Tuesday, November 15, 2011

The Morning Call Europe remains on edge

The Market

The indices (DJIA 12075, S&P 1251) drifted lower yesterday on little news and almost no volume. However, they closed within their intermediate term trading ranges (10725-12919, 1101-1372) as well as the short term up trends (11565-12514, 1227-1341).

As I noted in yesterday’s Morning Call, near term the areas to watch (1) on the upside is 1265/1275 which coincides with two trading boundaries as well as the S&P 200 day moving average and (2) on the down side 1230.

Volume was anemic; breadth declined; and the VIX rose putting in back within the upper zone of its current trading range (negative for stocks).

GLD fell modestly and remains within its intermediate term up trend.

Bottom line: I continue to believe the Market bias is to the upside. However, the closer stocks get to S&P 1372, the greater the likelihood our Portfolios will become sellers. That said, with the VIX refusing to trade down, I expect more stomach churning weeks. So I want to keep our cash cushion.

This makes me very nervous (medium):



There was no economic news yesterday; and the headlines out of Europe were quite positive: Italy has a new PM and the Italian legislative passed an austerity plan. However, an Italian government bond auction went very poorly, suggesting that the bond vigilantes are going to keep the heat on. While it is a drag on the equity market short term, it is probably a good thing longer term because it forces the political class to keep moving forward in its reform efforts. I will take some down 1% days as long as they result in progress toward fiscal reform.

The Italian austerity plan takes shape (medium):

Ron Paul on the EU debt crisis (medium):

What is the endgame (medium):

P.S. overnight Italian bond yields continued to surge as the new PM is having a tough time forming a cabinet that is willing to support any additional austerity measures other than those already passed. In addition, French bond yields are rising sharply and Spain was unable to sell out its latest government bond auction.

Speaking of political classes, the other weight on the Market was the lack of progress from the 'super committee’. We are nine days away from their deadline and they just keep jerking around. Some clearly view this negatively; however, as I suggested in last weekend’s Closing Bell, I will take $1.2 trillion is mandatory deficit cuts in a heart beat if the alternative is doing nothing. I don’t think this is a terrible solution--remember spending cuts/tax increases don’t go into effect till 2013 which means that if enough of the current group ne’er do wells in Washington get flushed in 2012, the composition of that $1.2 trillion deficit can change. The bad news scenario is if these jerk offs weasel on the cuts.

Bottom line: stocks (as defined by the S&P) are somewhat undervalued (as defined by our Valuation Model). The two largest threats to that undervaluation are (1) a disaster in Europe. True progress is being made; certainly enough to get the euros to a 'muddle through’ scenario. But there are a lot of moving parts to keep this train on the track. (2) a recession at home. Despite the modest improvement in the ECRI weekly index in the last two weeks, it is still signaling an economic decline. While I am not buying it yet, our economy is fragile and any number of exogenous events could disrupt the current sluggish recovery.

Of course, good things can also happen; so our Portfolios remain invested for higher stock prices. That said, as equities approach Fair Value, we will likely raise cash.