Posted by admin on January 27, 2012 | No Comments
Today the Dow closed at 12734.63, only about 150 points away from last year’s high of 12876 reached in May (click to enlarge):
Meanwhile, the S&P closed at 1318, with a little bit further to go before it can reach last year’s high of 1371 reached in May also (click to enlarge):
So the question is, where to from here? Personally, I think there is still a bit of room left in the markets. Still, as a practical matter, it’s good to be fading positions with profits and thinking about buying into defensive positions. Let’s discuss a bit the logic behind this opinion.
First, general technical indicators have not clearly reversed. They may have started to, but there is not yet evidence that the reversal is within the next couple days. My guess is we’re beginning to turn, but the process will take at least a couple weeks, if not more. I think the most likely scenario is a small pullback and another push, but of course, we must be open to a clear reversal (which could be sparked by Greece if debt talks there fail), or a period of sideways movement before a more definitive direction is established.
For the moment – meaning the next few days – the VIX remains low, bonds are up but only slightly, the Dow Jones Transports is also a little distance from its 2011 high (5308 today vs. 5627 last year) and many stocks are just above their 200-day moving averages. My simple – albeit far from perfect – rule of thumb for the next few days is to sell anything with a significant run and a decline in the last day or two; and to consider holding stocks that have been in an uptrend and have declined much less than the market.
While in the background, Europe remains a cloud over our heads. If debt talks conclude successfully, then we could have a catalyst for a little bit more in the rally. Of course, a failure would weigh heavily on stocks. For the moment, I lean toward a positive resolution. Also, last week there were rumors of a resolution in the lawsuit by the states against the banks. Apparently, the President wanted to be able to announce a conclusion at the State of the Union address this week. Now that deadline has passed, those rumors have faded. However, any resolution would bring clarity and an upward push for the financials. Finally, the bulk of the good earnings news is out, so we come to a period where other headlines, such as Europe, may come to dominate the media.
Finally, a quick note. In both 2010 and 2011, we had a small rally at the beginning of January, followed by a pullback, then another push upward, and then a final downward turn. In 2008 and 2009, the market started off both years headed downwards.
As I mentioned in my January 22 post, it is good to plan ahead and look at defensive positions, including:
- buying VIX calls
- buying the TLT
- buying defensive names, including dividend paying stocks
- buying puts or the short ETFs
We can also add buying utilities and the more aggressive call of shorting Europe to the list above.
January 27, 2012 | No Comments
Yesterday, the Fed announced that it would keep interest rates low until late-2014. Previously, the Fed had said mid-2013, and most had predicted mid-2014 at the latest. That the Fed was looking so far out surprised everyone.
While many would say that 2014 is far away, and that this was, after all, a prediction and not a promise, the statement still had far-reaching effects no the market. A quick review of the activity over the last two days shows the significant impact of such an announcement on a range of industries and sectors. After all, while the fundamentalist might be tempted to say that not much had changed, sentiment has changed, and sentiment moves markets.
Here are the “winners”:
- Treasuries rose, and yields on Treasuries immediately dropped as much as 10 basis points – a huge move in such markets. While this might seem counter intuitive, Treasuries rose because it was now safer to hold Treasuries for a longer period of time.
- Dividend paying stocks generally did well, because their yields became more attractive.
- Utilities rose, because their yields also became more attractive.
- Investments that depend on low interest rates for leverage rose sharply. For example, Annaly Capital (NLY), leverages by borrowing at low interest rates and buys mortgage-backed securities. By doing so, NLY provides almost a 14% yield. It could not do so without leverage.
- Commodities rose because lower interest rates makes hard assets more valuable relative to cheap paper money.
- Gold jumped, for the same reason that commodities did.
- The dollar fell, which was good for US exporters.
- Foreign currencies in countries that were not printing money, such as New Zealand, rose.
- In general, equities are favored, because they are expected to be a better alternative than Treasuries that yield next to nothing.
