Thursday, November 10, 2011

The Morning Call Is it really all over for Italy? + Subscriber alert

The Market


The indices (DJIA 11780, S&P 1229) suffered some serious whackage yesterday. Nevertheless, they closed (1) within their intermediate term trading ranges (10725-12919, 1101-1372), (2) within their short term up trends (11522-12472, 1221-1334) and held the 11719, 1230 [OK, it finished slightly below] resistance turned support level. So it is important to remember that despite the yesterday’s gut wrenching pin action, no trend has been violated.

Volume was up; breadth, as you might expect, plummeted. The VIX soared 30% and is back in that upper zone of its current trading range (negative for stocks).

GLD was off fractionally but remains well within its intermediate term up trend.

Bottom line: the S&P 200 day moving average proved much tougher resistance than I had expected. The $64,000 question today is, will 11719, 1230 offer equally formidable support? Whatever happens, given the proximity of the lower boundary of the short term up trends to the aforementioned support levels, it is likely that the short term trend will experience the same fate as 11719, 1230, i.e. if 11719, 1230 breaks so too will the short term up trends. So today could be a critical.

Short interest falls and so do mutual fund assets (short):

The Market is now not over bought (short):



The economic news yesterday contained two secondary data points: weekly mortgage applications which were quite strong and a small business sentiment indicator which was also positive. September wholesale inventories were reported down versus estimates of an increase; that is not that negative because wholesale sales were up and that means businesses are still holding down costs even as sales improve.

Nevertheless, Europe still dominated investor attention. As I noted yesterday, bond spreads blew out overnight (Tuesday) and the euro bourses nose dived. The reasons given:

(1) margin requirements were raised on Italian bonds,

(2) the announcement of Berlusconi’s resignation and the passage of austerity measures were supposedly too vague to give the bond vigilantes comfort,

(3) with Italian breakeven rates [i.e. the rate at which the country can service its interest payments and still meet budget requirements] at 6% and current rates at 7%+, investors began to worry about who would be willing to buy Italian bonds at 6% [i.e. the buyer of last resort]. The likely candidates are [a] the ECB, but it has said that it would not do that and [b] the EFSF bailout fund, but that isn’t fully operational yet. That leaves nobody because:

(4) as a result of the terms in the Greek bailout, private investors are unwilling to further invest in additional EU sovereign debt, specifically, [a] in the Greek bailout only private bond holders are taking the 50% haircut on Greek bonds; in other words only the private investors took a loss, but [b] the structure of the bailout did not trigger a default that would allow claims on existing credit default swaps, meaning that private bond holders are now afraid that any hedge against a risky EU sovereign debt purchases will be worthless.

Of course, at 9AM yesterday morning, there was absolutely nothing in the above that wasn’t known at 3PM Tuesday afternoon. Why the Markets decided to suddenly panic is all about confidence. They had it at 3PM Tuesday, they didn’t at 9AM Wednesday.

Not that all of the above aren’t reasons for concern. They are. But Tuesday, investors thought the EU was and would take the steps necessary to muddle through the current iteration of their sovereign debt problem. Wednesday, they were not so sure.

And that is what makes this investment environment the most schizophrenic in my memory--investors are trying to discount a potential problem, the variety of potential solutions and the impact of each of those solutions in serial fashion for each country; plus they have to deal a rapidly vacillating level of confidence in each step that takes place within each country.

Think about Greece, every step toward resolution of its fiscal/debt problem was subject to gut wrenching ups and downs until the final solution was announced. Now the whole process is starting all over again with Italy, even though the EU found a way to salvage Greek. True, it may not have been the best course in our opinion; but investors are no longer worried about Greece, at least in the short run.

The point of all this is to re-iterate something I said in yesterday’s Morning Call: ‘I don’t doubt that (1) there won’t be more hiccups in the current process’......

Summary of the latest events in Italy (medium):

More on the Italian dilemma (medium):

Goldman Sachs on the latest events in Italy (medium):

Over night news from Italy (medium):

And (short):

A eurozone break up? (medium):

Meantime back at the ranch, some analysts that I have talked to are telling me that it is likely that the ‘super committee’ can find common ground on about $600 million (out of $1.2 trillion) in deficit reduction measures, mainly because they are contained in both democratic and republican versions of the budget. That is sort of good news in that at least it would have the appearance of compromise, even though in truth the committee members would simply be supporting measures that they already support. That said, the same analysts are telling me that there is some movement toward a more comprehensive tax overhaul which would address the remaining $600 million. If that were to happen, it would be a major positive.

Bottom line: there were possibly two wrong conclusions in yesterday’s Bottom line:

(1) ‘the euros seem to be doing enough to manage their debt crisis to allay Market fears’ I don’t believe that yesterday’s hysteria necessarily negates that statement; though clearly investor concerns have ramped back up following the seeming disposition of the Greek default/bailout. To be sure, the Italian version is orders of magnitude larger in some ways [the absolute amount of indebtedness]; but it is smaller in others [debt to GDP, debt to tax revenue]. And to be sure, the Italians need to adopt a more fiscally responsible budget and implement measures that will improve economic growth.

However, to assume the continent was suddenly going to fall off a cliff as was the lead headline yesterday might be a bit too pessimistic. Clearly some work needs to be done to solve the Italians’ short term funding problems and it is not going to happen today. But the Greek episode demonstrated that the eurocrats were willing to at least take sufficient initial steps to plug the hole in the dyke. Granted Italy is a bigger hole and therefore will require greater effort/sacrifice by the EU. But in the end, either necessity or stupidity will prevail; and Greece gives me a reason to go with former, at least for today.

To be clear, this may all end very badly. If Markets began signaling so, then our trading Sell Discipline will force our Portfolios to raise cash (now at circa 15%).

(2) ‘(t)he major potential negative for the short term is the ‘super committee’ budget compromise....because if history repeats itself, there won’t be an agreement by the deadline which means that we could have another debt ceiling crisis before this group of clowns come up with a deal.’ As I noted above, individuals who are much closer to this situation than I and who are just as cynical as I, believe that not only will there be at least a [half assed] compromise but there could also be some significant movement toward tax reform. I would not bet a nickel on such an outcome; but in deference to my buddies’ expertise, I have to raise its probability of occurrence.

Subscriber Alert

The stock price of Kinder Morgan Energy Ptrs (KMP-$74) has traded below the upper boundary of it Buy Value Range. Accordingly, it is being Added to the High Yield Buy List. The High Yield Portfolios owns a full position in KMP, so no new shares will be purchased.