Tuesday, November 29, 2011

The Morning Call Anschluss or economic collapse?

The Market

The indices (DJIA 11523, S&P 1192) rallied big yesterday, but remain well within their intermediate term trading ranges (10725-12919, 1101-1372). In my opinion, they both are technically vulnerable to a further decline to the lower boundaries of their respective trading ranges. One interesting thing to note is that with yesterday’s bounce, a potential inverse head and shoulders formation could be developing in about 10-15% of the stocks in our Universe.

Volume rose substantially versus what we saw last week and breadth improved dramatically. The VIX plunged intraday to the lower boundary of the upper zone of its current trading range and then rebounded smartly. This action suggests further downside.

GLD bounced again right off the lower boundary of its intermediate term up trend.

SocGen on gold (medium):

Bottom line: while yesterday’s bounce lifted some stocks that were threatening to break support, it was of virtually no benefit to those that have already violated significant support levels. The good news is that (1) our Portfolios got much better prices for yesterday’s sales than I would have expected and (2) those sales completed all the sales I would expect to make from those technically damaged holdings. The bad news is that we may get additional technically damaged stocks.

A bull/bear market indicator (medium):


The economic news continues to be up beat: Black Friday sales were gangbusters and new home sales were positive. As I noted in yesterday’s Morning Call, the data keep making the argument for a second recession weaker and weaker. Plus the ECRI weekly leading index seems to be following suit even though the founder remains adamant that another decline is on its way.

Given this accumulation of better economic news, I think that the key to whether or not the US economy actually does ‘double dip’ rests with the consequences of the outcome of the EU sovereign debt crisis. That as I have said is not only a known unknown but it is also binary-the German either come through or they don’t. In the end if the euros muddle through, then we probably won’t have a recession; if they don’t, we are going to have to see how the known unknown unfolds.

To that subject, after dissing two overnight (Sunday) stories out of Europe, the latest headline is that Germany and France have agreed roughly on the terms of a more tightly integrated EU, the effects of which would be financial support of the struggling PIIGS in exchange for them relinquishing a good deal of the fiscal sovereignty. (In other words, a 1939 euro-anschluss redux without a shot fired or a drop of German blood spilled.) That seemed to sustain investors’ high as the day wore on. It is also the muddle through scenario; so if it occurs, that is good news and the danger of a EU implosion spilling over into a US recession would most likely be mitigated. The question, of course, is the probability--about which I haven’t a clue.

One version of the likely outcome (medium):

P.S. overnight the ECB failed to sell sufficient bonds to cover its recent purchases of Spanish and Italian debt and Italy had another absolutely disastrous bond auction.

Bottom line: equity prices are undervalued based on the unfolding US economic scenario, the Washington paralysis notwithstanding. They are also probably undervalued based on any economic disruptions in Europe caused by a failure to muddle through, given the net effect of our foreign trade with Europe as well as US corporations profit exposure to southern Europe where most of the economic disruption will occur. (Remember defaults [a] don’t lessen demand and [b] are a zero sum occurrence, lenders lose, borrowers win) What we don’t know is the magnitude of our financial institutions’ true net investment (i.e. net after any failure of counterparties to honor their CDS obligations) in EU sovereign and bank debt. That is a massive unknown and we won’t know it until after the fact. Hence, our Portfolios’ extremely sensitive trigger to any breakdown in a stock’s technicals.