Right now the SP 500 is selling off hard to 1126 down 40 points on the day in response to Fed’s remarks yesterday. While they see the weakness in our economy and the growing risks in Europe they’re willing to do little at this point. I must admit to feeling much better hanging on to our SDS hedges and not getting sucked into the rally last week, as this is a moment I’ve anticipated.
The SP500 is near the bottom of its trading range of 1100 to 1230 and this morning I’ve sold our SDS hedge for $25.41.
While the economy is weak the consensus opinion is that the US is already in recession, but this may not be the case: The Conference Boards leading economic index (LEI) rose .3% for the fourth straight month, expectations were for a .1% gain. The Conference Board put the chances of a recession at less than 50% but also suggested risks were rising.
The Ned Davis Economic Timing index has dropped but still remains at a level consistent with modest economic growth.
In addition, the FHFA purchase only housing price index rose .8% in July and while it remains 3.3% below its reading of a year ago it could be showing early signs of stabilization since this is the highest reading of 2011.
Investor sentiment is dismal, no doubt there but one must keep an objective eye on the data. While many consider the Fed’s lack of action as a negative, in my opinion the ball is really in the court of our political leaders. Fiscal policies are likely to have a greater impact on our economy than monetary policy. Monetary policy in balance sheet deleveraging economies is essentially pushing on a string since there is little loan demand. Individuals and corporations are saving capital rather than spending, hence you could drive rates down to 1% across the board and still see little ripple effect.
Lastly, from a technical viewpoint the early August low saw over 1200 stocks on the NYSE make new annual lows. At present the number is 735 which is a positive divergence and an early sign that selling could be exhausting itself.
While this smells acts and trades like a Bear Market, the news is not completely awful, just partially disgusting. Hence, based on my short term trading models we’re at a short term extreme and a bounce should be expected. Till proven otherwise we remain in a 1230 to 1100 trading range.
Brad
No positions
A short while back I decided to return to writing on the blog as a way to encapsulate my thoughts and review tactics and strategies. With the noise that exists within our culture and data driven industry we can lose ourselves to the impulses caused by the most recent data points.
The talking heads on TV uniformly speak with such clarity and conviction but are never held accountable to the results of their recommendations. Do they eat their own cooking the way I do? I doubt it very much. So while you the reader may consider that this blog is for your benefit please consider its also for my benefit at well.
What do we know:
The political leadership existent within the US and Globally lacks the political will and savvy to solve the debt and currency crisis. There is a continual sense that their intentions are to “kick the can down the road” for future leaders and tax payers. The lack of cross the aisle cooperation between parties is pathetic. The Republican’s lack of cooperation, even at the cost of benefit to the country in order to gain the White House appears to be the game plan. Speaker Boehner is even disagreeing with the proposed short term tax credits proposed in the jobs bill.
If you’re a country that cannot print money then you are crashing. Why this is lost upon the tea party, I have no idea.
There is a global race to devalue currencies. PIMCO predicts the Euro will fall to 1.20 USD within three to six months. When Janene and I were in Paris this May the Euro was 1.45 USD.
2012 estimated earnings for the SP 500 are coming down in deliberate fashion. In August the estimate for 2012 was $112, now they are at $110 and falling.
Most European stock markets are down 15%-20% while the US is down 2% for the year. Macroeconomic data continues to deteriorate. Last night Goldman Sachs lowered their end of the year target for the SP500 to 1250 down from 1400.
Investors are extremely bearish. AAII figures show 40% bears against 30% bulls. This is an uncomfortable status in light of my hedged positions. The issues of Greece, the Euro, our budget impasse, US debt, falling currencies and high odds of recession appear to be largely baked in the cake of many share prices.
Shares of dividend paying stocks look very attractive relative to bonds.
Contrary to Bernanke’s talk: US money supply is rising. Rising money supply frequently has a steroid effect in the short term for stock prices to move higher.
With Peyton Manning on the sidelines is there is no doubt that Tom Brady is simply the best at his position.
What I don’t know:
How low will SP 500 earnings estimates fall before they bottom? The average recession cuts earnings by 25% from the previous peak or in our case $75 a share.
While a Greek default is inevitable, can Europe handle a Greek default in an orderly fashion, and then an Italy default, followed by a Portugal default……..rinse and repeat.
Will the Chinese support the Euro to allow multiple currency options for its growth.
Can the European banks reduce their systemic risks and raise gigantic amounts of capital they require?
One potential cure-all would be for the Chinese to let the Yuan trade freely on its own merits? Is this just pie in the sky hopin and wishin?
Will investors finally purge Treasuries en masse and allow yields to rise?
Is our unemployment issue systemic (see Doug Kass) or cyclical (Paul Krugman)?
Can the opinions expressed by Tim Geithner in stating there will be no Euro Lehman’s be trusted?
How can Duane Allman and BB King be ranked higher than Eric Clapton in the Rolling Stone Top 100 guitarists of all time. I’ve adored Live at the Fillmore East since I was a kid and Riding with the King is superb but shouldn’t the breadth of work by Clapton be considered?