Of course, there are lots of “losers” as well:
- Banks, especially lending-oriented banks, suffered, since they will have to lend money at very low rates. Stocks such as USB and WFC, both of which reported solid quarters, took a hit today. This was partially because they have already had a big run, but this was as good a catalyst as any for these stocks to sell off. Add to this President Obama’s anti-bank stance in the State of the Union address, you have a bad environment for banks going forward.
- Insurance companies are hurting because they have to make payments to policy holders, but make very little money on their investments. Also, if the insurance companies put money in securities other than Treasuries, they have to take charges or reserve against such investments. This makes it difficult for insurance companies to invest in higher yielding securities.
- Companies that make money from float – that is, taking money that they hold and investing it overnight – suffer as well. Such companies include ADP, the payroll processing company that takes money from payers, invests them overnight when the money is in their possession, and then pays employees, will make less money from float. The retail brokers – E Trade, Schwab and TD Ameritrade, also do the same with customer’s accounts.
- The lower dollar hurts other currencies such as the Euro, and will hurt exporters such as Germany.
- As commodities prices rise, companies with a large percentage of commodities as inputs will see higher costs.
- Savers, and especially retirees dependent on savings, will suffer.
Traders were very busy over the last two days adjusting their portfolios.
I am long NLY, USB, WFC and SCHW for myself or for clients. I also have investments in commodities ETFs, GLD and several banks.
January 22, 2012 | No Comments
So we did break 1295/1300 on the S&P. So far, all indications are that the market continues to head toward the 1350 -1370 range. Everyone has different indicators, but the major ones I’m looking at include
- the break above 1300
- the VIX falling below 20
- bond falling, notably the TLT
- breakout in the DOW Transports, as well as the mid-caps (IWM, MDY)
- rally in financials and technology, major sectors supporting the market
- a slow move upward, which allows room for the rally to continue (a fast move up makes a fast move down more likely)
All this being said, my current hypothesis remains that we will get a rally in January that can fade sometime over the next few weeks. That’s because we really haven’t solved Europe and I expect that we will be reminded of that fact soon enough.
In the short term, the market can follow several possibilities paths. I pullback, especially now that the major earnings news is out, followed by a rise to 1350-1370; or perhaps a continued, slow, grinding melt-up. I fall back under 1295/1300 would cause me to question whether the market will make it to 1350-1370.
In terms of actual events, a resolution of the Greek negotiations with bondholders would be necessary for continued upward movement, and failure could put a dent in the market. You would think the Greeks and the bondholders would come to an agreement, and frankly, a positive expectation is already priced into the market. So be on the lookout for any disappointment to expectations.
Also, its time to think about when to sell and when to start taking defensive positions. Such re-positioning could include the following:
- buying VIX calls
- buying the TLT
- buying defensive names, including dividend paying stocks
- buying puts or the short ETFs
I highly doubt that the market can make it past 1370 on the S&P, so we’re not far from thinking of things going in the other direction.
January 11, 2012 | No Comments
So we have the delayed Santa Claus rally coming now in January rather than in December. Not much has really changed, except the calendar. Likely what happened is that by the last two weeks of December, traders had gone on vacation. So no time really for a Santa Claus rally.
The other factor, which has been underestimated, is the long-term funding facility that the ECB put together. Back in early December, we had a European summit, and the markets were disappointed because the ECB had hinted at stronger action. The market thought that was Eurobonds, but it turned out to be a medium-term funding facility where banks could borrow for up to 3 years. The disappointed market sold off, but banks promptly borrowed almost 500 billion Euros. Many questioned the impact of this move, because they doubted whether banks would take these funds and buy European sovereign debt. This was a valid question; why buy more European debt when it was likely to fall in price soon after? In fact, yields stayed high – especially in the range of 7% for Italy, the rate above which the world markets have tended to sell off.
But the 500 billion Euro funding did solve, at least temporarily, another problem – liquidity. In the final months of 2011, banks were becoming increasingly reluctant to lend to each other. In particular, the supply of dollars was rapidly falling, and this had caused banks around the world, including the Fed, to open swap lines at the beginning of December (marked “coordinated bank action” on the chart below). In a financial crisis, banks stop lending to each other because they are afraid that their counter parties might collapse, causing a significant loss. However, banks need continuous funding; without such activity, things can quickly spiral out of control. The coordinated bank action was a temporary solution; the ECB 3-year funding created liquidity for the foreseeable future.
