Thursday, November 17, 2011

The Morning Call, The Bond Vigilantes at Work


The Market
Technical


After spending most of the daily recovering from an early sell off, the Averages (DJIA 11905, S&P 1236) gave up the rebound in the last hour. Nevertheless, both index closed within its intermediate term trading range (10725-12919, 1101-1372) and its short term up trend (11597-12546, 1231-1347). On the very short term, I continue to watch 1230 (last support level) on the down side and 1265-1275 (short term resistance as well as the S&P 200 day moving average) on the up side.

Volume rose; breadth declined. The VIX rose, leaving in the upper zone of its current trading range (negative for stocks).

GLD was weak again, but remains well within its intermediate term up trend,
http://www.zerohedge.com/news/eu-gold-investment-demand-surges-135-world-demand-6-q3-2011

Bottom line: well, there was no bid under the Market yesterday; although between the bond vigilantes and our own beloved super committee, it is a wonder that the pin action wasn’t much worse. In the end, how the Market breaks out of the tight(ening) spread between support and resistance will likely determine price direction through year end.

As you know, my bet was that seasonal factors would govern trading through the Holidays and get prices close to the upper boundary of the current trading range. But if support can’t hold, then I will clearly have to re-think the trading position that was established in the Aggressive Growth Portfolio.


Fundamental

Headlines


The economic news was generally good: October CPI was below estimates and October industrial production was very strong; on the other hand, weekly mortgage applications were dismal. All said, these numbers should have provided a positive bias to prices (especially if the thesis that investors are starting realize that the economy may be better than expected).

However, every other headline weighted the Averages down:

(1) Fitch released a statement that the spread of the EU debt crisis would threaten US banks. Well, duh. That’s like telling us that the sun will rise in the east. Nevertheless, it is the announcement that precipitated the afternoon decline in prices; and clearly argues against any notion that investors have either discounted an EU disaster or that the ECB will become the lender of last resort.

(2) Moody’s down graded several German banks [something the universe has to be expecting],

(3) the PIIGS continue to come to Market with large bond auctions [last night it was France and Spain]; also not news; yesterday I provided the auction schedule through year end. If I can get it off the internet, it ain’t exactly inside information, Nevertheless, the bond vigilantes are turning this news into two inch headlines and as such are forcing the hand of the ECB. Either it steps up as the lender of last resort [and I believe that it will] and soon or the worst case scenario becomes a distinct reality.

P.S. overnight the Spanish bond auction was terrible, spreads are widening across Europe and the futures are down big.

This article argues that stocks are discounting that the ECB steps up as lender of last resort (medium):
http://blogs.wsj.com/marketbeat/2011/11/16/stocks-making-risky-bet-on-massive-ecb-money-printing/

If it doesn’t? The disaster scenario if Italy defaults (long):
http://www.nakedcapitalism.com/2011/11/italian-default-scenarios.html

(4) finally, there is an ongoing stream of press releases depicting a vapor locked super committee. And? Our entire political class is vapor locked; that is not news. It is also not news that if they remain so, then $1.2 trillion in mandatory deficit reduction measures kick in. How is that bad news, other than it being just another discouraging example of the extent of the ineptitude of our country’s leadership? We still have the mandatory cuts. The only bad news is if these morons construct a way to weasel on those cuts.

Bottom line: the two major risks to our Economic and Valuation Models remain the same: disaster in Europe, recession at home. The only thing happening that changes the odds of either occurring or not occurring is the bond vigilantes assault on the euro bond market which, as I noted, is moving the calendar forward where the ECB has to step up to the plate or watch the EU break apart.

In addition, yesterday’s events/pin action throws cold water on the hope I expressed in yesterday’s Morning Call that the volatility in investors psychology may be diminishing as the EU leadership moves forward in resolving their debt crisis and our economy seemingly improves.




Original content Steve Cook, All American Investor