Wednesday, September 05, 2012

The Morning Call---Draghi's new plan


The Market

Technical


The indices (DJIA 13035, S&P 1404) experienced a somewhat volatile day, finishing on the downside. Nevertheless, they remain within (1) their short term trading ranges---though they are remain quite close to the upper boundaries [12022-13302, 1266-1422], and (2) their intermediate term uptrends [12302-17302, 1295-1875].

Volume declined; breadth weakened. The VIX closed above the upper boundary of its very short term downtrend for the third day, thereby breaking that downtrend. It remains well below the upper boundary of a short term downtrend but above the lower boundary of its intermediate term trading range.

GLD rose fractionally, ending above the upper boundary of its short term downtrend for the second day. One more close over this boundary will likely result in additions to this holding. GLD also finished above the lower boundaries of (1) a very short term uptrend and (2) its intermediate term trading range.

Bottom line: the Averages remain within their primary trends. The most important question at the moment is whether the resistance offered by the upper boundaries of the indices’ short term trading ranges will prove a stronger force than the momentum from their very short term uptrends. As you know our internal indicator along with a number of breadth measures suggest that 13302, 1422 will prove the more powerful.

Even if that were not the case, I am still hesitant to be buying stocks when they are in the proximity of a resistance level of a primary trend. I would rather hold fire and pay an opportunity cost should prices break through those resistance levels.

Update on ‘the best stock market indicator ever’ (short):
http://advisorperspectives.com/dshort/guest/John-Carlucci-Best-Indicator-Ever-Update.php

Fundamental

Headlines


Yesterday’s economic data was a bit disappointing: the August ISM manufacturing index came in below forecasts while July construction spending was down. These somewhat gloomy stats led to early day loses in stock prices---although a couple of lower than forecast numbers in a string of generally upbeat datapoints (such as what we have had) is to be expected.

Later in the day, Bill Gross gave a thumbs up to a (another) reported Draghi plan---this one to buy short term (less than three years) bonds of countries with faltering economies and budgets. This got investors feeling a little more upbeat and equities rallied in the afternoon, though they were unable to reach the flat line. Since the plan would be little more than money printing, it also triggered buying in the inflation plays.

The rather tepid investor response this latest Draghi proposal reminded me a bit of the response to QEIII, i.e. everybody knows it will happen; they know it won’t do much good; so the expectations for its implementation doesn’t spawn much of a Market reaction.

There is only one problem. The Fed is trying to pump up a sluggishly growing economy; and while there are political/economic issues, the US is not in danger of dropping off a cliff tomorrow. So yes, investors believe QEIII will occur; that it won’t do much good but the most negative outcome to Bernanke’s useless money printing is inflation.

On the other hand, the eurocrats are trying to paper over fiscal mismanagement on a scale that makes our political class’ handy work look like that of rank amateurs. As you know my fear is for that moment when investors know the eurocrats are simply going to throw more printed paper at the problem and that it won’t do much good. Because unlike the US situation in which investors yawn and buy more gold, once investors stop giving the eurocrats the benefit of the doubt, the EU will run off the tracks.

We should get a better feel for investor sentiment tomorrow when the ECB meets. Expectations are that interest rates will be cut and that more details will be forthcoming on Draghi’s new, new bond buying plan.

Has QEIII already started (medium):
http://www.minyanville.com/sectors/precious-metals/articles/monetary-policy-qe3-Quantitative-easing-gold/9/4/2012/id/43693

Draghi’s plan (or lack thereof) (medium and today’s must read):
http://www.zerohedge.com/news/mario-draghi-reprises-hank-paulson-demands-full-monetization-authority-or-else-threatens-end-eu

Thoughts on Draghi’s plan from JPM (medium):
http://www.zerohedge.com/news/what-happens-once-mario-draghi-unleashes-european-creosote-bank

And (short):
http://www.zerohedge.com/news/one-chart-explain-why-ecbs-short-dated-bond-buying-program-will-fail

***overnight, Germany throws a wet blanket over the whole plan (medium):
http://www.zerohedge.com/news/germany-steals-draghis-bazooka-main-event-monetization-mutiny-grows

And investors send an all too clear message to the Germans (medium):
http://www.zerohedge.com/news/german-10-year-bond-auction-suffers-technical-failure

Europe continues to contract (medium):
http://www.nakedcapitalism.com/2012/09/the-european-zombie-slouches-on.html

Bottom line: stocks continue to meander at a level roughly comparable to Fair Value as defined by our Model. That is not surprising. After all, nothing in the flow of economic data, the political scene or Fed policy would cause a shift in the factors determining equity values and pricing stocks at Fair Value makes sense.

As always the ’but’ is that Europe is a mess. The latest ‘plan’ is to print money and buy (more) bonds of near defunct sovereigns and banks. But creating more debt does not solve the problem of too much debt. Serious reform has to take place in the fiscal governance of the EU and its members or sooner or later the whole exercise will go down like the Titanic. And to date, the EU effort including the latest plan to buy more short term bonds is like putting a Band-Aid on a gunshot wound. The risk remains that the Market will call ‘bulls**t’ on the eurocrats, EU sovereign interest rates do a Titan III shot and severe economic consequences follow.

Thus the tail risk of a eurocrat f**kup is enormous and would quickly alter the Fair Value calculation of our Model. It is for this reason that our Portfolios have an above average cash position and a large holding of GLD.

A look at third quarter earnings (medium):
http://www.zerohedge.com/news/financials-hide-analysts-earnings-recession-expectations


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.