Thursday, December 01, 2011

The Morning Call Not a game changer + Subscriber Alert


The Market
Technical


The indices (DJIA 12045, S&P 1246) exploded upward yesterday, remaining within their intermediate trading ranges (10725-12919, 1101-1372)--so much for the 50 day moving average and the S&P looking technically weak. Although to be fair, the fundamentals clearly trumped everything yesterday (see below).

As far as levels to watch now: (1) the late November lows now become a support level [11257, 1158], the 11741, 1230 resistance turned support turned resistance are now support levels again, (3) the very short term down trends off the late October highs now intersect at 12065, 1245--a move through this resistance would be positive, (4) the S&P 200 day moving average now intersects at approximately 1265.


As you might expect, volume and breadth were both strong; and the VIX traded lower than the upper zone of its current trading range--a positive if it can just stay/move down.

GLD rose nicely and closed within its intermediate term up trend.
http://www.marketwatch.com/story/gold-likely-to-be-higher-at-years-end-2011-11-30

Bottom line: the technical picture has changed rather markedly with yesterday’s rally. Certainly it is not near as negative. Our internal indicator proved right though one has to question whether we were just lucky or some kind of bail out was already being priced into stocks.

However, as good as this all felt, I don’t thing it changes anything in the intermediate term picture, i.e. I don’t think stocks trade above the 12919, 1372 upper boundary of the current trading range. That leaves some room to the upside; though in a flat Market, I only want our Portfolios buying stocks that are either in their Buy Value Range or that we made trading sales at higher prices. There simply aren’t any of those varieties around. That leaves us basically neutral; though all our Portfolios are going to Buy a small trading position in the Vanguard Dividend Appreciation ETF (VIG) and hope that it turns out better than the last time, I tried this.

Fundamental

Headlines


The economic news continues positive: (1) the ADP private payroll report was much better than anticipated, (2) third quarter productivity was basically in line, (3) November Chicago PMI was a blow out, (4) as were October pending home sales, (5) and finally the release of the latest Fed Beige Book showed most sectors of the economy improving in most sectors of the country. In other words, our economic forecast of slow sluggish recovery is not in jeopardy. If anything, our forecast (even though it hasn’t changed) may again be moving from the too optimistic camp to the too pessimistic.

Unlike the recent past, this data did have a salutary effect on the Market; although again Europe with a little help from China provided the two inch headline. First on China; its central bank lowered reserve requirements, in essence easing monetary policy. Investors have been concerned that the Chinese economy was headed for a ‘hard’ landing. This latest move helps assuage the worries that the Chinese government may wait too long to respond to that threat.
http://www.zerohedge.com/news/china-manufacturing-contracts-new-export-orders-see-biggest-2-month-drop-dec2008

I have already covered the coordinated global central bank effort to provide liquidity to EU financial institutions in an earlier post. But there are still points to clarify as we have learned more. First let me start with the conclusion: this action is not a game changer, but it does buy time to allow the EU to take the steps necessary to resolve their sovereign debt problem. Now a few more specifics;

(1) this credit facility is being made available to the EU banks, not the countries. Its purpose is to overcome a short term freeze up in liquidity in the EU financial system. So the Fed is not buying EU sovereign debt, it is lending money to the banks.

You may recall from past discussion that, in my opinion, the biggest risk to our economy/market forecast was not a default, or even multiple defaults nor was it the economic fallout from the default [s] itself; rather it was the fallout from the collapse those defaults would cause in the EU financial system and the spillover in to the US banks, i.e. the resulting inability of the European banks to meet their obligations as counterparties to CDS’s owned by US banks.

These measures address that risk directly. They don’t solve it; but they keep the banks alive in order to give the EU (read Germany) time to come up with a solution to address the real problems: the fiscal profligacy and lack of any growth plans for many of the EU members. In short, the risk of the EU financial system imploding has been lowered for the short term,

(2) as warm and fuzzy as the coordinated efforts of the central banks make investors feel, it does nothing, nada, zero, zilch to solve the underlying causes of European malaise. The PIIGS still need fiscal discipline which, based on their historical behavior, clearly has to be imposed from the outside; and the Germans remain unwilling to play any leadership role to that end. Until there is movement on that front, all that has been done is to relieve short term pressure that will surely return and overwhelm in the current good intentions.

