Marketwatch: S&P Could Break 1295
Posted by admin on January 11, 2012
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.
Filed Under: General