds.com/wmc/wmc111024.htm

Subscriber Alert

At the Market open this morning, additions will be made to the following holdings:

In the Dividend Growth Portfolio: Nucor (NUE) and the Wisdom Tree Emerging Markets Income ETF (DEM)

In the High Yield Portfolio: the Wisdom Tree Emerging Markets Income ETF (DEM)

In the Aggressive Growth Portfolio: Chas Schwab (SCHW), Staples (SPLS), the Wisdom Tree Emerging Markets Income ETF (DEM).