This explains why we have a rally, and especially, a rally in the US banks. Investors are, at least for the moment, no longer afraid of an immediate collapse. Yesterday, in an interview on CNBC, Jamie Dimon, the CEO of Chase, said that the European funding effectively took the issue of liquidity “off the table.” While little discussed in the media, I think this is the major reason for the January bullishness.
As of today, we sit just under 1295 on the S&P. If you look at the chart below, 1295 represents the bottom that was touched in February, April and July before the August collapse. Given the momentum we have seen so far, it looks likely that we will break above 1295. If so, we should see a rally up to the 1350-1370 range. It’s highly unlikely that we would exceed 1370, because this is last year’s high in April, and because Europe remains unsolved (meaning, we’re not going to be better than the high last year without solving Europe). We could fail at 1295. What could cause such a failure? Well, weak bond auctions in Europe, for one. Another factor would be weaker than expected earnings.
There are other indicators that bode well for the market:
- The Dow Jones Transportation Index has broken out above the 5060 area, meaning the transports are doing well in this market;
- the IWM is above the 200-day mark, which means that mid-caps are doing well;
- the XLF, the financial index, has broken above resistance at about $13 and is headed toward $14, meaning the financials are doing well also; and
- the VIX has fallen to 21, a level not seen since July 2011, before the August correction.
Despite all these positives, Treasuries have not reversed, which means that a lot of money remains in Treasuries. The TLT has fallen, but is holding at $118, not far off its recent high. To me, this makes sense because we do not have an “all clear” in the markets. I think that if the market reaches the 1350-1370 range, it will quickly reverse, mainly because we all know that problems in Europe remain and fear will return. Alternatively, the less likely, but still possible scenario is that we go sideways for a while but fail to break 1295. In this case, the market will eventually decline.
So over the next week or so, we must carefully watch the markets and be nimble if we are actively participating.
December 16, 2011 | No Comments
So the Europeans disappointed, again. It was likely that they wouldn’t give the market everything it wanted, but there was hope that there would be enough for a Santa Claus rally. That rally is looking less probably – more hopium (hope + opium), as the pundits would call it. Let’s take a closer look.
As the Europeans approached their major summit on the December 9th, markets were hopeful and were sitting at the 1265 level on the S&P, essentially the 200-day moving average. On the 9th, Mario Draghi, the newly annointed ECB chief, came and said he couldn’t understand why the market thought there would be Eurobonds. The week before he had hinted at some form of stronger action, so some in the market weren’t too happy with his proclamation. The market dropped to about the 1230 range. The next day, on the 9th, the ECB announced some liquidity actions and the Euro summit closed with a framework for greater integration. It was less than the market wanted, and the S&P fell to the 1205 range. In the process, the market crossed the 50 day moving average, which for the instant, has become upward resistance.
For me, it’s not clear yet which way the market will go. I’m somewhat downward biased, but I’m also waiting for a clearer signal. There’s almost no upward catalysts expected until the New Year, and possible downgrades by the credit agencies. Gold has been taking a beating lately, which usually means that someone is selling to be more liquid. That could be a central bank or it could be European banks in need of dollars. That wouldn’t really be a good signal either, though it depends on whether there is more selling.
All in all, hard to tell – for me at least. It’s wait and see for me.
December 6, 2011 | No Comments
So Merkozy, as Merkel and Sarkozy are now so fondly called, have agreed on the outline of greater European integration. That’s a step forward, but the only things that matter to the market are (1) whether the ECB will buy bonds; and (2) what the size of a bailout package might be – either through the European Financial Stability Facility (EFSF), or through some convoluted IMF mechanism. So this Friday, after a meeting of European ministers, we should find out what the reaction of the Europeans is to the Merkozy proposal. The key is after – what the ECB will do. At the moment, the market is bullish with hope. If the ECB doesn’t move enough after Friday, or if the ECB comes out with a process that the market thinks will take too long to execute, the market will decline. The ECB has hinted at stronger action, so expectations are high.
