Friday, September 07, 2012

The Morning Call-Draghi buys more time

The Market


The indices (DJIA 13292, S&P 1432) had a blowout day. The S&P busted through the upper boundary of its short term trading range (1266-1422) while the DJIA remains below its comparable boundary (12022-13302). That means that (1) our time and distance discipline becomes operative with respect to the S&P short term trading range and (2) the DJIA and S&P are in divergent trends. Both of these factors must be resolved before we can assume that the short term trend has been re-set from a trading range to an uptrend. Meanwhile, both Averages remain within their intermediate term uptrends (12311-17311, 1295-1875).

Volume rose but not significantly so; breadth improved. The VIX plunged 12% and closed below the former upper boundary of the short term downtrend. This was the fifth day since its break above that resistance level which means it was on the cusp of the time element of our discipline. I am not changing the call at this time but if the VIX continues its decline, I may reverse it.

I ran our internal indicator again last night with these results: in a Universe of 162 stocks, 61 were higher than their April 2012 highs, the time at which the Averages topped out at the 13302, 1422 level, 77 were not and 24 were too close to call. That is slightly worse than our review when the indices were DJIA 13250, S&P 1415.

GLD was up slightly, closing well above the lower boundaries of its newly re-set short term uptrend and the intermediate term trading range.

Bottom line: I hate being wrong and I am clearly in a position of being proven so if the S&P confirms yesterday’s upside break and the DJIA also confirms this move. However, before I club myself to death, both of those conditions need to be met. So for the moment, nothing changes. Clearly, the key is follow through.



Yesterday got off to a roaring start with a better than expected ISM nonmanufacturing index plus upbeat weekly jobless claims and the ADP private payroll report. The latter two got investors jiggy about a positive nonfarm payroll report today (OOOpps). That probably makes sense; although I think that a firming employment picture only confirms that the risk of recession is declining and does not suggest that the economy is about shift into a higher gear. To be sure these numbers are a plus and certainly accounted for some of yesterday’s strong pin action. But they are already in our Model and therefore do nothing to improve valuations

The other Market moving event was the ECB meeting and more importantly, the revelation of more specifics of Draghi’s new plan. Highlights include: (1) no ECB bond purchases will occur until an individual country requests help from the EFSF/ESM and agree to their terms, (2) any ECB bond purchases will be within their mandate of price stability, (3) purchases will be unlimited and focus almost exclusively on buying short term bonds, (4) the purchases will also be sterilized fully, i.e. the will be no growth in the money supply [yeah, right---how in the world do they sterilize an open ended commitment?], (5) results of any borrowing will be published weekly which will include specify individual countries and the amounts borrowed, (6) the new bond purchases will be pari passu to other private holders.

I want to be as fair as I can about this plan. The good news is that it will almost certainly buys time for the problem countries and banks to implement plans that will effectively deal with their insolvency. Equally important, judging by yesterday’s pin action, investors are indicating their willingness to continue to give the eurocrats the benefit of the doubt. I had questioned the durability of that motivation earlier in the week; clearly, I was premature at best.
However, this plan does nothing to correct or reform the irresponsible fiscal policies that got the PIIGS in trouble in the first place. Yes, there is the element of conditionality; but every loan made to date has been conditioned on the recipient country following lender guidelines and we know how that has worked out.

Furthermore, as I noted above, sterilizing an open ended commitment sounds more like wishful thinking than reasoned policy.

Finally, what bank or country is going to want to beg for funds and then have the ECB publish a weekly tally on how much they borrowed? Remember our TARP---all the banks were required to take money so that the ones in trouble wouldn’t be stigmatized, i.e. risk losing deposits as investors fled a demonstrably weak institution. We have already seen a mass exodus of deposits from southern European banks. How much worse could it get if citizens/depositors can now get a weekly update of just how deeply in trouble these guys are?

Here is more:


Bottom line: price is truth and truth says that the EU will ‘muddle through’. God bless those euros because that is our forecast. However, (1) given that outlook, the S&P’s Fair Value today is roughly 1382 as calculated by our Model. So nothing about this ‘good news’ drives me to push money in the Market. Granted our Portfolios have more cash than would be normal at Fair Value [15%], but (2) the ‘tail risk’ remains of an EU catastrophe, notwithstanding Draghi’s comments to the contrary. To be sure, he bought time; but nothing in his plan moves Europe a short hair closer to solving the underlying problems of fiscal irresponsibility the spawned the crisis in the first place nor does lending more money to already too indebted nations/banks correct the condition of too much debt.

In the end, I am simply too risk averse to bet my money on the chance that this time the euros really mean it. As I have said before, I would rather pay an opportunity cost for the assurance that this time they mean business.

The root causes of the current economic malaise (medium):

Steve Cook received his education in investments from Harvard, where he earned an MBA, New York University, where he did post graduate work in economics and financial analysis and the CFA Institute, where he earned the Chartered Financial Analysts designation in 1973. His 40 years of investment experience includes institutional portfolio management at Scudder, Stevens and Clark and Bear Stearns. Steve's goal at Strategic Stock Investments is to help other investors build wealth and benefit from the investing lessons he learned the hard way.