Long Clapton
Shocking to me is the fact that the US remains one of the strongest markets in the world as of today, strong on a relative basis if not absolute. Despite the headlines and Euro risks the US markets continue to tread sideways. Either there is disbelief that Euro contagion risks will not suck us under and that the current decline in US earnings estimates will only be a shallow decline. Neither issue can be proven right now so my mantra of being defensive is still in place.
I’ve been using this minor market strength to add to defensive hedges (SDS) and slightly reduce market exposure. Charts remain broken with the SPX sharply below the 200 day moving average. I’m currently immersed in conducting research into the effects of using moving averages into our investment strategies.
This is not a good time for investors to act upon the urge to be contrary. While I’d love to be heavily invested in every portfolio, broken markets take time to heal. 2008 was a great example, while the crash occurred in the Fall it took six months for the 200 day m.a. to decline to a reasonable point, in addition the earnings were allowed to bottom and finally turn up.
There is no reason to fear bear markets when you take a proactive approach. For about 30 years I was almost exclusively a long-only investor. But getting kicked hard in 2008 was more than enough to turn me into a more flexible investor. When this bear finally expends itself there will be a major rally where returns will be stunning, but we must exercise one the hardest of disciplines: patience. Ugh.
Long SDS
I came across an interesting website this afternoon.
If you’re an aspiring organic farmer or sustainable agriculture student seeking a little extra help, then tell Raising Organic Family Farms what you need to be successful. You could receive a scholarship, grant or mentoring support and ensure a bountiful harvest for years to come.
Trading summary: I never closed out the SDS short since the peak was only $25 and change and I’m looking for a sale price in the range of $26.5 – $27. Way too much uncertainty existent now. While the Beige Book shows few surprises, perhaps the biggest being that the US is not slowing to recession speed just yet, its very close to stall speed.
Keeping a long term perspective: One day this period will have passed but until that time comes protecting capital for our clients is our primary objective. I believe that within six to eight months out we’ll be in line for a major market rally especially if US growth ekes out even small gains. I would rather miss these one day ramps and not get impaled on the ensuing sell-offs than risk an entire portfolio in the hopes that growth may return in small measure.
I’m waiting for the fat pitch to come down the middle of the plate before I swing.
Long SDS
We remain in preservation mode, of which Gold is a part of the plan. However Gold continues its parabolic move upward so we’re seeing modest growth despite market weakness. My estimation is that Gold and now Silver are rising in anticipation of Bernanke’s speech in Wyoming at the end of the week. I zero expectations that Bernanke will present anything other than the next form of Quantitative Easing which will likely fail again.
If you’re an investor who’s stymied to make a decision against all the noise I’ll try to boil it down in a simple to understand process:
1. If the economy does not erode much further and if the European banks do not suffer a major failure then the chances are good that we’ve seen the market low. Selling at this point could be pointless as we could grind higher to the end of the year.
2. If the economy in the US continues to erode and lead us into another recession then don’t wait for the analysts to inform you that the recession is here, do some selling into rallies. Bear markets act quite differently then Bull markets. Bears tend to have very sharp up moves which fail quickly so you must be alert and when you see a high volatility day on the upside, pare back your equity funds. In general, recessions cost S&P earnings on average of 22%. Based on the most recent peak this could put the recession earnings estimate at $75. Apply a 10x to 12x P/E to $75 and you have a downside target in the range of 750 to 900 on the S&P 500. That could mean another 35% to the downside.
3. A major European bank fails. Sell first, sell anything. Europe has their Lehman moment and the risk to US markets is the ripple effect of the need to access capital. Gold will likely take a short term hit in this scenario. Downside risk to equities, see 2.
As the wise man once said: “This too shall pass”. Its not the end of the world but you must keep your eyes open and be aggressive in preservation of capital.
1:33 pm mst Credit Suisse lowers 2012 eps estimate to $85. First major bank to do so.
Long GLD, SLV
After a major market pullback the natural reaction might be to just hang in their for the follow up rally, but not so fast. Market bottoms are a process not a point in time. What I mean is that we may have made a bottom in equities on Monday but the odds are very high that we’re going to have a period of at least a few months to finally exhaust all the sellers. Markets will likely be whipped around like a puppy’s chew toy and I’d rather keep volatility to a minimum.
In the meantime scenes we’re likely to see:
Failure of a major European bank – Its not like they’re going to give a heads up notice. When you start banning short selling you know you’re in a losing battle.
2012 US earnings estimates: They haven’t budged at all. They stand now at $111 for 2012. Despite a plethora of weak economic stats the numbers haven’t moved down at all. They must come down to reality before they can be trusted. The downward revision process will likely be painful if you’re heavily invested in equities.
Commencement of QE3: So far the QE process has been a complete bust. But thats about the only arrow the Fed has in its quiver to aid the economy and its a loser……unless you own precious metals and then its manna from heaven.
While risk at the moment may not be very large, the prospects for Intermediate term gains in equities isn’t rosy either. This is not the time to be excessively bullish or bearish for equities. In the meantime we have lots of cash on hand and in many accounts the long equities are balanced by Gold, Silver, Swiss Franc’s and the SDS.
Gold and Swiss Franc’s still too hot for new money and needs to cool off. Silver is frustrating but could rally.
Happy Friday
Long SDS, GLD, SLV, FXF
