Friday, October 28, 2011

The Morning Call Positive, Si; Is it Enough? No


The Market

Technical


Amazing day. The indices (DJIA 12208, S&P 1284) went through all three stages of Titan III shot with almost no hesitation. Clearly, they left the 11719, 1230 level in the dust, remaining within their intermediate term trading range (10725-12919, 1101-1372). As I indicated previously, there is almost no resistance before prices reach the 12919, 1372 level.

Volume rose and breadth improved. The VIX plunged, finishing the day well outside of the upper zone of its current trading range in which it has been trading since mid August. Not to be repetitious, but this a plus for stocks.

GLD continued to work its way higher, closing safely within its intermediate term up trend.


Bottom line: the technical picture is clearly more positive. Indeed, I would have liked for our Portfolios to have bought stocks yesterday; but I wrongly assumed that sometime in intraday trading there would some profit taking. Au contraire; except for a slight sell off in the first hour and one at the close, stocks were on a rocket ride.

In fact, the S&P covered almost one third of the distance between 1230 and 1372 in just one day. Such a massive, swift, straight line move makes any entry point very difficult because if you enter a market order, you run the risk of getting filled at a much higher price than the quote at the time of order entry; if you enter a limit order, you run the risk that it will likely not filled. Indeed, history shows that it is not a smart move to buy into an emotional melt up unless it is off a clearly defined bottom. So as much as I wish that our Portfolios had Bought stock on Wednesday’s close, I just couldn’t chase stocks yesterday.

That is not to say, our Portfolios won’t add to their equity position; but I want to be careful with the S&P within 2% of Fair Value and I only want to Buy those stocks that are still in their Buy Value Range.

More disturbing analysis on high frequency trading (medium):
http://www.ritholtz.com/blog/2011/10/jumped-the-shark/

Fundamental

Headlines


Yesterday’s economic data was uninspiring: weekly jobless claims down very slightly; initial third quarter GDP was in line with expectations though it gave no indication of an impending recession; pending home sales were disappointing.

Of course, nothing really mattered except the ‘plan’ announced by the EU leadership overnight. I discussed the broad principles and included some initial analysis in yesterday’s Morning Call. Plus I have more commentary below from guys who know a lot more then I about the workability of the various aspects of the program. So I am not going to be repetitious.

However, my conclusions about are:

(1) all we have is a broad outline. There is likely to be numerous fits and starts before any policy is actually implemented; so angst has not been eliminated,

(2) that said, there appears to be sufficient agreement among the EU political class on the broad principles, that the ‘every man for himself’ disaster scenario, over the short term, is, if not completely off the table, certainly has diminished significantly in magnitude,

(3) longer term, this plan in no way deals with the underlying issues that caused this problem in the first place,

(4) therefore, either the short term respite being granted by investors will be used to take more affirmative actions to deal with the main problems or, sooner or later, another crisis will arise that will demand another forceful step toward resolution and the eurocrats and global markets will repeat what we just went through,

(5) however, if US political class [electorate] can get its act in order and develop more growth oriented monetary/fiscal policies, then, the US will be in better economic condition to handle a second EU failure whatever happens.

Analysis of the EU package (medium):
http://www.telegraph.co.uk/finance/financialcrisis/8851769/Europes-grand-gamble-risks-failure-without-ECB.html

And (medium):
http://www.minyanville.com/businessmarkets/articles/TODD-HARRISON-todd-harrison-random-thoughts/10/27/2011/id/37607

And (medium):
http://pragcap.com/europe-buys-some-time

And (medium/long):
http://www.zerohedge.com/news/looking-beyond-europe

More on the conditions for Chinese participation in the EFSF (medium):
http://www.zerohedge.com/news/china-lays-out-conditions-under-which-it-will-bail-out-europe-does-not-want-be-seen-source-dumb

And overnight, an Italian bond auction went very poorly, Fitch pronounced the Greek bond haircut a default (although their opinion doesn’t count), reactions from both German and Greek bankers were not positive and one analyst had the audacity to do the math on the bail out plan.

The German and Greek reactions:
http://www.zerohedge.com/news/euro-bailout-cracks-emerge-greece-just-says-no

The math:
http://www.zerohedge.com/news/euro-bailout-cracks-emerge-greece-just-says-no

Bottom line: I have tried to be clear that (1) our Models have assumed the good news scenario which included a Greek default/restructuring and strong measures in dealing with the underlying causes of the sovereign debt problem, but (2) as it became clear that the latter aspect of this scenario was not likely to be the case, I didn’t change our Models because the uncertainty was so high as to what the actual outcome would be. The plan announced yesterday brought some clarity and has elevated the Japan 2.0 alternative to the most likely; and as I also have tried to make clear, this means that, all other things being equal, our forecast for the long term growth rate of the US economy would decline.

I have already done some work on this possibility as well as the impact of much better than expected earnings results. However, I want to finalize that effort; so I will revise our Economic and Valuation Models in this week’s Closing Bell. The net effect will likely be a lower rate of US growth in 2012 as well as a lower Year End Fair Value.

Looking forward, the critical factors that I think that could most likely impact our Models in and beyond 2013 are (1) whether the US economy does or does not slip into recession and (2) a potential re-orientation of the Washington political agenda.

In the meantime, assuming some adjustments to our Models, stocks are likely at the worst slightly overvalued. That will increase my caution in putting cash to work; in other words, yesterday’s news brings clarity in that it reduces the risk of an EU collapse but it also affirms a Japan 2.0 like extended period of European economic stagnation which is not wildly bullish for Valuations from current levels.

To be clear, I haven’t become more bearish on the Market. In fact, eliminating the disaster scenario is a plus. But I also haven’t become more bullish. The range of potential outcomes has been narrowed; and, given that new range, Valuations are likely near Fair Value. So I feel comfortable Buying stocks in their Buy Value Range; but I don’t believe Buy Value Ranges are shifting to the upside, so there is no reason to chase prices up.