I would note that Portugal just passed a budget that reduces its budget deficit from 9% of GDP to 4 1/2%; and Italy apparently is about to follow a similar path. So progress is being made on the fiscal discipline front, albeit only a start.
http://scottgrannis.blogspot.com/2011/11/monetary-ease-takes-edge-off-panic.html

Ron Paul on the central bank EU bail out (medium):
http://www.zerohedge.com/news/ron-paul-statement-feds-bailout-europe

(3) as I have been saying for some time, the Germans are the key to any final resolution. Their primary demand is that some form of mandatory discipline on the fiscal policies of the profligate is a precursor to using the German balance sheet as collateral for the interim refinancing of sovereign debt as it is simultaneously being reduced. The problem with that demand is that to accomplish it would require a change in the constitution of the EU--which takes time and the approval of 16 other countries and which isn’t going to happen anytime soon.

As big a conundrum as this is, a solution is starting to take shape, i.e. the ECB lends money to the IMF which then lends it to the individual countries with the necessary fiscal disciplinary strings attached (a role the IMF has traditionally played). Assuming that works, it allows the Italians et al to blame the IMF for the tough fiscal measures that need to be taken and provides the Germans the reassurance that in fact the prodigal countries have been duly humbled.

I am not saying that this is going to happen; I am saying it is the way out of this dilemma and the liquidity being provided by the global central banks keeps the EU financial system in tact while it is being implemented. We will know a lot more by this time next week because there are several high level EU ministers meeting coming up.

Follow up the day after (medium):
http://www.zerohedge.com/news/headlines-todays-yesterdays-and-tomorrows
http://www.zerohedge.com/news/french-yields-fall-record-other-sovereign-spreads-collapse-following-successful-french-spanish-

(4) don’t be surprised that this global QE will be followed by our own US version whether it is called QE3 or any other name. In the end, it means more money sloshing around the world and that should be good for gold.

Peter Schiff on the meaning for gold (7 minute video):
http://www.zerohedge.com/news/peter-schiff-explains-what-todays-global-fed-funded-bailout-means-future

Bottom line: the US seems on track to grow as we expect. There may still be defaults in Europe but I don’t believe that they will sufficiently destructive to abort our recovery. The key is the EU financial system remaining functioning while the eurocrats work out the fiscal solution. If that happens, our economic/market forecasts will likely be within the range of probable outcome. If the eurocrats can’t find the will to deal with the issue of fiscal irresponsibility, no amount of liquidity assistance from EU allies will save their bacon.

So as happy as I am with yesterday’s announced coordinated effort to backstop the EU financial system, the EU has not yet arrived at the endgame. That means that I while I am not altering any of the assumptions in our Models, the risk remains that they are too optimistic about the outcome of the EU sovereign debt crisis.

In other words, our forecast is the ‘good news’ scenario and in that scenario, stocks are undervalued. Further, in my opinion, the latest action by the central banks provides enough relief that stocks in short term could approach Year End Fair Value which is 1330. However, I see no reason to assume that stocks will re-set to an intermediate term up trend.

Subscriber Alert

All the above said, I do think that the renewed hope that the central bank move has spawned probably sets the Market up for a decent rally, at least through the EU summit next week; and if the Germans don’t torpedo an EU solution to the sovereign debt problem, we could see it continuing. As a result, our Portfolios are going to take a 2-3% trading position in the Vanguard Dividend Appreciation ETF at the open this morning.

The stock price of Kinder Morgan Energy Ptrs (KMP) has traded above the upper boundary of its Buy Value. Accordingly, it is being Removed from the High Yield Buy List. The High Yield Portfolio owns a full position in KMP.

The stock price of Quality Systems (QSII) has fallen below the lower boundary of its Buy Value Range. Accordingly, it is being Removed from the Aggressive Growth Buy List. While it did not fall to its Stop Loss Price, due to a complete lack of visible technical support, the Aggressive Growth Portfolio Sold on half of its holding.